CRD IV/CRR

Basel III is being implemented in the European Union from January 2014 through the Capital Requirements Directive IV (CRD IV) and the Capital Requirements Regulation (CRR). The aim of these regulations is to improve the resiliency of the banking sector by requiring more and higher quality capital and more balanced liquidity. The key elements of CRD IV/CRR are:

  • Higher quality capital base
  • Higher minimum capital requirements
  • Additional requirements for calculating risk-weighted assets (RWAs)
  • Leverage ratio
  • Liquidity standards

Higher quality capital base
CRDIV/CRR includes a revised definition of the capital base, intending to encourage higher quality capital and hence better loss-absorbing capacity.

Higher minimum capital requirements
The minimum requirements are:

  • 4.5% Common Equity Tier 1 (CET1),
  • 1.5% Tier 1,
  • 2% Tier 2, and
  • An additional 2.5% CET1 for a capital conservation buffer.
  • An additional 0-2.5% CET1 for a countercyclical capital buffer, where the rate is set depending on the excessive credit growth in the different countries. In addition to this, a systemic risk buffer and a SIFI buffer to be covered by CET1 can be implemented subject to national discretion.

Additional requirements for calculating risk-weighted assets (RWAs)
RWAs will mainly be affected by additional requirements related to counterparty credit risk, by the introduction of a capital charges for credit valuation adjustment risk (CVA risk) and CCPs. RWAs will also be affected by the introduction of an asset correlation factor of 25% for exposures to financial institutions. Furthermore, situations of wrong way risk and periods of stressed market data for simulated products must be reflected in the RWAs calculations.

Leverage ratio
CRDIV/CRR introduces a non-risk based measure to limit an excessive build-up of leverage on banks' balance sheets. The ratio is suggested to be a binding measure from 2018 but disclosed from 2015. Current proposal is a 3% ratio of equity to assets.

Liquidity standards
CRDIV/CRR introduces two quantitative liquidity standards:

  • The liquidity coverage ratio (LCR) – secures sufficient level of liquidity to meet anticipated net cash outflows over a 30 day stress period.
  • The net stable funding ratio (NSFR) – Prevents funding mismatches by establishing a minimum amount of stable funding based on the nature of a bank’s assets and activi-ties over a one-year horizon.

LCR is expected to be phased-in from 2015 while NSFR might be introduced from 2018.

Latest developments
The CRD IV/CRR entered into force on 1 January 2014. The Regulation will be directly applicable in all EU countries, while the Directive will have to be implemented in national legislation. In Sweden and Finland the national implementation took place during summer 2014.