The new Risk Reduction Measure Package

The 2009 financial crisis led to significant changes in the banking system with waves of new Directives and Regulations coming into force. The most prominent changes were the introduction of the Capital Requirement Regulation (CRR), the Capital Requirement Directive IV (CRD IV) and the Bank Recovery and Resolution Directive (BRRD). These requested banks to hold more capital and have in place a detailed plan on how to survive a rough patch, leading to the introduction of the bail-in concept.

The above-mentioned Directives and Regulations are not the only rules that banks need to follow and although these are already rigorous, the European Commission had recently published an updated version of these Directives and Regulations building on the existing EU Banking Rules. The new Rules are referred to as the Risk Reduction Measure package (RRM) and includes the CRD V, the CRR 2 and the BRRD 2. To mention a few, the key changes introduced by this banking reform package are:

• Leverage Ratio (LR): The LR calculates the maximum size the bank can grow, independent from the riskiness of the underlying exposures. It is set at 3% of Tier 1 capital and applies in addition to the risk-based capital requirements.
• Net Stable Funding Ratio (NSFR): NSFR is a liquidity ratio confirming whether banks have sufficient stable funding to cover long-term assets. Before the RRM this ratio was not binding, but now it became mandatory. Apart from the NSFR, banks must also calculate the LCR, guaranteeing that they have sufficient High Quality Liquid Assets (HQLA) to fund cash outflows for the next 30 days.
• Market risk: With regards to market risk, the EU are still behind since they decided not to include the Fundamental Review of the Trading Book (FRTB) framework as adopted by the Basel Committee on Banking Supervision (BCBS) in 2017. Instead, the co-legislators adopted a reporting requirement, which will be applicable once the elements reviewed at international level are introduced via a number of delegated acts.
• Proportionality: The EU regulators are focusing more on the concept of proportionality. This means that small banks will benefit from more simple calculations and less detailed requirements, notably in areas such as market risk, the NSFR, counterparty credit risk, interest rate risk in the banking book, and remuneration requirements. This should reduce excessive costs on banks.
• Sustainable finance: The RRM also requests the EBA to investigate on the environmental, social, and governance (ESG) risks. ESG-related risks will eventually be publicly disclosed by large institutions.
• Bank crisis management framework: The rules on the subordination of Minimum Requirement for own funds and Eligible Liabilities (MREL) instruments are tightened. Thus, we are expecting an increase in debt issues by banks.

Prior to the introduction of the RRM, Anti-Money Laundering (AML) rules were vividly mentioned in the above-mentioned rules and regulations, since different regulatory authorities are responsible for AML. Taking Malta as an example, the FIAU is more focused on the investigatory aspect of AML/CFT while the AML Unit within the MFSA (the prudential supervisors) is more focused on the supervisory aspect of AML/CFT. With the introduction of the RRM we are seeing a convergence between prudential and AML authorities and thus regulatory bodies are expected to cooperate and exchange information better, especially in areas such as authorization, fit and proper tests and the supervisory review and evaluation process.

In order to explain the importance of this link, the European Banking Authority (EBA) published an opinion on how EU legislators should strengthen the link between money laundering & terrorist financing risks (MLTFR) and prudential issues. This opinion forms part of the EBA's ongoing work relating to the Money Laundering Action Plan of 2018.

The opinion illustrates amendments to the CRD V which require prudential supervisors to act on AML/CFT information with:  

• Article 91 requires prudential supervisors to verify that the banks’ management body are of sufficiently good repute and possess sufficient knowledge in relation to MLTFR.
• Article 97 requires prudential supervisors to inform authorities if they notice that a bank’s governance arrangement, business model and/or activities gives rise to ML/TF concerns.
• Article 117 requests prudential supervisors, AML supervisors, and Financial Intelligence Units to cooperate within their respective competences and to provide each other with information relevant for their respective tasks.

The Opinion also makes reference to the European Union Anti-Money Laundering Action Report which sets out a number of requirements to improve the effectiveness of AML/CFT supervision. It also notes that while supervision of financial institutions’ compliance with AML/CFT requirements remains an exclusive competence of the national AML/CFT authorities, the report notes that better exchange of information and collaboration between the authorities and prudential supervisors (such as the MFSA), especially cross-border, is vital to achieve effective supervision.

In addition, the report set out a number of short-term non-legislative actions addressing 8 key objectives:

1. identify the factors that contributed to the recent money laundering cases in EU banks, by providing possible actions for the medium and long term;
2. map relevant money laundering and terrorist financing risks and the best prudential supervisory practices to address them;
3. enhance supervisory convergence and better take into account AML aspects in the prudential supervisory process;
4. ensure effective cooperation between prudential and money laundering supervisors;
5. clarify aspects related to the withdrawal of a bank's authorization in case of serious breaches;
6. improve supervision and exchange of information between relevant authorities;
7. share best practices and find grounds for convergence among national authorities;
8. improve the European supervisory authorities' capacity to make better use of existing powers and tools.

In the local arena, we have also witnessed a very important development. Recently, the Malta Financial Services Authority (MFSA) notified all Financial Services License Holders about the publication of the revised version of the Implementing Procedures - Part 1 which were issued by the Financial Intelligence Analysis Unit (FIAU). The revised version was rendered effective from 19th July 2019 and carries out a series of legislative amendments to the Prevention of Money Laundering Act (PMLA) and to the Prevention of Money Laundering and Funding of Terrorism Regulations (PMLFTR).

The new amendments are rather extensive and although the banking industry is affected by ongoing regulatory changes since the financial crisis, the ultimate aim of these changes are to make the world a safer place by reducing the appetite for the shadow economy, money laundering, funding of terrorism and the danger of failing financial institutions which is ultimately borne by the taxpayer.