Don’t bet on bank deregulation yet
European regulators aren’t done with capital increases, especially for banks with unjustifiably low risk weightings.
A hearing at the European Parliament in mid-December caused much end of year excitement in bank capital circles. Chair of the Single Supervisory Mechanism, Andrea Enria, said that greater use of subordinated debt could serve to offset the impact on some banks of common floors on risk weights under the Basel framework.
According to Enria, the EU’s fifth capital requirements directive will give eurozone banks on average 90bps in capital relief in the early 2020s – equating to about €74 billion according to Bank of America research. That’s because CRD5 – part of the implementation framework for the Basel reforms – also newly allows banks to count sub-debt towards some of their individual capital requirements, so-called Pillar 2.
This suggestion that the ECB will not – as previously expected – find ways to universally maintain the equity component of Pillar 2 could, in effect, reduce banks’ additional capital demands over the coming years by about half.
However, as markets did not properly price in a €135 billion Basel hit modelled by the European Banking Authority in July, investors would be wrong to rush back into the sector now that the actual impact may be much lower.