Reforms of EU Banking Rules – Key highlights for banks and branches

Near final texts of the EU banking reforms known as CRR3 and CRD6 were published on 6 December 2023 and are expected to enter into force on 1 January 2025 and mid-2025, respectively.

Transitional arrangements have also been introduced to help banks to gradually adjust to the new rules.

Overall, CRR3 and CRD6 will significantly reshape regulatory frameworks for banks, potentially requiring substantial amendments to existing capital and liquidity requirements. The European Banking Authority reports that EU Banks’ minimum Tier 1 capital requirement would increase by 9%. The new rules will also impact on non-EU banks and their branches.

In this briefing, we highlight five of the key areas of change.

1. Output floor

There are two general approaches to risk weighting of assets for credit risk under existing bank capital adequacy requirements. One approach is found in the rules (the ‘Standardised’ approach) and the other is carried out by the banks themselves (the ‘internal ratings-based’ approach or ‘IRB’). Following the financial crisis, the IRB approach has roused some controversy since on average internal models tend to lead to a lower capital charge than the level that would be demanded by the Standardised approach. It is also thought that the need for historical data can act as a barrier to entry for new banks.

The new output floor is aimed at reining in banks’ use of IRB models by ensuring that risk weighted assets (RWAs) do not fall below a defined percentage of the RWAs that would be calculated under the Standardised approach. This is intended to promote the safety and soundness of firms with internal model permissions and to facilitate competition between Standardised - and IRB - approach firms.

The floor will be set at a factor of 72.5% of the RWA calculated using the Standardised approach but the relevant provisions allow for the factor to be phased starting with 50% between 1 January 2025 and 31 December 2025 and increasing annually until 1 January 2030. Overall, RWAs calculated under the IRB approach, using internally developed models, are expected to increase due to the constraints introduced by the output floor.

The near final text confirms that in order to ensure that own funds are appropriately distributed, and sufficient capital is held, the floor should be applied at all levels of consolidation but there are provisions for this to be carried out on a consolidated basis if member states consider that the objective can be achieved otherwise. Also, the commission will be expected to examine the effect of the output floor on capital requirements, as well as broader considerations on capital and liquidity requirements, as part of a report to be presented to the Parliament and the Council by 31 December 2028.

2. Standardised approach for credit risk

In the Standardised approach for credit risk (SA-CR), banks must use a predetermined risk weight schedule to calculate RWAs, assigning a risk weight to each asset and off-balance sheet position and aggregating the RWA values accordingly.

CRR3 will make significant changes to the current regulations to implement the Basel 3.1 revised SA-CR. These revisions seek to enhance the risk sensitivity of the standardised methodology and will increase the granularity and differentiation of risks.

Notably, CRR3 will modify existing provisions concerning various aspects such as the exposure value of off-balance sheet items, credit exposures to institutions and corporates, treatment of specialised lending exposures, exposures backed by real estate, equity exposures, and defaulted exposures.

For example, key changes to exposures to multilateral development banks (MDBs) under the standardised approach include the introduction of risk weights ranging from 20% to 150% as per ‘credit quality steps’ for externally rated MDBs (excluding those MDBs eligible for 0% risk weight), and a risk weight of 50% would apply to unrated MDBs. This is in contrast to the current approach of treating exposures to MDBs in the same manner as exposures to institutions with unrated MDBs attracting a risk weighting based on the external rating of the sovereign.

3. IRB approach for credit risk

Changes are also being introduced to update the IRB approach for consistency with Basel 3.1 standards. The IRB approach is currently sub-divided into two applications:

1. Advanced IRB (A-IRB), where internal calculations of probabilities of default (PD), loss given default (LGD) and credit conversion factors are used to model risk exposures; and
2. Foundation IRB (F-IRB), where internal calculations of PD, but standardised parameters for LGD and credit conversion factors are used.

Among other things, CRR3 will:

• Restrict the use of internal models for calculating own funds requirements for credit risk to specific exposure classes, thereby reducing the scope of the A-IRB approach. This means that banks must apply either F-IRB or the Standardised approach for certain asset categories such as exposures to large and mid-sized corporates, banks, and other financial institutions
• Introduce minimum values for banks’ internal estimates of IRB parameters, known as input floors, which serve as inputs in computing RWAs
• Remove the 1.06 scaling factor currently applied to RWAs to offset the anticipated rise in RWAs.

4. ESG risks

The reforms also emphasise integrating environmental, social and governance (ESG) factors into banks’ risk management systems and in supervision.

Key measures in CRR3 include new harmonised definitions of the different types of ESG risks, bank regulatory reporting requirements on their exposures to ESG risks, and extended requirements relating to the disclosure of ESG risks.

CRD6 specifically requires banks to take into account the short, medium and long term for the coverage of ESG risks in their strategies and processes to assess and maintain on an ongoing basis the amounts, types and distribution of internal capital. Accordingly, the internal capital allocation of banks to address ESG risks will be key to strengthening resilience to the negative impact of these risks.

The near final text confirms that banks should take into account ESG risks when assessing the value of collateral. The EBA is mandated to assess whether a dedicated prudential treatment for exposures to ESG risks would be warranted. The parties also agreed on lower risk weight for exposures to EU Emissions Trading System (40%) to fight climate change and to support the role of banks in financing the green transition.

Various regulatory and supervisory efforts are underway in relation to ESG risks and EU banks will be keen to explore how the requirements in CRR3 and CRD6 align with and impact other policy initiatives and supervisory expectations. Certain aspects may affect some banks more than others as, for example, the ECB already requires them to consider climate and environmental risks in collateral valuations. However, forthcoming EBA guidelines could offer useful clarity for the industry and help smooth adoption among less sophisticated institutions.

5. Third-country branches

Under the existing regulatory framework, the treatment of third country branches (TCBs) is determined largely by individual Member States, save that TCBs must be treated no more favourably than EU-bank branches. This has led to national divergences in the regulation and supervision of TCBs which creates arbitrage opportunities and associated risks, and has spurred demands for greater uniformity.

CRD6 introduces harmonised rules for the prudential supervision of non-EU bank branches, including a new regime with minimum requirements covering capital, liquidity, governance and outsourcing. A tiering system for branches will be established based on their size and activities, with systemic branches facing a requirement to ‘subsidiarise’ (i.e. establish a standalone entity requiring bank authorisation in the EU). Existing TCBs must seek re-authorisation if they do not meet CRD6 standards. Additionally, affected branches will face stringent reporting and record-keeping obligations.

The legislative process is ongoing, with the implementation of the new licensing requirement expected in Autumn 2026, after an 18-month transposition period post-publication and a 12-month period of transitional relief for licensing applications before any cross-border services restrictions apply.

In the meantime, third country groups (including TCBs) need to assess compliance gaps and engage with supervisors to understand their expectations. This will be particularly important for branches in jurisdictions with varying regulatory approaches, as they may experience significant changes in reporting and record-keeping requirements.