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EU Banks Face Stricter Capital Requirements

The European Union has introduced new capital requirements for banks across the region, aimed at ensuring their financial stability and preventing future crises.

The Capital Requirements Regulation (CRR)

The CRR came into effect in 2014 and is directly applicable across the EU. The regulation introduces several new capital and liquidity requirements, including:

  • Minimum common equity tier 1 ratio: 4.5%
  • Minimum tier 1 ratio: 6%
  • Overall capital ratio: 8%

These ratios are fully binding, and any breach could lead to a withdrawal of the bank’s licence.

Capital Buffers

In addition to these minimum requirements, the CRR also introduces capital buffers, including:

  • Capital conservation buffer
  • Institution-specific countercyclical capital buffer
  • Systemic risk buffer
  • Buffers for systemically important institutions

The size of these buffers varies depending on the existence of cyclical and structural systemic risks. Banks that breach the buffer requirements will face restrictions on dividend payments, but a breach cannot lead to a withdrawal of the licence.

Pillar 2 Capital Requirements

The Swedish Financial Supervisory Authority (SFSA) has also introduced additional capital requirements, known as pillar 2 capital, which cover risk elements not fully covered by the CRR. These requirements are currently not binding and are determined on a case-by-case basis.

Ownership Restrictions and Implications

The CRR places restrictions on ownership of banks, requiring any entity holding a controlling interest to be approved by the SFSA. A controlling interest is defined as:

  • Holding 10% or more of shares or votes in the bank
  • Having significant influence over the management of the firm

There are no restrictions on foreign ownership of banks, and entities controlling banks have certain legal and regulatory implications and responsibilities, including:

  • Reporting changes to the management structure to the authorities
  • Complying with consolidated supervision conducted by the SFSA

In the event that a bank becomes insolvent, shareholders may be liable for losses incurred by the company, provided they acted with intent or were grossly negligent. The SFSA also has the power to reduce the share capital of the bank, potentially incurring losses on direct shareholders.

Revised Capital Requirements

The European Commission proposed revisions to the CRR in November 2016, aimed at making capital requirements more risk-sensitive and addressing excessive reliance on short-term wholesale funding. The revised rules are still pending agreement between the Council and the European Commission.

The proposed changes include:

  • A binding leverage ratio
  • New requirements to reduce long-term funding risks
  • Increased transparency around banks’ use of derivatives and securitizations

Conclusion

The CRR has introduced significant capital requirements for EU banks, aimed at ensuring their financial stability and preventing future crises. The regulation places restrictions on ownership of banks and introduces additional capital buffers. While the revised rules are pending agreement, they are expected to further increase the resilience of EU banks.