Aiming to address the market failures revealed in the aftermath of the crisis, and while building on the three pillars of the Basel II framework, the Basel Committee on Banking Supervision introduced in December 2010 a number of fundamental reforms that seek to raise the quality and quantity of the regulatory capital base, enhance the risk coverage, strengthen micro-prudential regulation and ensure the resilience of banks in periods of stress. The revised framework, endorsed by the G20 summit in Seoul, also has a macro-prudential focus addressing systemic risks that can build up across the banking sector as well as the pro-cyclical amplification of these risks over time.
Only a few months later, in July 2011, with the overarching goal to strengthen the resilience of the EU banking sector, the European Commission brought forward the so-called CRD IV package, a comprehensive review of the EU banking prudential rules included in Directives 2006/48/EC (the Capital Requirements Directive) and 2006/49/EC.
Reflecting the substance and level of ambition of Basel III rules while taking into account the specificities of the European banking sector, the CRD IV package consists of a dual proposal containing a Directive governing access to deposit-taking activities and a Regulation on detailed prudential requirements for credit institutions and investment firms.
The key objectives of the CRD IV package are to address the shortcomings exposed during the financial crisis, to move towards a single rulebook regulating credit institutions in order to prevent recent problems from reoccurring in the future, and to ensure that risks linked to the issues of financial instability and pro-cyclicality are more effectively contained.
To that end, the Commission's proposal increases the amount of own-funds banks need to hold as well as the quality of those funds (stronger capital requirements of 8% plus two supplementary layers, which each can amount to 2.5%, or even more for the counter-cyclical buffer). It also harmonises deductions from own funds in order to determine the amount of regulatory capital that is prudent to recognise for regulatory purposes.
To improve short-term resilience of the liquidity risk profile of financial institutions, the Commission proposes the introduction of a Liquidity Coverage Ratio, the exact composition and calibration of which will be determined after an observation and review period in 2015. In order to limit an excessive build-up of leverage on credit institutions' and investment firms' balance sheets, the Commission also proposes that a leverage ratio be subject to supervisory review.
Implications of a leverage ratio will be closely monitored before its possible move to a binding requirement on January 1 2018. Reforms are also proposed to encourage banks to clear OTC derivatives through central counterparties.
Greek preparations
While the core principles of the new capital rules are set and regulators and market players, in EU and worldwide, have started preparing for the most efficient transition to the post-Basel III landscape, on the Greek front the discussions around the transition process are clearly at a very premature stage, both at regulator's and industry level.
Indeed, the Bank of Greece, through the issuance of a series of Governor's Acts, has so far focused on the implementation of the key amendments entered into force through Directives 2009 and 2010 (CRD II and CRD III), largely based on CEBS technical advice and covering large exposures, hybrid capital instruments, supervisory arrangements (colleges), liquidity risk management, securitisations, trading book (stressed VaR, incremental risk charge), resecuritisation, remuneration and adjustments to certain technical provisions.
The above key reforms have taken place by a series of recent amendments of the Greek basic banking Law 3601/2007 (mainly through Laws 3746/2009, 3862/2010, 4002/2011 and 4021/2011) in conjunction with the various implementing Governor's Acts (in particular under Nos 2630, 2631, 2632, 2633, 2634, 2635, all as of 29.10.2010) that translate into Greek law: among others the provisions of 2009/111/EC (CRD II) and 2010/76/EU (CRD III). In addition, in the recent months the Bank of Greece has urged Greek financial institutions to maintain capital ratios well above the current minimum as a precaution.
Such central bank's call for additional capital buffers is also consistent with the requirement towards Greek banks under the current IMF/Eurozone Stabilisation and Recovery Programme for Greece to maintain a Core Tier 1 ratio of 10%, with measures necessary to meet such threshold to be commenced by the beginning of 2012. That said, apart from the above implementation steps the Greek regulator has not yet invited the Greek banking industry to any official ad hoc dialogue regarding the potential impact, capital targets and major transition issues of the new Basel III/CRD IV rules.
In the thick of it
At the same time, Greek lenders are struggling to demonstrate capital and liquidity resilience much earlier than envisaged by the new rules. Since the beginning of 2010, Greek banks have been at the very centre of the macroeconomic headwinds and fiscal imbalances of the troubled Greek economy.
Sharp loan impairments coupled with inability to access the inter-bank markets, loss of market confidence, accelerated deposit outflows, increased reliance on European Central Bank funding and gradual erosion of their capital base are some of the challenges faced by Greek banks amid the Greek sovereign debt crisis.
In order to absorb the shocks stemming from this repressionary environment, systemically important Greek banks on several occasions had to tap government bail-out funds. The Greek state, either directly or through the Hellenic Financial Stability Fund, had to intervene and to offer rescue funds in an unprecedented fashion, mostly through convertible capital and guarantees, measures that inevitably led to increased state control over Greek private banks and forced them to significant restructurings.
On a parallel front, pressures on the Greek banking system have multiplied in the spotlight of the private sector involvement negotiations, the voluntary debt swap deal with private bondholders which Greece needs to have in place before a major bond redemption comes due on March 20.
Greek banks are heavily exposed to Greek sovereign bonds with a GGBs portfolio of nominal value of about €45 billion ($57.5 billion) – €39 billion book value after June 2011 impairments – compared to an aggregated core capital of €22 billion (97% of the domestic GGB holdings are with the six largest Greek banks). Depending on the as yet unknown outcome of the negotiations around the Greek debt's restructuring, Greek lenders are expected to report sizeable accounting losses driven by impairments of their Greek government bonds holdings (only in response to the July 21 private sector involvement agreement, Greek banks impaired their holdings of government bonds by 16% on average, less than the 21% benchmark, generating accounting losses of about €5 billion).
Notably, in the above distressed environment, the focus of attention of ailing Greek lenders has clearly shifted toward the most immediate and significant challenge – building a firewall through successful re-capitalisation – and less towards the medium- or long-term planning of the implementation of the new capital rules. Following the publication of the recent EBA Recommendation on the EU banks' re-capitalisation and in close liaison with the Bank of Greece, Greek lenders are indeed concentrating their short-term efforts on devising plans to build up the required exceptional (yet temporary) capital buffers against sovereign debt exposures and staggering recession.
Such capital plans focus mainly on the generation of core Tier 1 through balance sheet restructuring and sale of assets, opportunistic buy-back of hybrids and scaling back of unprofitable operations.
At the same time there is less doubt that, despite the long transition periods, complying with the higher capital quality, risk coverage and liquidity standards imposed by the new rules would literally cause the recapitalisation needs and cost of capital of the Greek banks to skyrocket at levels that, as industry experts repeatedly reckon, do not allow Greek bank managers to set any realistic medium or long term capital targets nor explore any concrete roadmap towards implementation of the final Basel III/CRD IV regime.
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Nikolaos Fragos
Karatzas & Partners
Nikolaos Fragos’ main areas of practice are banking, capital markets, securities and investment funds law. He joined Karatzas & Partners in 2007 having previously worked with the financial services team of PricewaterhouseCoopers (Frankfurt) and the asset management supervision division of the German Federal Financial Services Supervisory Authority (BaFin).
Fragos has been a member of the Athens Bar Association since 2002 and studied law at the University of Athens (LLB) and the University of Cologne (LLM, Dr jur). He is author of several contributions in the above areas of law published in renowned Greek and foreign legal magazines. |