At a glance:
- The European Commission has proposed its long-awaited legislation that will bring Basel 3.1 into force in the EU.
- While years of crucial negotiations now follow, the CRD6/CRR3 proposal gives EU-based banks a much clearer view of the likely revisions to the prudential capital framework that are coming.
- The Commission’s proposal modifies the international Basel 3.1 standards quite considerably, in both their timing and substance, in order to limit the expected capital impact they will have on EU banks.
- Our analysis below categorises these modifications in five ways: where the proposals delay, defer, direct, diverge or differ from the Basel 3.1 standards agreed in 2017.
Relevant to: Board members, executives, investors and senior leadership of banks operating in the EU.
On 27 October, the European Commission published an extensive series of amendments to the EU Capital Requirements Regulation [here], the Capital Requirements Directive [here] and to the Bank Recovery and Resolution Directive [here]. These are now collectively known as CRD6/CRR3 and they primarily implement the Basel Committee on Banking Supervision’s (BCBS) December 2017 agreement on the finalisation of the Basel 3 bank capital framework (Basel 3.1).
This proposal now gives banks a much better idea of how the EU is likely to implement Basel 3.1 and what additional measures they should expect to be part of the law (such as initiatives on ESG risks, management accountability and third country branch supervision).
The Commission was under significant pressure to limit the large expected capital impact of Basel 3.1 on EU banks and, as a result, has proposed a number of amendments to the BCBS framework to moderate capital increases, and in some cases has made amendments that reflect features of the EU economy that it believes require specific treatment. Overall, this means that CRD6/CRR3 is a proposal that implements the Basel framework with a number of significant modifications, the net effect of which, by the Commission’s own assessment, is an increase of minimum capital requirements for EU banks by an average of 6.4% to 8.4%.
The proposal now kicks-off a lengthy period of political negotiation before CRD6/CRR3 can become law [see next steps analysis below]. The implication of this, however, is that significant changes can still be made to the EU’s approach by the European Parliament or European Council as part of this process and banks will need to take note of the areas that are most controversial/could be most susceptible to change in the text.
Our analysis of the proposals
The CRD6/CRR3 package is a complex set of legislative proposals that goes well beyond implementing Basel 3.1 – it modifies and amends the international standards considerably. We see this manifesting in the proposals in five ways, where they: Delay, Defer, Direct, Diverge or Differ as against the BCBS’s 2017 agreement on Basel 3.1.
1. DELAY – Pushing out the implementation of the framework
The Commission sets 1 January 2025 as the implementation date for most articles of CRR3 (covering the majority of the Basel 3.1 framework) (CRR Art. 2). This is two years later than the BCBS’s 1 January 2023 deadline.
The phase-in period for the standardised Output Floor is also pushed back by two years, so that the fully-loaded framework will not come into force until 1 January 2030 at the earliest, whereas the BCBS timeline runs until 2028.
Given the time CRD6/CRR3 negotiations are expected to take, January 2025 is very likely the earliest feasible implementation date and it is unlikely that there will be pressure from EU Member States (MS) to implement earlier. Some MS could, however, push for the EU to adhere to the BCBS’s 2028 date for the fully-loaded Output Floor to be implemented.
2. DEFER – creating additional transition periods
With the exception of the five year Output Floor phase-in, the BCBS expects all components of Basel 3.1 to be implemented in full on the initial go-live date (moved to 1 January 2025 by the CRD6/CRR3 proposal, as discussed above).
However, the Commission proposes adding new transition periods for several components of the package, including:
- Increases in risk weights for equity exposures to be transitioned from 2025 to 2030 (CRR Art. 495a) in order to mitigate the immediate effect of what is expected to be a significant relative increase in capital requirements.
- LGD increase for specialised lending to be transitioned from 2025 to 2030 (CRR Art. 495b) while the EBA assesses the adequacy of the PD and LGD input floors. The Commission can revise the parameters, based on the EBA’s assessment.
- Leasing exposure as CRM to be transitioned from 2025 to 2030 (CRR Art. 495c) in order to give the EBA time to assess the appropriateness of the Basel 3.1 calibration. The Commission is empowered to revise the calibration if it judges it necessary.
- Allowing firms to continue to apply a 0% credit conversion factor for unconditionally cancellable commitments (UCC) until 2029, followed by a graduated transition period until 31 December 2032 (CRR Art. 495d) after which the BCBS’s 10% credit conversion factor for UCC (CRR Art. 111(2)) will apply.
3. DIRECT – Mandating an EU-wide approach to certain aspects of regulation
The Commission proposes that, in certain areas such as where the BCBS permits national discretions, all EU MS should adopt the same treatment, including:
- Under the revised operational risk framework, setting the value of the Internal Loss Multiplier component to 1 for all EU banks, which would effectively remove loss history as a component of the Pillar 1 operational risk capital charge (CRR Recitals, para 36).
- Banks with a Business Indicator Component of more than €750 million would be required to track and disclose their operational losses in accordance with BCBS requirements.
- All EU banks should use the “loan splitting” approach when calculating RWAs for loans secured by real estate property. The loan splitting approach is the current approach used for Standardised RWA calculations for residential mortgages in the EU (CRR Art. 124-126). 
- Freezing the Systemic Risk and P2R buffers for banks that become captured by the Output Floor, to prevent “arithmetic” increases in capital requirements, until a double-counting assessment is undertaken by competent authorities (CRD Art. 104a and 133).
- Amendments to CRR to ensure that the BRRD is effective and operates as intended:
- a requirement for resolution entities to deduct holdings of MREL instruments issued by subsidiary entities within a resolution group (CRR Art. 72e);
- changes to CRR to ensure that both risk-based and non-risk-based requirements are taken into account (CRR Art. 72e);
- changes to CRR to ensure that the approach to resolving a group that includes third country entities is effective (CRR Art. 12a, CRR Art. 72e) ;
- changes to CRR to ensure that subsidiary entities in a resolution group are able to issue and recognise eligible debt instruments in meeting their internal TLAC requirements (CRR Art. 72b).
4. DIVERGE – Taking a different approach to the Basel text
There are a number of areas where the Commission’s proposals differ from Basel 3.1, reflecting their view of EU specificities. These include:
- The Output Floor will apply at the highest level of consolidation in the EU, but must be calculated for each EU subsidiary. With respect to the Output Floor, the Commission proposes a number of amendments which reduce the capital impact of the Output Floor during the transition period (CRR Art. 465):
- an adjustment to the calculation to allow 125% of unfloored RWAs to be used as an option for the basis of the calculation;
- allowing IRB firms to use 65% risk weight until 31 December 2032 for unrated corporates whose PD is estimated as being less than 0.5%, when calculating their Standardised RWAs;
- allowing IRB banks to set the risk weight for residential mortgage loans with LTV up to 55% at 10% not 20% until 31 December 2032; and to set the risk weight for the portion of the loan with LTV between 55% and 80% to 45% not 75% until 31 December 2029, with a transition of the risk weight from 45% to 75% running from 2029 to 2032. This treatment is subject to conditions that ensure the loans are appropriately low-risk.
Specialised and infrastructure lending
- A preferential approach for unrated specialised lending facilities is introduced (CRR Art. 122a), allowing for lower risk weights for object finance exposures that meet certain criteria in relation to the quality of the collateral package.
- The preferential infrastructure supporting factor previously implemented in the EU is retained (CRR Art. 501a), allowing for lower risk weights for lending that supports specified infrastructure projects, as long as it does not overlap with the high quality specialised lending approach.
- The BCBS sets out that, for residential mortgage exposures, the “at origination” LTV must be used, and that increases in valuation of the underlying property are only permitted to feed in to the LTV where amendments have been made to a property that increase its value – which means that in most circumstances the LTV of a property, and the associated risk weight on a mortgage, can only be reduced by repayment of principal. The Commission proposes that EU banks will be permitted to revalue property assets and reflect the valuation in LTV, subject to certain constraints (CRR Art. 208).
- Where residential real estate losses in a MS meet specified limits, are demonstrably low for the MS as a whole, and are published by NCAs the Commission proposes to permit loans that would otherwise face higher risk weights due to being classified as income producing real estate to use the lower risk weights permitted for use with residential loans (CRR Art. 125).
- Where commercial real estate losses in a MS meet specified limits, are demonstrably low for the MS as a whole, and are published by NCAs the Commission proposes to permit loans that would otherwise face higher risk weights due to being classified as income producing real estate to use the lower risk weights permitted for use with commercial loans (CRR Art. 126).
Ability to revert from IRB to Standardised
- For a period of three years from 1 Jan 2025 to 31 December 2027, the Commission proposes to permit banks with IRB permissions to move portfolios back from IRB to Standardised. This is subject to certain conditions, chiefly that the decision is not done with the intent of regulatory arbitrage (CRR Art. 494d). The BCBS rules retain the prohibition on IRB banks reverting to less sophisticated approaches.
- A lower risk weight for the commodity delta risk factor for carbon trading is proposed (CRR Art. 325 as).
- The governance and control over the alternative standardised approach (ASA) is specified in some detail (CRR Art. 325c), including:
- requirements for a documented policy framework;
- an independent risk control unit that designs, implements and monitors the ASA, including specified reporting requirements;
- a requirement for independent review of the ASA to the satisfaction of the NCA. This proposal exceeds the requirements in the BCBS framework
- In order to ensure that there is a level playing field with other international jurisdictions, the Commission will have the ability to amend market risk requirements to align with international developments via a Delegated Act, or to postpone the application of the framework by two years (CRR Art. 461a).
5. DIFFER – Initiatives that fall outside of the Basel 3.1 framework
As expected, the CRD6/CRR3 proposal contains a number of initiatives that are not found in the BCBS framework. The most prominent of these are:
The supervision of third country branches (TCBs) faces quite material changes, including some significant new powers for EU NCAs (CRD Art. 48):
- All TCBs to be subject to an authorisation requirement, including a reauthorisation requirement for existing TCBs.
- TCBs to be categorised as:
- Class 1 (individual branch): total value of the assets booked by the TCB in the MS is equal to or above 5Bn EUR or TCB takes retail deposits or is not a “qualifying TCB”; or
- Class 2 (individual branch): assets below 5Bn EUR.
- TCBs will be subject to an assessment of their systemic importance if, individually in one MS or collectively across all MS, they exceed 30Bn EUR in assets.
- TCBs to be subject to requirements for capital endowment, liquidity, governance and controls, and specification of and adherence to booking approach.
- For systemic TCBs, a number of remedies are proposed:
- Require the TCB to subsidiarise.
- Require the TCB to restructure its assets/liabilities so that it ceases to be systemic.
- Impose additional requirements on the branches and/or subsidiaries of the TC group.
- Defer imposing any of these requirements for a period of 12 months, subject to the supervisor conducting a reassessment within that 12-month period.
The importance of ESG risk in the prudential framework is demonstrated by the inclusion of the phrase “environmental, social and governance risks” in the title of the Directive. The topic is covered in both the Directive and the Regulation, both directly and indirectly, and banks will have to demonstrate significant improvement in the sophistication and completeness of their approaches to ESG issues:
- Pillar 3 disclosure requirements for ESG risks are extended from only large, listed banks to all banks in scope of CRR (CRR Art. 430)
- ESG considerations are to be included as a specific component of management responsibilities, including through developing specific plans and quantifiable targets to monitor and address the risk of misalignment of firms’ business models with wider EU policy objectives (such as Net Zero transition) (CRD Art.76).
- Supervisors have also been given new powers allowing them to require banks to reduce the risk of misalignment with relevant policy objectives of the EU, and broader transition trends relating to ESG factors over the short, medium and long term (including through adjustments to their business models, governance strategies and risk management). (CRD Art. 104)
- Banks are given new, formal requirements systematically to identify, measure and manage ESG risks, and their supervisors need to be able to assess risks at both bank and systemic levels (Article 87a).
- ESG risks need to be considered over short-, medium-, and long‑term horizons, with long term to be at least 10 years. NCAs are to ensure that banks conduct internal stress tests on their resilience to the long-term negative impacts of climate-related risks, and eventually wider ESG risks (CRD Art.87a).
- The EBA has been given a mandate to develop Guidelines on ESG risk management, the content of the plans described in Article 76, and internal and supervisory stress testing (Art. 87a), and integration of ESG risks into the SREP.
- The timeline for delivery of the EBA’s report on a potential prudential regime for ESG risks is to be shortened from 2025 to 28 June 2023 (CRR Art. 501c).
- Changes to a property that increase environmental efficiency are to be regarded as unequivocally increasing the value of the property for revaluation purposes (CRR Art. 208).
Revisions to strengthen and make more consistent the fit and proper assessments for senior managers and members of the management body (CRD Art. 88):
- The Directive sets out a requirement for MS to require banks to draw up statements setting out the roles and duties of each member of the management body, senior management and key function holders in a manner that looks similar to requirements in management accountability regimes in other jurisdictions.
The future prudential treatment of crypto-assets (CRR Art. 461b):
- The Regulation mandates the Commission to assess, by 31 December 2025, whether a dedicated prudential treatment of crypto-assets is justified. This assessment should take into account the development of standards by the BCBS and, after consulting with the EBA, the Commission will submit a report and a new legislative proposal to the European Parliament and Council.
Next steps in the finalisation of the framework
Now that the European Commission has released the text for CRD6/CRR3, the proposal will enter the EU’s normal legislative process in both the European Parliament and European Council. This process involves lengthy negotiations in specialised committees of each body and must then be concluded by negotiations between the two in order to arrive at a final text that becomes law.
These negotiations always result in substantial changes being made to the legislation and there is considerable risk that the final CRD6/CRR3 will look meaningfully different in key areas.
Among these, we expect the areas where the Commission has substantially diverged from or deferred the effect of the Basel 3.1 framework to generate opposition with some MS. We also believe that there may be pressure in the Council for the EU still to meet the BCBS’s January 2028 target for the full implementation of the framework (i.e. the full calibration of the Output Floor). There are also areas where the legislators will seek to take CRD6/CRR3 further than what the Commission has proposed, such as on ESG risks where we expect the European Parliament to push for a fuller reflection of risks in the prudential framework this time around rather than to wait for future legislation.
During the upcoming negotiations, some important interim milestones will give firms a better idea of how the text is evolving. Among them, the European Council’s “General Approach” (their common agreed position on the law ahead of negotiations with the Parliament) will be particularly influential.
In terms of timing, both previous CRD/CRR negotiations took over two years to complete, and CRD6/CRR3 talks are likely to take a similar amount of time. As a result, we do not expect a political agreement on a final law to be reached before late 2023 at the earliest.
While the CRD6/CRR3 law is not yet finalised, banks have a considerable amount of work to do in order to prepare for the introduction of the Basel 3.1 framework, and particularly the standardised Output Floor.
For more of our analysis on these topics, you can read our reports on implementing the revised standardised approaches in Basel 3.1 (here) and the implications for banks’ capital management of the standardised Output Floor (here).
 These figures are considerably lower than previous impact assessments done by the EBA, which estimated an 18.5% average increase in minimum capital requirements if the Basel 3.1 framework was implemented in full. This gap in estimates shows the likely effect of the modifications that the CRD6/CRR3 proposal contains.
 Basel 3.1 proposes that banks should risk weight mortgage exposures on a “whole loan” basis – the whole loan should receive the same risk weight, based on a table where risks weights are determined by the overall LTV of the loan. The “loan splitting” approach is permitted in Basel 3.1 as an option, whereby the risk weight of the loan is calculated in 2 parts: a fully secured part up to 55% LTV with a risk weight of 20%; and an unsecured part above 55% LTV with a risk weight of 75%.
The European Commission has proposed its long-awaited legislation that will bring Basel 3.1 into force in the EU. While years of crucial negotiations now follow, the CRD6/CRR3 proposal gives EU-based banks a much clearer view of the likely revisions to the prudential capital framework that are coming.