In 1988, central bankers from the US, Japan, and several European countries published Basel I, which was going to be the first of the many upcoming standards to harmonize capital requirements across the countries. Capital requirements define how much capital buffer banks must hold to absorb losses during difficult times, and the aim of the first Basel standard was to create a level-playing field for internationally operating banks.
In Europe, the Basel standards have been taken into EU legislation. The Capital Requirement Regulation 3 (CRR3), based on the latest Basel standards, entered into force in EU countries at the beginning of 2025. Banks calculated their capital requirements under CRR3 for the first time for the reporting period Q1 2025.
ALM Partners offers a comprehensive CRR3 solution to calculate and to report bank’s capital requirement. Having led the implementation of this solution to our customer banks, I would like to share some insights from this regulatory change. But first, let’s explore the key changes introduced by CRR3 compared to the previous CRR2 legislation.
Key changes in capital requirement calculation
While core of CRR3 is to define how banks must calculate their capital requirements, much of the actual work and cost comes from building necessary reporting capabilities for CRR3. Among reporting professionals, these are known as COREP OF, LE, and LR reports. CRR3 introduced more granular reporting obligations, and at the same time, the reporting framework underwent a major technical overhaul.
The third, and arguably most important, aspect of the changes introduced by CRR3 lies in the bank’s business operations, where it affects policies and everyday practices. For example, this includes changes to loan application assessment and collateral valuation process.
The most impactful business implications of CRR3 relate to the use of internal models. These are credit risk models that the bank builds by itself to estimate the quality of its’ assets. With regulatory approval, banks have been allowed to use these models when calculating the capital requirements instead of the standardized approach (which can be thought of as simpler credit risk models provided by the regulator).
The internal models cannot be used in CRR3 era as wide as before and the capital requirement benefits gained with the models are capped. The so-called output floor sets a limit ensuring that the maximum benefit of internal models is 27,5 % to bank’s risk weighted assets compared to the standardized way.
Another update in CRR3 involves the credit valuation adjustment (CVA), which was first introduced in the Basel standards as a lesson learned from the 2008 financial crisis. CVA aims to adjust the market value of over-the-counter (not publicly traded) derivatives to reflect the counterparty’s credit risk, compared to a risk-free scenario.
The way banks calculate capital requirement for operative risks, such as cyberattacks or employee misconduct leading to financial losses, has also been overhauled – and aligned with Financial Reporting (FINREP), which is an EU-wide regulatory reporting for banks alongside CRR3. Another risk area, market risk, has also been refined under CRR3, although its’ implementation is postponed by one additional year.
Key changes in CRR3 consider mortgage loans
Besides the aforementioned changes introduced by CRR3 brought compared to the previous CRR2 legislation, I consider the risk weighting of the exposures secured by mortgages on immovable property to be one of the most significant updates (the risk weighting applied to each loan sets the capital requirement at a level that reflects not only the size but also the riskiness of the asset).
These mortgage loans, where the obligor, for example, buys a new house and takes out a loan by pledging the property to the bank, form a big part of European banks’ business. The way capital requirements are calculated for these loans has a direct impact on the margins that also you and I pay on our mortgage loans.
Under CRR2 legislation, when banks used so-called standardized approach, residential mortgage loans commonly received a risk weight of 35%, and commercial properties 50%, up to a certain collateral value limit. The remaining part of the exposure was handled based on the counterparty. This caused the exposure to be split in two, and thus it was named loan-splitting method in both Basel standards and in CRR3 (with a bit different risk weights and collateral value limits).
New concept: ETV ratio
The real renewal in CRR3 concerns the loans where the obligor’s ability to amortize the loan depends primarily on the cash flows that the collateral property produces. For example, this is the case when taking a loan to buy an apartment for rental purposes. These loans are known as income producing real estate exposures (IPRE exposures), and their risk weight is based on the loan-to-value ratio (in CRR3 jargon exposure-to-value, ETV), meaning the ratio of the loan and its collateral(s) — the smaller the better.
Although the concept of ETV ratio is new in capital regulation, it is widely used in banking under the term LTV (and with some different calculation rules) e.g. when granting loans, using mortgage loans as collaterals in covered bonds, and also in FINREP in the domain of regulatory reporting.
Reporting capital requirements using the DPM model
European Banking Authority (EBA) had been preparing already for some time a renewal of reporting data model DPM (common Data Point Model for all regulatory reporting under the control of EBA). The implementation of this new reporting data model was aligned with the CRR3, so that the first CRR3-based capital requirement calculations for Q1 2025 had to be reported using the updated data model, although banks were given extension of 1,5 month for delivering the reports.
Combining the launch of CRR3 reporting (COREP OF, LE and LR) with the reporting data model renewal made sense, as CRR3 caused anyway many changes to the reporting templates. The regulator’s logic was likely to avoid double work, allowing banks to implement CRR3 changes directly into the new reporting framework.
This DPM renewal is still ongoing. Other reports, such as FINREP and COREP liquidity reports (LCR, NSFR, and ALMM), must be reported using the upgraded data model after a transition period. If your organization is still navigating this process and could use additional support, please contact our representatives. We would be happy to discuss your needs and see how we can help.
Making the implementation happen
The third key aspect of CRR3, as mentioned at the beginning of this article, focuses on how banks adapt regulatory changes in their business and operational processes. It also includes the practical work within the bank and collaboration with partners like us at ALM Partners to ensure compliance.
For example, the assessment of loan applicants must now reflect the new regulation. The need to gather and store new types of information in the bank’s systems has required development work from IT and data teams.
At ALM Partners, implementation of CRR3 has been one of our top projects over the past few years. Our services in this area cover the entire value chain: from handling data from different operative systems, to calculating capital requirements, and finally producing and delivering COREP OF, LE and LR reports to the competent authority.
My own passion lies at the intersection of banking, data and regulation — where collaboration between people with different skills and backgrounds is essential to achieving the set goals. Leading our CRR3 implementation project as a project manager has been especially rewarding for me. While this article has focused on general changes introduced by CRR3, I will continue the topic in a future article, where I’ll dive deeper into the practical challenges we faced and solved during CRR3 implementation for our customer banks.
