The European Banking Authority (EBA) its final draft of implementing technical standards (ITS) on 9 July 2024, aligning with the amending capital requirements regulation version 3 (CRR3), which incorporates the latest Basel III reforms. According to the EBA, the ITS update would affect credit risk, market risk, credit valuation adjustment (CVA) risk, leverage ratio and the transitional treatment of exposures to crypto-assets. Vincent Galand, risk partner, and Victoria Sadzot, senior manager, at EY Luxembourg, provided detailed insights on these changes in an interview.

Legislative history

Galand and Sadzot recalled that on 27 October 2021, the European Commission proposed amendments to the capital requirements regulation to finalise the EU’s implementation of the Basel III reforms applicable to credit institutions and investment firms. The proposal, known as CRR3, introduced more stringent and risk-sensitive standardised approaches for credit, market and operational risk while imposing further restrictions on the use of internal models. CRR3 is aimed to enhance the financial resilience of the EU banking sector while accounting for its specificities and role in financing economic recovery and transformation within the EU.

The European parliament approved the final texts of CRR3 and capital requirements directive 6 (CRD6) on 25 April 2024, and the CRR3/CRD6 package was published in the official journal on 19 June 2024. The final draft ITS was published on 9 July 2024. As an EU regulation, CRR3 will become applicable on 1 January 2025, with transitional periods extending until 2032. CRD6 must be transposed into national law by 10 January 2026, except for provisions concerning third-country branches, which will be applied from 11 January 2027.

Key changes in CRR3

Financial institutions and investment firms are subject to CRR3 requirements. One critical Basel III reform measure, the “output floor,” limits the variability of banks’ own funds requirements calculated by internal models, ensuring a minimum of 72.5% of the capital requirements based on standardised approaches. CRR3 introduces transitional arrangements until 2032 and specifies the output floor’s application at both individual and consolidated levels, with a possible derogation for member states to apply it only at the consolidated level under certain conditions.

Credit risk

CRR3 enhances the risk sensitivity of the standardised approach for credit risk by introducing a more detailed treatment of various credit risk exposures, Galand and Sadzot explained in the interview. These include exposures to institutions, corporates, specialised lending, retail, currency mismatches, real estate secured, subordinated debt, equity and defaulted exposures. It also revises the calculation of off-balance sheet items and the use of external credit assessments, with a phasing-in period for certain provisions. The own funds requirements and standardised credit risk templates were updated to reflect new and amended exposure classes, such as subordinated debt exposures and secured by mortgages on immovable property and acquisition, development and construction (ADC), with increased granularity for reporting these exposures.

Reporting requirements

The CRR3 templates now include a more detailed breakdown for exposures secured by residential and commercial real estate, with further distinctions for income-producing real estate and non-income-producing real estate exposures. Memorandum items were updated for alignment and includes exposures to central banks separately. Additional changes address transitional provisions for credit conversion factors, the impact of currency mismatches and the reporting of equity exposures during the transitional period, with revisions to the decision tree and amendments to include defaulted exposures in the collective investment undertakings (CIUs) exposure class.

Internal models

CRR3 limits the use of advanced internal risk-based (IRB) approaches for certain exposure classes that are difficult to model, aiming to reduce complexity and improve comparability of own funds requirements. New exposure classes, such as CIUs, have been introduced, and changes include separate classes for regional governments, public sector entities and large corporates, as well as adjustments to retail and SME reporting. The framework removes the possibility of reporting institutions under the advanced IRB approach and introduces new rules for conversion factors, affecting templates and instructions for reporting.

Lending losses

Revisions in the instructions and templates were made for reporting losses from lending collateralised by immovable property, along with clarifications on certain aspects of the instructions. Additionally, legal references in the instructions were updated to reflect the new articles in CRR3 related to exposures secured by immovable property and specific reporting obligations.

CVA risk

Three new approaches--simplified, basic and standardised--for calculating own funds requirements for credit valuation adjustment risk were introduced, along with conditions for using these approaches. Templates include reporting for excluded transactions, eligible hedges, derivative positions of CIUs and a breakdown by counterparty types, as well as the reporting of systematic and idiosyncratic components of CVA risk for the reduced basic approach.

Market risk

The simplified standardised approach for market risk involved amendments to reporting templates to reflect new multiplication factors. The fundamental review of the trading book (FRTB) framework will eventually replace the current market risk models, until its implementation, potentially delayed until 2026.

Trading book and banking book

Rules for assigning positions to trading and non-trading books were established, including default assumptions, documentation and monitoring requirements, applicable to all institutions regardless of their market risk calculation approach. Amendments included a new template for reporting the trading book composition, designed to be cost-effective for institutions and exempting those using the credit risk framework from detailed reporting. The trading book template categorises positions by risk type and complies with CRR3 presumptions, with potential future updates to include items excluded from threshold calculations. A separate template will also be introduced to capture reclassifications between books and their impact on own funds requirements.

Operational risk

CRR3 introduced a unified approach for calculating own funds requirements for operational risk, known as the business indicator component (BIC), based on a financial statement proxy. Consequently, reporting the minimum information required for assessing an institution’s own funds requirements for operational risk is suggested. This template includes information on other operating expenses and the approach for computing the financial component (FC) and will be reported quarterly by all institutions at both individual and consolidated levels.

Crypto-assets

In December 2022, the Basel Committee on Banking Supervision released the final version of a standard to manage the risks banks face from their crypto-asset holdings, as the existing rules were not adequate. This standard will be enforced starting 1 January 2026, but some parts are still being worked on. Additionally, CRR3 introduced a temporary rule for banks’ crypto-asset exposures, aligned with the EU’s new markets in crypto-assets (Mica) regulation. This temporary rule will be in place until a new regulatory framework is established.

Leverage ratio

CRR3 introduced minor updates and clarifications to the leverage ratio, including updated references to CRR articles and additional rows in reporting templates to capture exclusions from the total exposure measure, such as exposures related to institutional protection schemes and collateralised exposures to shareholder credit institutions. Changes to the credit risk framework affected the reporting of off-balance sheet items and exposure classes, requiring a split by standardised approach and IRB exposure classes.

Galand and Sadzot emphasised that while CRR3 aimed to refine risk sensitivity and provide a more consistent approach to risk management in the banking industry, it posed several challenges. The use of internal models had been made more restrictive, reducing capital savings achievable under the IRB approach. At the same time, the complexity of the new standardised approaches had significantly increased, posing other challenges for institutions, whether as direct users of these methods or through their inclusion in the output floor.

According to Galand and Sadzot, the new CRR framework introduced enhanced data and disclosure requirements, which would likely involve additional efforts and resources for collection, management and reporting. However, they agreed that from a risk perspective, “the CRR3 framework displays greater risk sensitivity, better capturing nuances between the different exposure classes and the effect of risk mitigation factors, where applicable. It will also lead to enhanced comparability of own funds requirements and make the EU financial system more resilient.”