On 26 June 2020, the new Regulation (EU) 2020/873 (CRR 2.5) was published in the Official Journal of the EU to amend both CRR and CRR 2 as a response to the COVID-19 pandemic. It applies from 27 June 2020.
CRR 2.5 follows a proposal from the EU Commission published on 28 April 2020 which we covered in our May Newsletter.
CRR 2.5 is not changing the regulatory framework fundamentally. However, it brings several amendments to mitigate the impact of the pandemic and to allow a fast recovery of the EU economy. We will be shortly discussing the main amendments in the following text.
Preferential treatment of COVID-19 related public guarantees for NPE backstop
Under the current CRR rules, banks are required to determine for each and every non-performing exposure (NPE) the amount not sufficiently covered by provisions and, consequently, to deduct such amount from CET 1 capital.
NPEs guaranteed by official export credit agencies receive a preferential weighting factor of 0% for the first seven years following the NPE classification. CRR 2.5 extend the same preferential treatment to public guarantees issued in connection with COVID-19.
Update of IFRS 9 transitional arrangements
In order to mitigate the negative effects of the IFRS 9 implementation on capital, CRR introduced transitional arrangements allowing banks to add back to their CET 1 capital the difference between the expected credit losses (ECL) calculated according to IFRS 9 and impairments calculated according to IAS 39. This add-back could be recognised in CET 1 capital over the transitional period spanning from 1 January 2018 to 31 December 2022, gradually decreasing over time – 95% in 2018, 85% in 2019, 70% in 2020, 50% in 2021 and 25% in 2022.
Since it is expected that the COVID-19 pandemic will significantly increase the ECL losses, CRR 2.5 updates IFRS 9 transitional arrangements. The ECL losses accounted for in 2020 and 2021 can be fully added back (100%) to CET 1 capital in 2020 and 2021. The add-back is then gradually decreased between 2022 and 2024; 75% add-back is allowed in 2022, 50% in 2023 and 25% in 2024.
Changes in the calculation of Leverage ratio (LR)
CRR 2 introduced a possibility to temporarily exclude exposures to central banks from the LR calculation (i.e. from the total exposure measure/denominator in the calculation). In case of exclusion of these exposures, banks, instead of complying with LR of 3%, have to calculate and comply with increased LR, which compensates for the exclusion of exposures (compensation mechanism).
CRR 2.5 changes the way the compensation mechanism is calculated. This is a permanent change, which applies from 28 June 2021.
On top of that, banks may temporarily, until 27 June 2021, exclude exposures to central banks from the total exposure measure without applying the compensation mechanism.
Exclusion of overshooting from back-testing market risk models
Banks using the internal model approach for calculating the own funds requirements for market risk have to back-test their internal models daily so as to ensure adequate predictive accuracy of the internal model used. Failures in the back-testing requirements (so called “overshootings”) above a certain number result in an additional quantitative multiplier being applied to the own funds requirements for market risk.
According to CRR 2.5, the competent authorities may in exceptional cases allow banks to exclude from the calculation of the quantitative multiplier overshootings that occurred between 1 January 2020 and 31 December 2021 (market volatility related to COVID-19).
Temporary treatment of public debt issued in the currency of other member states
Since 2020, for the purpose of the calculation of RWA arising from public debt issued in the currency of other member states, banks apply the risk weights ranging from 0% to 150% depending on the credit quality step (until 2017 0% risk weight was used and in 2018 and 2019 reduced risk weights were used).
CRR 2.5 reintroduces the preferential treatment for these exposures, i.e. 0% risk weight until the end of 2022, 80% reduction of the regular risk weight in 2023 and 50% reduction of the regular risk weight in 2024.
In addition, in terms of large exposure limits to public debt issued in the currency of other member state, competent authorities may allow banks to incur exposures up to 100%, 75% and 50% of the their Tier 1 capital until the end 2023, 2024 and 2025 respectively, after taking into account the effect of credit risk mitigation.
Temporary treatment of unrealised gains and losses from sovereign exposures measured at fair value through OCI
CRR 2.5 allows banks from 1 January 2020 to 31 December 2022 (the period of temporary treatment) to remove from the calculation of their CET 1 the amount of unrealised gains and losses stemming from sovereign exposures measured at fair value through other comprehensive income.
The amount that may be removed from CET 1 decreases over time, i.e. 100% in 2020, 70% in 2021, and 40% in 2022.
SME and infrastructure supporting factors
CRR 2 revised the SME supporting factor and introduced a new one for infrastructure projects, both to be applied from 28 June 2021.
CRR 2.5 brings forward the application date for both factors to 27 June 2020.
Treatment of SW assets for the calculation of regulatory capital
CRR 2 modified the rules for deducting intangible assets from CET 1 capital by excluding prudently valued SW assets. The original application date of 12 months after the date of entry into force of the relevant regulatory technical standard has been changed by CRR 2.5 to the date when this standard enters into force.
Postponement of Leverage ratio buffer for G-SIIs
The implementation of Leverage ratio buffer for G-SIIs has been postponed. The new application date is 1 January 2023.
13-7-2020