Both pieces of European legislation will now be revised for the first time. The aim is to enhance financial stability and to reinforce confidence in the banking sector. The European Commission has already presented comprehensive proposals for amending the CRR and CRD IV (see BaFinJournal December 2016 - only available in German). Negotiations between the member states are currently ongoing. At the same time, the Basel Committee on Banking Supervision (BCBS) is developing new own funds requirements.

In an interview with BaFinJournal, Raimund Röseler, Chief Executive Director of Banking Supervision, explains why the issue of proportionality is so important for him, how he assesses the Commission’s proposals and what he expects from the negotiations at the global level.

Mr Röseler, why do the European own funds requirements need to be revised?

The actual trigger is of course the new rules adopted in Basel that we want to transpose into European law. Another factor is that CRD IV and CRR have been in force for quite some time now. Scrutinising legislation like this from time to time and seeing whether and where there is a need for improvement is a perfectly natural and necessary process.

Do you think there is a need for improvement?

Definitely, and above all as far as the issue of proportionality is concerned. The prevailing view in the past was that it was possible to act proportionally within a single rulebook. However, practical experience has now shown that this approach has its limits. For example, it is not possible to fully waive certain rules. It is only possible to apply them with differing levels of intensity. To ensure greater proportionality, we need more flexibility in the rules. The fact that this is an urgent issue is something we see every day in our discussions with the institutions.

What’s the rush now?

The institutions are facing a growing level of regulatory detail. And I’m not just talking about banking regulation. Securities regulation, tax law and a large number of other legislative requirements are also affecting the institutions – and to a degree that is not always justified. It is therefore a legitimate concern for the smaller institutions that we quickly find a way to enable greater proportionality.

What do you think of the Commission’s proposals in this respect?

In my opinion, they’re a step in the right direction, but they don’t go far enough for Germany. These are selective proposals that only address individual issues. As far as LSIs¹⁾ are concerned, meaning less significant institutions that are subject to national supervision, the Commission is in principle proposing exemptions from certain rules for very small banks. But in doing so, it is setting the limits far too low.

How high are the limits?

In order to benefit, for example, from a relief from the disclosure requirements, a bank’s assets must not have exceeded an average of EUR 1.5 billion in the four years prior to the disclosure period. Only if it meets that requirement would the institution be classified as “small” under the Commission’s proposals. From our perspective, this is too low.

Where do you think it should be?

If you define thresholds, you will always face the problem of creating cliff effects – in other words incentives to land just above or below this threshold. My own approach in the first instance would therefore be to opt for a threshold that already exists, because the cliff effect is already there. We could take the SIs²⁾, meaning those institutions that are directly supervised by the European Central Bank. Alternatively, we could use systemic importance which gives us an existing comprehensive methodology for identifying institutions that pose a threat to financial market stability.

Systemic importance would be the decisive factor here. And this also makes sense: institutions that are large, complex, heavily interconnected or difficult to substitute must be regulated more extensively than those that will not affect financial stability if they run into trouble.

And what would the second step be?

It’s possible that this sort of division will not be sufficient. I can imagine a situation where a further differentiation is necessary for those banks that do not pose a potential systemic risk, specifically between the somewhat larger institutions and the really small banks that cannot pose any systemic risk.

But wouldn’t this still produce cliff effects?

Absolutely, but this isn’t actually undesirable in principle: If we take the systemic importance of the institutions as the distinguishing criterion, rather than total assets, this creates an incentive to pose less of a systemic risk. This is a thoroughly positive aspect.

What’s important is that the supervisor must at any event have the ability to make adjustments. For example, if a bank in the bottom cluster has a certain business model and the supervisor thinks it is appropriate to assign it to the middle cluster, it must be able to do so. Banks are not all the same.

What should the relief specifically encompass in the individual clusters?

The Basel requirements would be applied largely 1:1 to the institutions in the top group – after all, they were specifically developed for large systemically important banks.

In the middle segment, what I have in mind is a selective relief in specific regulatory areas. Some requirements could be waived entirely, for example recovery planning or disclosure requirements.

And in the bottom cluster, I think that a very high degree of relief from the requirements would be appropriate. We simply don’t need many of them there any more: the disclosure requirements, the recovery and resolution planning obligation – normal insolvency law applies here if a bank gets into difficulties – or the remuneration rules. I can also imagine simplifying requirements such as LCR or NSFR³⁾ to a significant extent, because they were developed in Basel for the large banks. Of course we still need liquidity requirements here, but simple liquidity ratios could be considered, for example.

Are you actually suggesting a “Small Banking Box”?

To be honest, I don’t find that term particularly appropriate. It suggests that there are several sorts of closed boxes: one with very strict requirements, for example, and another one to which very simple rules apply. I would see the whole thing much more along the lines of a continuum, a smooth transition. Perhaps that’s why it would make more sense to talk of a “Small Banking Toolbox” or a more proportional regulatory regime.

Can your proposal be applied to all of Europe?

Why not? After all, we’re are proposing to differentiate based on the degree of systemic importance. Of course the effects will differ from country to country. Here in Germany, for example, a particularly large number of institutions would be categorised into the bottom segment. But the fact is also that these institutions simply pose less of a systemic risk to German financial stability.

How do you think your proposals will be received by your European partners? Will they listen to the German voice?

It’s no doubt the case that proportionality is more important for us than it is for most other countries. To a certain extent, the situation here in Germany is unique. We have around 1,600 LSIs – elsewhere, the number is in the double or low triple digits. So their need for proportionality is also lower than it is for us.

But if we can bring home the message that this is a reasonable approach, then I think we stand a good chance. Previously, the dogma of level playing fields held sway: absolutely the same rules for all institutions in Europe. But this was the wrong approach because it simply doesn’t fit economically. That’s because all institutions just aren’t equal, nor do they all compete with each other. So we need greater differentiation, and that’s something we need to make clear. And what would be a better way of organising this differentiation than by basing it on the degree of systemic importance?

Are you also willing to compromise?

Of course. This is merely the first idea that we’re throwing into the ring. There will no doubt be sensible arguments why some things should be done differently. And these are things that will certainly have to be taken into account.

Doesn’t your approach entail a risk that necessary regulation will be watered down again?

Not by ensuring greater proportionality, and not because of the “Small Banking Toolbox” that I have in mind. It’s not about watering down rules, it’s about simplifying them – and that isn’t necessarily the same as making them less strict. There’s no point in sticking doggedly to rules that aren’t necessary. What we want is appropriate regulation.

Negotiations on the own funds requirements, referred to as Basel III, are also ongoing at the global level at the moment. Shouldn’t you wait until results have been achieved there before revising CRD IV and the CRR?

That would be a good idea – if we already knew when that would be. At the moment, unfortunately, that just isn’t the case. All we can do therefore is be pragmatic and launch the reform now. We can’t wait forever – that wouldn’t be fair on the institutions. And if it looks like they’re getting closer to a result in Basel in the course of this process, we can still respond to that.

How confident are you that the countries in the BCBS will reach a consensus?

I think that we can do that. All the players are determined to reach a consensus. That’s encouraging, but there are still some difficult obstacles to overcome. What’s clear is that we want a compromise, but not at any price.

And what price would be too high?

All that’s really left to reach agreement on in the negotiations is the design and calibration of the output floor for internal models, meaning a percentage limit that the capital requirement may not fall below. All other issues have been settled. We have always said that we want a regime with a certain degree of risk sensitivity. But if the output floor is set too high, we remove any risk sensitivity. For the vast majority of institutions, the output floor would then effectively be the binding factor. But it really should be no more than a backstop, a fall-back option. And that’s why it shouldn’t be too high.

The debate in Basel is about regulation, but the USA seems to be moving in the opposite direction. Do you see a risk of a global wave of deregulation?

Most definitely. If the USA deregulates, that will spill over to Europe, and the calls here to regulate less or allow relief from the requirements will get louder so that European banks can compete with American banks. And the risk of a new crisis would not be too far away.

What needs to be done to prevent that?

At a push, Europe will have to go its own way. We must make sure that we can sustain sensible regulatory standards here.

Despite the competition?

Despite the competition. After all, we have seen that the price of a threat to financial stability can be much greater for an economy than short-term obstacles to competitiveness.

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