The stance of the European Parliament’s Economic & Monetary Affairs Committee towards Basel III implementation is in focus after the European Council last Tuesday backed key elements of European Commission proposals, including transitional arrangements mitigating the impact of the output floor.

The banking industry has been concerned about the impact of the Basel III output floor, which in its original form could contribute to an increase in capital requirements well above the 10% maximum increase deemed appropriate according to a G20 mandate, with banks using the internal ratings-based (IRB) approach potentially facing particularly sharp increases in risk weights for mortgages. EU implementation will come via changes to the Capital Requirements Directive and Regulation (Banking Package 2021).

In October 2021, the European Commission proposed transitional arrangements that would ease the impact of the output floor for residential mortgage lending during a phase-in period. On Tuesday, the European Council, after a year of negotiations, adopted a position that echoes the proposed transitional arrangements that would temporarily ease the impact of the output floor for residential mortgage lending.

The Council’s decision comes despite a joint intervention on Friday from José Manuel Campa, chair of the European Banking Authority (EBA), Luis de Guindos, vice-president of the European Central Bank, and Andrea Enria, chair of the supervisory board of the ECB, warning against deviations from the internationally-agreed Basel III rules.

The European Parliament’s Economic & Monetary Affairs Committee (ECON) is scheduled to vote on its position on 5 December, but the official timeline could slip – with the subsequent plenary parliamentary vote and trilogue process also delayed – due to the political uncertainties and distance between the relevant parties’ positions.

ECON rapporteur Jonás Fernández, a Spanish socialist MEP, has called for stricter Basel III alignment, pushing back against the Commission’s transitional arrangements and instead proposing that only residential mortgage lending that satisfies certain ESG criteria be eligible for the preferential treatment – for which one source suggested only 1% of mortgages would qualify.

But other ECON members, such as Austria’s Othmar Karas of the European People’s Party, have tabled amendments supporting the Commission’s proposals and furthermore making them permanent, as well as extending the less burdensome treatment to commercial mortgages.

The European Mortgage Federation-European Covered Bond Council (EMF-ECBC) last month highlighted its support for such amendments, again warning of the potential impact on the banking industry and the real economy of measures that do not reflect European specificities and differences in risk.

The industry body cited research by Copenhagen Economics that estimated an average increase of 18% in capital requirements among the EU’s larger banks, equivalent to some €22bn of additional capital needing to be held against EU mortgage portfolios according to the Banking Package proposals, or €39bn to restore capital ratios to pre-package levels. The authors noted that some banks will face a much more severe impact than the average, while markets set to be worst hit include Denmark, Germany and the Netherlands.

The EMF-ECBC also sees the increase in capital requirements and blunter risk calibration resulting from the current proposals as a potential threat to the European mortgage financing model, including covered bonds and the long term access to capital markets they provide.

The overall impact could ultimately be lower availability of mortgages, higher rates for borrowers, and more off-balance sheet lending from less-regulated entities.

Jens Tolckmitt, chief executive of the Association of German Pfandbrief Banks (vdp), said the industry believes the transitional arrangements proposed by the Commission should be made permanent and expanded.

“Because it’s not a transitional problem,” he said, “it’s a structural problem. If you have a low risk business like mortgage lending, it’s not a question of moving from today’s situation to a future situation and making that easier through a transitional arrangement; it’s simply justified to treat these loans preferentially because they have proven to be safe.”

He noted the additional safeguard that preferential treatment becomes unapplicable should loss rates for institutions rise.

“And we think that if commercial loans fulfil the same requirements, they should be treated equally to residential mortgage loans,” added Tolckmitt.

The proposed treatment of acquisition, development and construction (ADC) commercial real estate exposures has also been flagged: they face a risk weight of 150%, rather than the 100% for ADC residential real estate. Such lending is typical of that necessary to support the Commission’s Renovation Wave initiative, and market participants argue that it is just one example of how the burdens of the Banking Package run counter to the role the banking industry could be playing in helping achieve the EU’s broader goals – particularly against the worsened economic backdrop.

“On the one hand, the European Institutions are calling for greater banking sector support for the REPowerEU and Renovation Wave, especially for the younger generation and vulnerable borrowers, in retrofitting their homes,” said EMF-ECBC secretary general Luca Bertalot, “while on the other hand, the different legislative proposals on Basel III, Taxonomy and EPBD seem to be not yet providing a clear, consistent and systemic line of action for housing finance. The European institutions need to look at the upcoming legislation not in silos, but at the overarching impact it is having on the housing landscape.

“We have 2000 banks in Europe ready to step in and provide the private capital that is needed and are trying to provide strategic support with efforts such as the Energy Efficient Mortgages Initiative. We just need clear recognition of the importance of the housing sector ecosystem.”

Photo: ECON committee vote; Source: European Parliament; Copyright EU