International and national regulatory frameworks
“Basel III: A global regulatory framework for more resilient banks and banking systems”
After the U.S. housing bubble had burst in summer 2007, a global banking, financial and economic crisis unfolded in several stages, starkly highlighting shortcomings in regulation, above all in the banking sector. To redress these shortcomings and enhance banks’ resilience, the Basel Committee on Banking Supervision (Basel Committee) started to review and upgrade the Basel II framework. The outcome of the framework revision was published in December 2010 as “Basel III: A global regulatory framework for more resilient banks and banking systems.” Basel III requires banks to hold more and better-quality capital, introduces liquidity standards and implies changes to the calculation of risk-weighted assets. In the years that followed, the Basel Committee launched a comprehensive review of the 2010 version of the capital adequacy regulations, seeking to achieve a balance between simplicity and risk sensitivity. Above all protracted discussions about how to redesign the capital floor made it impossible to finalize the revised Basel III framework as planned at the end of 2016. The agreement reached in December 2017 provides for an output floor ensuring that the capital requirements based on internal models are no lower than 72.5% of the capital requirements established with standardized approaches. This limits the amount of capital benefit a bank can obtain from using internal models.
Conversion of Basel III into EU law
After the publication of the original Basel III framework, the European Commission issued legislative proposals for its implementation in July 2011, i.e. the Capital Requirements Regulation (CRR) and the Capital Requirements Directive (CRD). The two instruments have been applicable since January 1, 2014. As an EU regulation, the CRR is directly applicable in the Member States. Accordingly, this regulation includes all the provisions that are directly addressed to supervised institutions, such as minimum capital ratios. Conversely, the CRD is an EU directive and must therefore be written into national law. It contains provisions addressed to the competent national authorities, such as those governing cooperation between home and host supervisors. In Austria, the CRD was implemented by amending the Austrian Banking Act.
In late November 2016, the European Commission presented a comprehensive package of reforms to complete the regulatory agenda proposed in response to the financial crisis. The far-reaching proposals target, for instance, the elimination of weaknesses and the introduction of additional provisions in legal acts related to own funds and resolution. All these efforts will be complemented by measures that have yet to be fully implemented, such as the leverage ratio (LR) and net stable funding ratio (NSFR) requirements defined by the Basel Committee. Finally, bail-in tools are to be implemented to ensure the orderly resolution of failing banks. These tools are based on recommendations by the Financial Stability Board and the corresponding resolution framework of the EU.
The legislative process of converting this set of measures into EU law is currently ongoing.
Austrian Banking Act
The Austrian Banking Act, which entered into force on January 1, 1994, contains the key provisions governing banking and banking supervision in Austria. The Banking Act mainly contains general provisions establishing the conditions for running a credit institution and basic provisions of the supervisory regime as well as consumer and creditor protection provisions. Furthermore, the Banking Act gives the Financial Market Authority (FMA) and the Ministry of Finance broad regulatory powers. The regulations issued on the basis of this authority lend clearer definition to the general provisions of the Banking Act.
Apart from the Banking Act, the CRR and the CRD, there are numerous other special laws (such as the Building Society Act) and regulations in Austria (such as the KI-RMV credit risk management regulation for banks) that relate to banking operations. Compliance with these special laws and regulations must be monitored by the FMA and the OeNB.
The provisions of the Banking Act and regulations based thereon are heavily influenced by EU legislation, but the Banking Act also contains a range of legacy provisions which reflect the characteristics of the Austrian banking industry as it has evolved over time. The directly applicable SSM Regulation, which governs the transfer of specific banking supervision tasks to the European Central Bank (ECB), also changed the banking supervision mandate of the OeNB and the FMA under the Banking Act to some extent.
Regulatory framework for crisis Management
The Bank Recovery and Resolution Directive (BRRD) provides the regulatory framework for crisis management in the EU financial sector by setting uniform rules for the recovery and resolution (see Single Resolution Mechanism) of banks. On this basis, the Austrian Bank Recovery and Resolution Act created the domestic legal framework for dealing with (distressed) banks that are failing or likely to fail.
Capital requirements under Basel III
Under Basel III, capital consists of tier 1 capital and tier 2 capital, with tier 1 capital consisting of common equity tier 1 capital plus additional tier 1 capital. The distinction between higher- and lower-quality (subordinated) tier 2 capital was eliminated. Furthermore, capital has to meet more stringent qualitative criteria to qualify for both tier 1 capital and tier 2 capital. As short-term subordinated capital proved inadequate during the crisis, all instruments of this category were dropped from the framework; they no longer qualify as eligible capital. Basel III prescribes the following minimum capital requirements (capital components as a percentage of risk-weighted assets):
- 4.5% common equity tier 1 capital,
- 6.0% tier 1 capital (common equity tier 1 capital plus additional tier 1 capital),
- 8.0% total capital (tier 1 capital plus tier 2 capital).
The changes will be phased in under transitional provisions, some of which will be applicable until end-2023.
Capital buffer requirements under Basel III
In addition to the minimum capital requirements, Basel III and the underlying national rules prescribe capital buffers that are to be built up especially during periods of high credit growth and that can be drawn down in periods of stress. The combined buffer requirement contains different buffers that must exclusively consist of common equity tier 1 capital.
- Capital conservation buffer: 2.5% (when fully phased in, i.e. from January 1, 2019 onward), mandatory for all institutions, phase-in started on January 1, 2016.
- Countercyclical capital buffer: The national competent authority (in Austria: the FMA) may impose this additional buffer, which was phased in on January 1, 2016, if credit growth is judged to be excessive. The buffer rate, which depends on the geographic region of a given bank’s credit exposure, ranges from 0% to 2.5%.
- Systemic risk buffer: This buffer of at least 1%, which was introduced on January 1, 2014, may be imposed by the national competent authority.
- Capital surcharge for systemically important institutions:
- Capital surcharge for global systemically important banks (G-SIBs). Banks identified by the Financial Stability Board (FSB) as global systemically important banks (G-SIBs) have been subject to higher capital buffer requirements since January 1, 2016. The surcharge ranges from 1% to 3.5% depending on a bank’s systemic importance.
- Capital surcharge for other systemically important institutions (O-SIIs): Since January 1, 2016, the national competent authorities may require O-SIIs to maintain an additional capital buffer of up to 2%.
Leverage ratio under Basel III
Banks are obliged to report their leverage ratio to the competent authorities. This allows the latter to assess the risk of excessive leverage and to identify potential shortcomings of internal risk models. In addition, banks must disclose their leverage ratio at least on an annual basis. The leverage ratio reflects a bank’s tier 1 capital over total on- and off-balance sheet exposures. Regulatory tier 1 capital is made up of common equity tier 1 capital and additional tier 1 capital. Regulatory capital requirements for banks are currently being reviewed at the European level. As a result of this review, a minimum requirement of 3% for the leverage ratio (as laid down in Basel III) will be introduced.
Liquidity requirements under Basel III
As the recent financial crisis has shown, banks also need to have a strong liquidity base. Therefore, Basel III comprises rules aimed at ensuring that banks have sufficient liquidity reserves to meet their payment obligations at all times, i.e. also under stress.
Since 2015, banks have been required to meet the liquidity coverage ratio (LCR) to enhance their short-term liquidity buffers. Banks that fulfill the LCR have sufficient liquid assets to withstand a 30-day stressed funding scenario.
To secure stable longer-term refinancing, banks will be required to meet the net stable funding ratio (NSFR) from 2018, which limits banks’ room for maneuver in maturity transformation. Put simply, the NSFR reflects the ratio between an institution’s available amount of stable funding and its required amount of stable funding over a one-year horizon. In the EU, banks have to apply the LCR and NSFR minimum requirements both at the level of individual institutions and at the consolidated level. Subgroups and individual banks may be granted a waiver under certain circumstances.
Coverage of market risk under Basel III
Additional changes under the Basel III framework include enhanced market risk coverage. Stricter rules are to apply to specific holdings in the trading book, which is likely to result in an increase in risk-weighted assets. Moreover, incentives for moving derivative contracts to central counterparties have been introduced, and capital charges for OTC transactions have been increased to make them less attractive.
Conversion of the BRRD into Austrian law
In Austria, the BRRD was written into national law with the Austrian Bank Recovery and Resolution Act (known by its German acronym BaSAG). The BaSAG contains provisions on the following three areas and stages:
- It requires banks to develop recovery plans and empowers a resolution authority to develop resolution plans and remove obstacles to resolution (prevention).
- It enables supervisory authorities to intervene at an early stage by granting them additional powers (early intervention).
- It designates a national resolution authority and provides the authority with the necessary powers and tools (resolution, see Single Resolution Mechanism).
The BaSAG is aimed at ensuring an orderly market exit of banks without causing substantial negative repercussions for financial stability while protecting depositors and other customers and keeping the taxpayers’ burden to a minimum. Prior to the adoption of the BaSAG, the obligation to produce recovery plans and resolution plans as well as the FMA’s power of early intervention had, in part, been incorporated into the Austrian Banking Intervention and Restructuring Act and the Austrian Banking Act. The relevant provisions of the latter two acts were adapted to the BRRD and integrated into the BaSAG.
With the BaSAG, Austria has created a national legal framework for dealing with banks that are failing or likely to fail (see also Single Resolution Mechanism). The provisions on recovery plans and early intervention are addressed to the supervisory authorities, the provisions on resolution are addressed to the resolution authority.