Finally here: EU publishes CRR III and CRD VI in the Official Journal

It has been known for a long time: The EU recently (19.06.2024) published the Capital Requirement Regulation III (CRR) and the Capital Requirement Directive VI (CRD) in the EU Official Journal, which will come into force 20 days later (09.07.). The CRR is binding for affected institutions from 01.01.2025. This was preceded by extensive negotiations and the final approval of the Parliament and Council of the European Union.

New features of CRR III

Compared to the currently valid CRR II, CRR III fundamentally revises the regulations for calculating the capital requirements in Pillar I. Both the standardized approach (CRSA) and the internal ratings-based approach (IRBA) for calculating credit risk have been reformed. With the entry into force of CRR III, the obligation to apply the IRBA completely and uniformly ("completely or not at all") no longer applies, which enables a more flexible application of the IRBA. In order to also enable a more flexible application, the risk classes in the IRBA have been defined more granularly and closer to the CRSA. Alignments between the IRBA and the CRSA can be found in credit risk mitigation techniques such as collateral and guarantees.

The introduction of the output floor makes it mandatory for IRB institutions to also calculate the CRSA. The output floor limits the capital requirements from the IRBA (after a transitional phase) to 72.5% of the capital requirements from the CRSA. As a result, this means that the capital requirements for banks with internal risk measurement procedures may not be more than 27.5% below the requirements that would result from the exclusive application of the standardized approach.

The closer alignment of the risk classes with the IRBA also results in some changes for the CRSA. For example, the risk weightings of the "special financing" risk class will be managed more granularly by distinguishing between project financing, property financing and commodity trading financing in future, as is already the case in the internal model. Another significant change to the CRSA is the elimination of the home country rating for unrated institutions through the introduction of a Standard Credit Risk Assessment Approach (SCRA) for deriving risk weights. Here, the risk weightings will range between 30% (rating A+) and 150% (rating C) (150%).

Significant adjustments were also made to the calculation of the credit valuation adjustment (CVA) risk: New approaches for calculating capital requirements for CVA risk are being introduced, which can be mapped using a standardized approach (SA-CVA), a basic approach (BA-CVA) and a simplified approach for institutions with a low CVA risk. At the same time, the previous calculation methods have been abolished. Other changes in CRR III include the introduction of the Fundamental Review of the Trading Book (FRTB) approach in the area of market risk.

From 2025, only a standardized approach will be permitted for the capital backing of operational risk. In addition to Pillar I, CRR III also contains extensive changes to the reporting and disclosure requirements in Pillar III.

Overview CRD VI

CRD VI contains a number of revised provisions on supervisory tools, in particular on the access of third-country banks to the EU market, and enshrines the integration of ESG risks into the corporate governance and risk management of banks in EU law. For example, CRD VI strengthens the powers of supervisory authorities to impose sanctions and remedial measures, introduces stricter requirements for banks from third countries wishing to operate in the EU and obliges banks to take greater account of ESG risks.

What is in store for banks?

The implementation of CRR III and CRD VI will have a significant impact on banks operating in the EU. Institutions are therefore required to realign their internal processes, risk management procedures and reporting in order to meet the new requirements. The changes to the CRSA and the IRBA not only require adjustments to the calculation of risk-weighted assets (RWA), but will also lead to higher RWA overall and therefore to higher capital ratios in some cases. The European Banking Authority (EBA) assumes that the RWA in the standardized approach will increase by 8-10% from the previous CRSA to the new CRSA.

The introduction of the output floor not only leads to higher capital ratios for IRBA institutions, but also means that they must always use the CRSA to calculate the floor. As the difference in capital ratios between IRBA and CRSA institutions will be lower due to the floor, banks are therefore required to make strategic decisions regarding the orientation of their calculations. The innovation of the flexible application of the IRBA could become interesting for some CRSA institutions in the future, as it offers them the opportunity to apply the IRBA at least partially.

The changes to the CRSA and IRBA will lead to an increase in capital requirements, which in turn poses challenges for overall bank management. Banks are therefore required to rethink their business models and review and, if necessary, adjust their pricing strategies and capital allocations.

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