The European Union is preparing a rewrite of international capital requirements as part of a growing effort to soften the blow of regulations on struggling banks.
The European Commission will announce a sweeping plan as early as next month for enacting global standards, including a requirement for lenders to have more stable funding to weather a future crisis. The EU's executive arm is debating ways of softening the rule's impact on trading in derivatives and short-term funding markets that could spare banks billions of dollars in costs.
"Our aim is legislation that supports financial stability, but allows banks to lend and support investment in the wider economy," Valdis Dombrovskis, the EU's financial services chief, said earlier this month. The bloc's rules need to be "as growth-friendly as possible," he said.
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The stable-funding rule, which comes into effect in 2018, requires banks to have long-term funding for loans, securities, derivatives and repurchase agreements so they're not vulnerable to sudden market meltdowns. It's a response from the Basel Committee on Banking Supervision to the failure of banks such as Northern Rock Plc and Dexia SA, which were nationalized after losing short-term funding access in the financial crisis.
The Basel Committee, whose members include the U.S. Federal Reserve and the European Central Bank, sets standards that are then enacted by authorities around the world.
The commission's proposal for updating EU capital rules will incorporate global standards on bank leverage, market risk and debt that can be tapped for restructuring and recapitalization in a crisis, as well as the net stable funding ratio.
"We are now looking at how to best implement these standards in the EU legal framework, taking into account the European specificities," Vanessa Mock, a spokeswoman for the Brussels-based commission, said by email. "No final decisions have been taken."
Faced with weak banks that have cut thousands of jobs and are struggling for profitability, the commission is reassessing financial services laws in a bid to kick-start the economy. It opened the door to a flood of lobbying in the past year by soliciting industry feedback on the costs and consequences of regulations.
Trading Desks
The stable funding rule emerged as a key concern for the biggest banks, with some saying it would send costs spiraling if Europe hews too closely to the international standard.
About a fifth of EU banks need to have more stable funding, and the industry needed an additional 240 billion euros ($261 billion) as of end-2015, according to the European Banking Authority.
The financial industry says a bank's overall level of funding masks the massive impact the regulation would have on specific trading desks and types of business.
"If there is a significant additional funding requirement attributed to the derivatives business, then generally it'll get allocated to the derivatives business," said Mark Gheerbrant, head of risk and capital at the International Swaps and Derivatives Association. "It'll make derivatives costlier and could impact the economics of participating in this business."
The industry and the commission have zeroed in on how the standard hits derivatives and the repo market, where banks and other traders exchange trillions of dollars in cash and securities for short-term funding needs.
In May, the commission sought feedback specifically on the rule's impact on derivative transactions and repo markets, saying a "too punitive treatment" could "limit banks' access to some funding sources and increase the constraints on banks' funding," leading to a "decrease of funding available to finance the real economy."
When experts from EU member states met in the summer, a majority was in favor of crafting an alternative to the derivatives restriction, according to minutes of the meeting seen by Bloomberg. Most of the experts also supported a change to the rule's impact on short-term financial transactions, the minutes show.
Funding Requirements
The Basel restriction on derivatives would lead to an additional annual cost of as much as 15 billion euros and would damage the ability of banks to trade derivatives with their clients, according to a June letter to the commission from ISDA, the Association for Financial Markets in Europe and the Institute of International Finance.
The industry argues that the rule, which requires banks to have more stable funding for gross derivatives liabilities, doesn't properly take into account the collateral lenders receive from clients that is meant to reduce risks from the trades.
The three trade groups called on the commission to defer adopting the restriction until it has been able to fully analyze the market impact and consider alternative approaches. The associations said in the letter that they planned to provide the commission with analysis on "suitable alternatives."
Banks including Barclays Plc and Deutsche Bank AG have told regulators that the rule threatens short-term trading because it imposes different funding requirements on each half of the market: repos and reverse repo agreements. The 5.4 trillion-euro market is split about evenly between the two types of trades.
The industry has warned that those differences could have a huge impact on banks' bottom lines. There is a funding shortfall of between 72 billion euros and 260 billion euros, according to an estimate by the International Capital Market Association from December. ICMA has called for an exemption from the rule for trades that last less than half a year.
"The main problem is the repo market is for short-term funding," said Andy Hill, a senior director at ICMA. "The regulation is really about long-term funding for banks and long-term liquidity. The rule tries to apply a long-term requirement to a short-term business."
Bloomberg News
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