11th February 2020

Scope reviews where bank capital requirements are heading
Trend

The European Central Bank(ECB’s) recent disclosure of Pillar 2 requirements for the nearly 120 significant institutions it supervises was helpful for investors. The requirements, which have been in force since the start of the year, must be met entirely with CET1 capital.

Banks demonstrating some improvement in credit fundamentals (such as AIB, Deutsche Bank and UniCredit) saw Pillar 2 requirements come down. For Nordea, the significant decrease follows the switch to the ECB as its supervisor. Barclays, meanwhile, saw an increase following the removal of the Pillar 1 operational risk floor.

Some excitement emerged during the fourth quarter of 2019 around the Article 104a amendment to CRD IV, as this allows for Pillar 2 requirements to be met with a mix of common equity and (lower quality) AT1 and Tier 2 capital instruments. Banks so far have sent mixed messages, with some expecting this to go ahead(e.g. UniCredit, Bankia) while others have been more cautious(e.g. Deutsche Bank).

“With the average Pillar 2 requirement being 2.1% for banks supervised by the ECB, CET1 requirements could decline by about 92bp on average,” said Pauline Lambert, executive director in the banks team of Scope Ratings and author of the latest AT1 quarterly.
“We raise a few caveats, however. First, the amendments to CRD IV still need to be adopted and transposed by member states. As the deadline is 28th December 2020, Article 104a will be in effect from 2021 at the earliest. Second, supervisors maintain discretion to require a higher proportion of Tier 1 capital or CET1 capital, if they deem it necessary. Lastly, implementation of the final Basel III framework is expected to raise capital requirements.”

The EBA estimates that full implementation would increase minimum capital requirements by nearly 24% on average between 2022 and 2027. “While supporting full implementation, regulators have acknowledged that absolute capital needs should not increase mechanically just because risk-weighted assets have. Consequently, there is room to potentially lower Pillar 2 requirements, especially if the amended framework captures risks which were not previously included,” said Lambert.