New regulations, particularly the final Basel III capital rules, may hamper banks' ability to finance Europe's post-pandemic recovery and support investments in the green economy transition, according to BNP Paribas SA Chairman Jean Lemierre and Deutsche Bank AG CEO Christian Sewing.

The last part of the Basel III framework will be implemented Jan. 1, 2023, and has to be fully adopted by the beginning of 2028. Although both deadlines were delayed by one year due to the COVID-19 pandemic, banks are still worried the additional capital requirements will be a setback in the current environment.

Officials from several EU countries, including France and Germany, have also asked European regulators to amend a key component of the final Basel framework known as the output floor, which limits banks' use of internal models to calculate credit risk in their portfolios, the Financial Times reported June 8. They warned that adopting the international Basel standards as they are could disadvantage EU banks.

'Sky cannot be the limit'

High capital requirements are important for making banks safe but the "sky cannot be the limit," Lemierre said at the June 15 European Financial Integration Virtual Conference, organized by the Association for Financial Markets in Europe and the Official Monetary and Financial Institutions Forum.

"We cannot increase the capital requirements of the bank endlessly at a time when there are massive needs for financing modernization, technology, climate change policies and so on," he said.

With an estimated negative impact of 20% to 25% on big European banks' capital, the final Basel rules will "take the oxygen away" from the sector just as it is fighting the impact of COVID-19 and preparing for "huge investments" in the future, Sewing said at the same event.

The European Banking Authority's latest estimates show that Europe-based global systemically important banks will face an average increase of 23% in their minimum Tier 1 capital requirements when the final Basel III rules are fully implemented. The estimated impact does not take into account the effects of the COVID-19 pandemic, the EBA said in December 2020.

In its Supervisory Review and Evaluation Process for 2020, the ECB found that, during the pandemic, nine eurozone banks have fallen below their pre-COVID-19 minimum SREP capital requirements, warning that more may face problems as lower profits limit their ability to generate capital.

In the first quarter of 2021, capitalization at the largest European banks was robust, according to S&P Global Market Intelligence data, with nearly half of the 21 credit institutions in the sample recording capital buffers of 500 basis points or more.

Rule changes

Before implementing the last set of Basel rules, regulators should consider the current economic situation in Europe and how bank balance sheets on the continent differ from bank books in the U.S., Sewing said.

"If I just think about the external rating corporate clients have here and in the U.S., it's completely different," he said.

Sewing called for adjustments to the Basel III rules.

"We need to make sure that regulatory reforms, which were needed in order to make these banks more robust [after the 2008 financial crisis], are not overburdening banks now," he said.

Mark Kandborg, deputy head of the large corporates and institutions business of Nordea Bank Abp, said at another panel at the conference that the output floor agreed in December 2017 will lead to "an unjustified increase in capital requirements" and the rules should be reviewed, especially when it comes to low-risk corporate and mortgage exposures.

"We do understand the challenges of creating such a single global rule book balancing both the simplicity and the comparability, but we also need to balance that with the risk sensitivity. ... We should avoid penalizing low-risk portfolios when they are justified by high credit quality," Kandborg said.

Banks in the Nordics and the Benelux region are among those facing the biggest capital impact from the Basel III output floor because many of them have large mortgage books with a fairly low risk coverage, the result of historically low mortgage default rates.

Regulators disagree

Regulators at the conference said banks will have plenty of time to adjust to the new Basel rules and stressed the importance of Europe accepting global standards as they were drawn up.

"A prerequisite for a successful and enduring financial integration at a European level, is for Europe itself to be aligned with global financial standards in order to achieve a truly global level playing field," Pablo Hernández de Cos, chairman of the Basel Committee on Banking Supervision and governor of the Spanish central bank, said in a video address.

"The actual capital impact is likely to be much lower than is asserted by some stakeholders, not least because of the sufficiently long transitional arrangements," de Cos said, noting the full implementation of the reforms will be in 2028, two decades after the global financial crisis.

Steven Maijoor, former chairman of the European Securities and Markets Authority and current board member of the Dutch central bank, said the output floor must be adopted to reduce the excessive variation in risk-weighted asset estimates produced by the current system.

Maijoor dismissed the banks' argument about the Basel rules being a barrier to their support for the economic recovery, saying there is no link between the two. The recovery is playing out now while the main impact of the reform will take effect around 2027 and 2028, he said.

An ECB study of the effects of the final Basel III rules shows a modest negative impact in the beginning but in the longer term, there are economic benefits of the Basel III reforms, Maijoor said.