EBA steps up efforts to provide guidance on CRR III-related changes
As part of the European Banking Authority’s (EBA) mandate to provide additional guidance or technical standards following the implementation of the EU Banking Package (namely through CRR III and CRD VI), it has recently published a number of guidelines and technical standards to facilitate effective implementation of the regulation.
1. Final Guidelines on the treatment of Acquisition, Development and Construction (ADC) exposures to residential property under the standardised approach of credit risk
The EBA has released its final Guidelines on the treatment of Acquisition, Development and Construction (ADC) exposures to residential property under the standardised approach of credit risk, as part of the CRR III framework.
Institutions can now apply a reduced risk weight of 100% - instead of the default 150% - to qualify ADC exposures, provided they meet two key conditions:
Condition 1: Significant portion of total contracts
To qualify for the reduced risk weight, at least 50% of the sum of sale prices over the amount of credit facility (for sale contracts) or 50% of total number contracts (for lease contracts) must meet one of the following criteria:
Pre-sale contracts with a minimum 10% cash deposit
Pre-lease contracts with a deposit equal to three months’ rent
Executed sale or lease contracts
In addition, financing must be secured in an equivalent manner. This means that:
Deposits or instalments must be paid into segregated accounts
These funds must be forfeitable if the contract is terminated
The above contract conditions must be fully met
Condition 2: Revised equity threshold for risk weight reduction
Following feedback and insights from industry stakeholders, the EBA has lowered the obligor-contributed equity threshold from 35% to 25% of the property’s value upon completion.
Recognised forms of equity include:
Cash contributions by the obligor
Land or property already owned and contributed to the project
Subordinated loans or instruments junior to the ADC exposure
Segregated investments, grants, or marketable assets directly linked to the project
Out-of-pocket expenses for development or construction
2. Consultation paper on draft guidelines amending the application of the definition of default (DoD) under Article 178 of Regulation (EU) No 575/2013
The EBA published a consultation paper proposing amendments to the guidelines on the application of the definition of default under Article 178 of Regulation (EU) No 575/2013, aligned with the CRR III regulatory framework. The key proposals relate to:
The net present value (NPV) loss threshold in debt restructuring remains unchanged at 1% as it sufficiently flexible, risk sensitive and consistency with existing standards.
3.Draft guidelines on Ancillary Services Undertakings (ASUs)
The EBA published a consultation paper proposing draft guidelines to clarify the definition and scope of Ancillary Services Undertakings (ASUs) under Article 4(1)(18) of CRR III. These guidelines aim to harmonise the identification of ASUs across Member States, ensure consistent application of prudential consolidation rules and address emerging risks from evolving banking models.
Undertakings are identified as an ASU when its principal activity:
is a direct extension of banking (activities fundamental to the value chain of core banking services such as loan brokerage, debt recovery, risk management, amongst others).
is ancillary to banking (activities that support, complement or rely on banking such as IT systems, shared marketing channels or operational leasing linked to banking operations);
The EBA may classify other activities as ASUs on a case-by-case basis should they resemble the points above.
To qualify as an ASU, an undertaking must be 50% or greater of any of the following indicators:
the undertaking’s assets;
the undertaking’s revenues; and
the undertaking’s personnel dedicated to qualified activities.
Authorities may still classify the entity based on qualitative judgment if thresholds are not meet.
4. Final draft Regulatory Technical Standards on the allocation of off-balance sheet items and the specification of factors that might constrain institutions’ ability to cancel unconditionally cancellable commitments under Article 111(8) of Regulation (EU) No 575/2013
The EBA has released its final Draft Regulatory Technical Standards under Article 111(8) of CRR III. These standards clarify how institutions should classify off-balance sheet items and assess their ability to cancel unconditionally cancellable commitments.
For off-balance sheet items not listed in Annex I to CRR III, institutions must assign these items according to the following guidelines:
For an off-balance sheet item where institution is already exposed to the risk of credit losses in the event of default of the obligor or the credit facility (any amount that the client is already required to draw in the future), the amount shall be assigned to bucket 1 and allocated a 100% credit conversion factor (CCF).
For an off-balance sheet item not yet exposing the institution to the risk of credit losses in the event of default of the obligor or credit facility, at least one of the following criteria shall be met:
(a) if the client has a contractual right for drawing this amount in the future that still needs to be exercised before the amount is drawn, the amount shall be assigned to bucket 3, which attracts a 40% CCF.
(b) if at least one non-credit risk related event still needs to occur before a default of the obligor or the credit facility exposes the institution to the risk of credit losses on this amount, the amount shall be assigned to bucket 2, thus allocating a 20% CCF.
(c) if at least one contractual requirement related to the client’s credit worthiness prevents a drawdown in case of a default (according to Article 178 CRR) and the institution has processes in place that ensure that any non-compliance prevents the drawdown, the amount shall be assigned to bucket 2, allocating a 20% CCF.
Institutions must evaluate the following factors to determine its ability to cancel any unconditionally cancellable commitments:
Risk management deficiencies: Gaps in monitoring or IT systems.
Commercial considerations: Impact on client relationships.
Reputational risks: Market perception of cancellations.
Litigation risks: Potential legal consequences from client losses.
What does this mean for you?
The EBA’s latest and forthcoming guidance and technical standards present a strategic opportunity for banks to accelerate CRR III compliance. Our Banking Advisory team at PwC Malta is here to help navigate you through this dynamic regulatory landscape, enhance your disclosures, as well as outline the necessary implementation stages required within your risk management and internal systems.
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