The final version of Basel 31, which has come to be known as “Basel 4” will be implemented in the EU2. On 27th October 2021 the European Commission (EC) published the long-awaited “Banking Package” implementing the Basel 4 rules in the EU3. This package is expected to be agreed by the end of 2022 and passed by the European Parliament in early 2023, with a scheduled EU start date of 1 January 2025.
The world of Basel 4 is posing considerable challenges for banks. Despite the EC saying that the intention is to avoid significant increases in their capital requirements, the European Banking Authority (EBA) has found that the measures would produce a 13 per cent increase in capital requirements for EU banks (a capital shortfall of EUR33bn)4. The bulk of this impact will be felt by the major, Advanced, banks – who are the most active users of credit risk insurance.
Under Basel 4 advanced banks will have their internal credit risk modelling approaches restricted to Foundation level and will have to measure their risk-weighted asset (RWA)outputs against what a Standardised bank’s approach would be for the same exposures. The required 72.5% Output Floor will negatively affect Advanced banks whose RWAs are modelled to give more than 27.5% benefit.
The term CRI does not appear in Basel and the Capital Requirements Regulation (CRR). Insurance has always been addressed as a subset of guarantees. The industry has been working together through its many associations5 to obtain specific recognition of CRI. Its efforts were successful: the latest CRR draft mandates the EBA to report to the Commission on the eligibility and use of insurance as credit risk mitigation and to amend the treatment applicable to credit insurance.
In our opinion, Basel 4 will reduce the attraction of insurance for banks if there is no counter balancing recognition that insurance possesses superior risk weighting due to its policyholder status and to the tightly regulated – and relatively uncorrelated – position of insurers under Solvency 2 in the EU.
The target for the industry associations now is to obtain acceptance. The fundamental advantages of CRI, working with the EBA to assist with the mandated report, with key issues being to involve the European Insurance and Occupational Pensions Authority (EIOPA) in the evaluation process, to clarify the CRI eligibility criteria and to secure a shorter timetable than 31 December 2026 for the assessment to avoid legal uncertainty between the implementation of the revised CRR and the completion of the evaluation.
A great deal is at stake: a properly codified regulatory structure with appropriate risk weighting will ensure the continuing successful development of CRI which has become for banks a crucial support for lending and trade finance, and for insurers a valuable and profitable non-correlated product line.
To maintain the successful development of credit risk insurance, our Financial Solutions team at Willis Towers Watson is continuing its active engagement with industry bodies principally under the aegis of ITFA (International Trade and Forfaiting Association), where Financial Solutions was a founder member of the ITFA Insurance Committee. We are also working with our many banking clients to design new strategies and implement innovative solutions: captives, risk participation agreements, monetisation projects and capital markets. We can see many opportunities for credit risk insurance to be adapted intelligently so that it not only stays relevant and secure for financial institutions’ risk and capital management, but increasingly valuable as a portfolio and distribution tool.
1 https://www.bis.org/bcbs/publ/d424.htm This has come to be known as“Basel 4”, because it is more far-reaching than the rules initially described as “Basel III” in 2010 and 2011
2 The UK is no longer directly subject to the EU regulations. It would be reasonable to expect the UK regulators to adopt a similar position to the EU CRD and CRR.
3 https://ec.europa.eu/commission/presscorner/detail/en/ip_21_5401
5 ITFA, IACPM, LMA (banking), LMA (Lloyd’s), IUA, ICISA, ICC.
