Perspectives | 20 July 2020
Over recent
years, technology and software have become strategic assets for competitiveness
and resilience in the banking sector. Institutions have no choice but to invest
to develop and deliver innovative services whilst managing ever greater IT and
cybersecurity risks.
The pandemic
and announcement of lockdown measures posed a significant challenge for banks’
technology teams as hundreds of thousands of jobs were moved from office
settings to employees’ homes. The way services were provided and distributed to
customers had to adapt to the new circumstances and financial institutions had
to rapidly increase their level of investment to beef up their IT capacity and
build resilience into their infrastructure.
Firms have
therefore made significant investments in technology and will have to continue
to do so, which poses interesting questions in terms of the prudential
treatment of software:
“We need banks to invest in software development to remain competitive and contribute to the digitalisation of the EU economy. Software investments remain penalised in Europe compared to the US where software is risk weighted as an ordinary asset, like premises and equipment.” Frederic Oudéa, President of the European Banking Federation
In terms of
regulatory capital, software assets are currently treated as intangible assets
that must be deducted from a bank’s Common Equity Tier 1. From a prudential
perspective there are concerns regarding the uncertainty of the recoverable
value of software. Especially in a situation of gone concern. Generally,
software cannot be sold separately.
Covid-19 related measures
and new prudential treatment
The European Parliament
published on 26 June 2020 the final version of measures aimed at mitigating the
economic impact of the Covid-19 pandemic in the European Union. One of the
amendments brings forward the date for the new prudential treatment of software
prescribed in the revised Capital Requirements Regulation, CRR2.
Article 36(1)(B) of CRR2 introduces an exemption
from the deduction of intangible assets from CET 1 in case of “prudently
valued software assets, the value of which is not negatively affected
by resolution, insolvency or liquidation of the institution”.
The EBA was mandated
to develop draft Regulatory Technical Standards (RTS) to specify how this provision
will be applied. The RTS was published on 9 June 2020 with a reduced 1-month
consultation period. This draft standard introduces a prudential treatment
based on the amortisation of software assets.
Under this
approach, the positive difference between the prudential and the accounting
amortisation would be fully deducted from the CET 1 capital, while the
residual portion of the carrying value of the software would be risk weighted
at 100%.
The costs
related to the research phase cannot be capitalised and will be expensed in the
income statement, whilst the costs related to the development phase will be
recognised as intangible asset. It is interesting to note that the boundaries
between research and development costs are at the discretion of the institutions,
so they could be tempted to inflate their development costs, which constitute
the value of the intangible asset, in order to amortise more and benefit more
from the prudential relief.
The intensity
of the regulatory benefit will depend on the level of banks’ annual investment
in software.
The proposed
approach is expected to be easy to implement and applicable to all institutions in a standardised manner.
Timetable
From the EBA’s
perspective, it seems difficult that the whole process including the adoption
and publication of the RTS can be completed before the end of 2020. However,
banks, for their part, would like to see this implemented as soon as possible.
It is also interesting to
note that the UK has previously given some indication that this might be an area where the UK might diverge from the EU post
Brexit. It will therefore be important for banks to remain aware of the
publication of the RTS as technically it will apply from the date of
publication, it would be applicable in the UK if this publication happened
before the end of the Brexit Transition period at the end of the year.
Stay tuned….
Article prepared by Yannis Mindjou, Manager in FS Consulting, London
References:
1. https://eba.europa.eu/regulation-and-policy/own-funds/regulatory-technical-standards-prudential-treatment-software-assets
2. https://eba.europa.eu/calendar/public-hearing-consultation-cp-rts-prudential-treatment-software-assets
