The ECB plans to streamline the banking regulatory framework but clearly refuses to lower capital buffer requirements

The Zhitong Finance App learned that the ECB proposed a simplified banking regulation plan on Thursday. It plans to streamline the complex regulations introduced after the global financial crisis, but it will not reduce the overall intensity of supervision.

The banking industry has long complained that the regulatory burden is too heavy, while some countries, such as the US, are pushing for deregulation and relaxation of capital requirements on the grounds that regulations restrict banking activities.

The ECB, however, is adhering to its core position: simplifying rules is by no means the same as reducing capital requirements. Thursday's proposal focuses on reducing, rather than reducing, the capital buffer banks must hold to guard against potential shocks.

ECB Vice President Degindos said, “Simplified regulation should maintain banks' resilience, and banks' resilience means capital levels to us. We have no intention of weakening the current capital position of European banks.”

Streamline levels without lowering standards

According to previous reports, the ECB's primary recommendation is to simplify banks' capital requirements and the design of the buffer system (i.e. capital structure).

The ECB plans to integrate existing multi-tier capital buffers into two categories: one is an unreleasable buffer, and the other is a releasable buffer, which can be reduced by regulators during periods of economic downturn.

The new releasable buffer will combine countercyclical capital buffers and systemic risk buffers. These two buffers are usually calculated during periods of economic stability and released during economic downturns.

Notably, the non-mandatory second-pillar guidance on capital levels will be kept separate and placed above the releasable buffer.

The ECB stated in a statement that it also plans to reduce the components of the leverage ratio framework from four to two, including a 3% minimum leverage requirement and a single buffer limit. For smaller banks, this single buffer amount can be set to zero.

Furthermore, the ECB is proposing to expand the scope of application of the “Small Bank Regulatory Framework” to include more banks in the category of simplified regulatory requirements.

Or push for convertible debt reform?

Degindos said that the ECB also believes that the risk absorption capacity of convertible bonds known as additional tier 1 capital (AT1) instruments is questionable. The reason is that banks rarely actually use such tools to absorb losses, so they should be reformed so that their attributes are closer to the nature of equity.

This type of financial instrument attracted widespread attention in 2023. At the time, Credit Suisse fully wrote down AT1 bonds worth 16.5 billion Swiss francs in a government-led transaction acquired by rival UBS. Although a Swiss court later ruled that the write-down was unlawful, the relevant appeal is still pending.

Degindos emphasized, “We can improve the loss absorption capacity of such tools. Ultimately, AT1 tools should be closer to the nature of equity.”

The ECB proposed two reform alternatives: the first option is to optimize the design of the AT1 tool to further guarantee its loss absorption capacity without changing the essential positioning of the tool;

The second is a more aggressive solution, which is to completely remove the AT1 instrument from the capital buffer system under the continuous operation of banks. However, the ECB pointed out that the plan may not comply with the relevant provisions of the Basel Agreement, violate the principle of simplified regulation, and lead to changes in regulatory capital requirements.

Degindos said that the ECB's special working group on regulation supports both of the above plans. According to people familiar with the matter, this statement also suggests differences in the positions of France and Germany on this issue.

At the same time, the ECB is also calling for a reform of the coverage and methods of bank stress tests within the EU so that they have higher reference value, both for individual banks and from the perspective of systemic risk.

The above proposal has been approved by the ECB Governing Council and will be submitted to the European Commission for consideration in the next step. Any actual policy adjustments, even if implemented, may take months or even years.

Degindos said, “This will be the starting point for our discussions with the legislature. We are not a legislature; we can only make policy recommendations to it.”