CRD V should eliminate uncertainties, not introduce new regulations

CRD V Banking Regulation

Prof. Dr. Christian Schmaltz is welcoming CRD V, but only as long as it eliminates uncertainties of CRD IV and does not introduce additional regulations. The moderator of this year’s Handelsblatt Conference EBR-European Banking Regulation talked about impacts of Brexit, current regulation issues and the possibility of a new financial crisis.

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Prof. Schmaltz, what are the burning regulatory issues for banks at the moment?

Prof. Dr. Christian Schmaltz: Every regulation goes through four phases:
– First phase, “Global Design”: from the idea to publication by the Basel Committee
– Second phase, “European/National Implementation”: from the publication in Basel to publication by the EBA and BaFin, the German Financial Supervisory Authority)
– Third phase, “Implementation at the Bank”: from EBA/BaFin publication to compliance
– Fourth phase, “Mandatory Compliance”: from the go-live date onwards.

Each of these stages is “labour-intensive” in its own way and has its own burning issues. Stages 1 and 2 involve impact studies, industry opinions and background talks. Stage 3 involves business concepts, programming and projects. Stage 4 involves the elimination of bugs and gathering experience wherever there have been changes in response to new (banking) control requirements.

I believe that the following regulatory initiatives will have the most far-reaching impact at stage 1: capital floors, finalisation of the credit risk standard approach, the regulatory treatment of value adjustments, finalisation of the leverage ratio and the interest risk in the banking book.

I believe that the following regulatory initiatives will have the most far-reaching impact at stage 2: NSFR, FRTB, Small Banking Box, European “standardisation” of IRBA approaches and implementation of the securitisation framework.

I believe that the following regulatory initiatives will have the most far-reaching impact at stage 3: (still) BCBS 239, ILAAP and the expected 5th MaRisk amendment.
Initial experience is currently being gathered with the following stage 4 initiatives in matters of control: LCR, SREP buffer, EBA consistency analyses and regulatory stress programmes.
One particular initiative that is not driven by regulators but which is nevertheless very labour-intensive is IFRS 9. So we must not forget that initiatives can be started not only by banking regulators, but also by other institutions, and they, too, can cause a strain on the budget.

How do you see the significance and also the availability of equity at German and European banks in the future?

Prof. Dr. Christian Schmaltz: It will vary from one bank to another. It was only yesterday that I had a chat with a bank where they felt that capital “is not the problem”. But the Median Bank will continue to be close to the regulatory (SREP) OCR with its capital for the next two or three years.

Will Brexit have an impact on the future of banking regulations and also on the players of the banking regulations? Will or might anything change in this respect?

Prof. Dr. Christian Schmaltz: Brexit (as far as we can see in October 2016) will only remove the UK from the EBA, not from the Basel Committee. However, the UK might seek close association with the United States, which is known to be critical of Basel, and might therefore push for a softer interpretation or wording (Pillar 2) of many regulations.
However, I don’t believe that the EBA or ECB will abandon its narrow, conservative interpretation of the Basel requirements. There is only one point where I reckon our European regulators might be prepared to rethink or soften their position: competitive distortion and low long-term profits. This might actually lead to the kind of deregulation we saw in the early 2000s. But before this happens, there is an entire range of other ways in which the regulators might make it easier for the banks to conduct their activities. Firstly, they might reactivate the securitisation market through a differentiated assessment of securitisation. This could lead to enormous capital relief for the banks. Secondly, they might apply a benevolent interpretation of the various CRR waivers. This could lead to a reduction in regulatory costs. Thirdly, they might either gradually increase interest or, alternatively, they might give up their political resistance to negative deposit interest (for private customers). This would be the only way to prevent the earnings gap of the banks from narrowing instead of continuing to grow. But such a decision will be made not in London or Berlin, but in Frankfurt, Berlin, Rome and Paris.

The European Commission is currently working on a new CRD V. How do you see this project from an academic perspective?

Prof. Dr. Christian Schmaltz: If CRD V eliminates the uncertainties in CRD IV, then I would see it as positive. If, however, it means introducing new regulations, then I would see that as critical. After all, not even all the regulations in CRD IV have been rolled out yet, and the consequences are still waiting to be digested. As Mr. Dombret mentioned on one occasion, I think it would be good if we could catch our breaths first.

Do all the currents regulatory provisions cover a possible new financial crisis? Have the regulators and the banks learnt their lessons?

Prof. Dr. Christian Schmaltz: I do think they will prevent a repetition of the financial crises we had. The reforms are closing existing gaps and opening up new ones, or rather, they are making gaps seem attractive which once seemed unattractive compared with the previous ones.

This is why it’s important to watch out for new behavioural patterns, products, business ideas, etc. at the banks and to evaluate their risk implications. Regulators should be suspicious when they see new products or activities again which many banks regard as licences to print money. Quite often it turns out that such products or activities have carried the wrong price tags, and the supposed profits are no profits at all, but in fact risk premiums that should be set aside and not paid out. However, this means that regulators need to have their ears close to the market and that they recruit professionals who have some market expertise. I’m not so sure if the current HR policy of our regulators meets this criterion.

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Prof. Dr. Christian Schmaltz is moderator of Handelsblatt Conference EBR – European Banking Regulation in November 2016 in Frankfurt. Discuss with him and other experts current topics of European Banking Regulation.