The European Central Bank announced on Tuesday that eurozone banks will need to set aside slightly more capital next year compared to 2023. The average risk-weighted assets required for 2024 under Pillar 2 standards for common equity tier 1 capital (CET1) will be 1.2%, up from 1.1% this year. This change comes as a response to an uncertain macroeconomic outlook and tighter financing conditions.
Understanding Pillar 2 Requirements
Pillar 2 is a supplementary capital requirement that adds to the minimum capital requirement known as Pillar 1. It accounts for certain risks that are not covered by the initial requirement. The ECB emphasizes that internal governance, risk management, and capital planning are crucial areas for supervisory action, given the deteriorating risk outlook.
Strengthening Capital Requirements and Mitigating Financial Risks
Overall, the CET1 capital requirements have increased to 11.1% in 2024, up from 10.7% in the previous year. This adjustment reflects efforts to mitigate against financial risks. The ECB states that addressing internal governance, risk management, and capital planning deficiencies is a priority.
Importance of Effective Risk Management
Market turmoil earlier this year demonstrated the importance of managing interest-rate risk effectively. The collapse of Silicon Valley Bank and the takeover of Credit Suisse by UBS highlighted the need for the banking sector to be proactive in this area.
Solid Capital and Liquidity Positions
While highlighting necessary improvements, the ECB also recognizes that banks currently have solid capital and liquidity positions that exceed regulatory requirements. Furthermore, profitability has rebounded to levels not seen in over a decade, strengthening banks’ ability to endure external shocks.
Areas for Improvement
To enhance banks’ resilience and ensure robustness, the ECB will require them to address deficiencies in their asset and liability frameworks, as well as credit and counterparty risk management. Additionally, banks need to expedite the remediation of shortcomings in internal governance, management of climate-related risks, and continue their progress in digital transformation.
In summary, eurozone banks are expected to uphold higher capital requirements in 2024 due to an uncertain macroeconomic outlook and tighter financing conditions. The ECB emphasizes the importance of addressing deficiencies and managing risks effectively to strengthen the banking sector’s resilience.
