Checker_flag_Large_NEG_loThe EU’s second Capital Requirements Regulation (CRR2) entered into force on 27 June 2019, with many of its provisions taking effect in June 2021. It implements a sizeable portion of the international post-crisis regulatory framework, and is primarily designed to enhance the stability of the European banking sector. However it also takes a number of steps towards improving the state of competition in, and competitiveness of, the European banking sector.

How CRR2 seeks to help smaller banks compete

The Basel Committee on Banking Supervision (BCBS) standards for bank capital and liquidity, on which CRR2 is based, are designed to be applied to large, internationally active banks. However, in the EU’s Single Rulebook approach, the same rules are generally applied to all EU banks, irrespective of their size. This creates a disproportionately high cost of compliance for some firms, and can hold back smaller banks from competing effectively.

CRR2, in its final form, establishes a definition of small and non-complex firms that allows the targeted simplification of some elements of the package. The conditions a bank must meet to qualify as small and non-complex relate to: assets; trading book size; percentage of activities conducted in the EU; and total value of derivative positions. However, CRR2 states the thresholds are not absolute and that Member States may use their discretion to lower the thresholds in their national banking markets.

CRR2 reduces the regulatory burden for small and non-complex firms in a number of areas:

  • Qualifying firms will be able to use a simplified version of the Net Stable Funding Ratio. For such firms, compliance with a simplified standard will include collecting and reporting fewer data points contributing to the calculation of available and required stable funding, reducing the complexity of the calculation and the cost of compliance.
  • Firms with limited derivative exposures will be able to apply a simplified version of the Standardised Approach for Counterparty Credit Risk (SA-CCR). For smaller firms that previously used the Mark-to-Market Method or the Original Exposure Method (OEM), EU legislators determined that both the SA-CCR and the simplified SA-CCR would be excessively burdensome. They have retained the OEM for firms with limited derivative exposures, creating a three-tiered framework.
  • Smaller firms will be subject to a more proportionate treatment for the Fundamental Review of the Trading Book (FRTB). Under a revised version of the derogation for small trading book businesses, more banks with limited trading book activities will be allowed to apply the credit risk framework, rather than the new provisions for the trading book. The upper threshold for trading book size has been modified to EUR 50 million and 5% of the firm’s total assets, from EUR 20 million and 6% respectively. CRR2 also gives the Commission a mandate to reassess how firms with medium-sized trading books calculate their capital requirements for market risk, with a view to creating a more proportionate framework. Until this assessment is complete, firms with small and medium-sized trading books will be exempt from the new reporting requirements under the FRTB.

These measures have been welcomed by banks1 and regulators2 alike. Small and medium-sized banks are an important part of the European economy. Policymakers typically welcome measures that help them thrive and increase competition and choice in the banking system. This also contributes to the resilience and stability of the European financial system. 

How CRR2 seeks to help all banks compete

CRR2 does not only focus on small and non-complex firms. All European banks face competitive threats from actors outside the traditional financial services sector. With the technology-driven evolution of the banking sector creating an imperative to deliver services through new platforms, arguably the threat that looms the largest is from global technology companies with large customer bases, commonly referred to as ‘BigTechs’.

While greater investment in technology assets, or the outright acquisition of technology companies, might seem to be part of the answer for banks, the existing CRR rules make this costly for banks to do.

In line with the definition of capital in the Basel framework, the original CRR requires that intangible assets, net of their associated deferred tax liabilities, are deducted from Common Equity Tier 1 (CET1) capital. Software assets are currently considered ‘intangible assets’ under IFRS accounting rules. Excluding tax effects, a heavy investment in in-house software technology is therefore likely to have a detrimental effect on regulatory capital. Given that a large part of the value of many technology firms can be based on their software, acquiring one can lead to a large capital hit for banks that a non-bank or BigTech firm would not face.

Recognising that software is becoming an ever more important asset for banks, CRR2 amends this treatment, creating an exception for prudently valued software assets (with the caveat that the value of those software assets are not negatively affected by resolution, insolvency or liquidation). This means that banks will no longer be required to deduct the full value of eligible software assets from their CET1 capital. This could reduce banks’ capital costs of developing their own software or of acquiring FinTechs and help them in their efforts to offer customers services in more innovative ways.

A further benefit of this rule change is that it removes a competitive disadvantage that European banks have had against their US peers. Research3 conducted by the Association for Financial Markets in Europe (AFME) has shown instances of US banks capitalising software as a tangible asset, and allowing European banks to do the same could help to create a more level global playing field.

The effect of this change will not be fully known until draft Regulatory Technical Standards (RTS) are issued by the EBA (due by 27 June 2020, to be implemented by 27 June 2021). This will be a challenging RTS for the EBA to draft, as software is a broad concept that covers many different types of assets, not all of which preserve their value in a wind-down situation.

Where we go from here

This will not be the end of the road: with the European Commission due to propose the next major bank capital package (including CRR3) in 2020 to implement the remaining elements of the BCBS’s Basel III framework, proportionality will remain high on the agenda of EU policymakers.

The national banking associations of nine EU Member States (whose home banking markets house more than 80% of the small and medium‑sized banks in Europe4) recently published a joint position paper urging further enhancements to proportionality in the EU regulatory framework, including Pillar 2, remuneration requirements, recovery and resolution plans and reporting.

It also seems likely that EU legislators will use the next banking package to facilitate the digitalisation of the European banking sector. With the EBA’s own impact assessment indicating that the implementation of Basel III will lead to a 25% increase in required Tier 1 capital for large European banks, improving the competitiveness of the European banking sector will likely be a key priority for legislators.

Although other parts of the CRR3 package, such as the output floor and the credit risk framework are likely to be more prominent areas of focus, identifying further ways that the regulatory framework can facilitate an evolving technology landscape in banking would undoubtedly be a positive step.








David Strachan – Partner, Head of EMEA Centre for Regulatory Strategy

David is Head of Deloitte’s EMEA Centre for Regulatory Strategy. He focuses on the impact of regulatory changes - both individual and in aggregate - on the strategies and business/ operating models of financial services firms. David joined Deloitte after 12 years at the FSA, where in his last role, Director of Financial Stability, he worked on the division of the FSA into the PRA and the FCA.

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Rod Hardcastle – Director, Regulatory Capital Specialist

Rod is a Director in the EMEA Centre for Regulatory Strategy and has over 25 years of experience in Financial Services, both as a practitioner - including roles at major full service banks in the UK - and in advisory roles. Rod is a subject matter expert in bank regulation, particularly prudential regulatory capital, credit risk management and the Internal Ratings Based approaches.

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SCott MArtin

Scott Martin – Senior Manager, Centre for Regulatory Strategy

Scott is a Senior Manager in the Centre for Regulatory Strategy advising on international banking regulation, with a particular focus on bank capital, strategy, cyber risk and public policy-making processes. Scott is also the host of Deloitte's financial services podcast Regulated Radio. Before joining Deloitte in 2015, he worked in Brussels as an EU regulatory strategist advising a number of global banks and other financial institutions. He is a graduate of the London School of Economics and previously worked as a political advisor to Canada’s Minister of Finance and Minister of Foreign Affairs.

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Alex  Spooner - Senior Associate, EMEA Centre for Regulatory Strategy

Alex is a Senior Associate in Deloitte's EMEA Centre for Regulatory Strategy, specialising in European and UK prudential banking supervision. Prior to joining Deloitte Alex worked at a large outsourcing firm, and completed internships at two internationally active law firms. Alex graduated from the University of Nottingham in 2018 with a degree in Law with Spanish and Spanish Law.

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