Finance is one of the most tightly regulated sectors in the Western world, and not without reason. It forms the foundation on which modern welfare states are built on. Historically, it has been one of the most fragmented sectors within the European Union, as each of the member states had spent centuries co-evolving with their local finance providers. Each has adapted to local needs and has been shaped by local histories.
European Monetary Union
Slowly but surely, the European Commission is seeking to accomplish a true monetary union within the member states, mimicking the formation of the largest contemporary federal republic – the United States of America. The process has been far from a walk in the park, and there is still considerable work required before the “United States of Europe” becomes a sovereign superstate.
Adopting the Euro as a common currency was a major accomplishment towards the goal. Another important aspect, hidden from plain sight, is unifying the regulation between the member states. For the traditional banking sector, one of the most important regulatory frameworks is called the Basel Framework. Now in the third iteration of the framework, it is often referred to as Basel III. Banks are currently implementing the latest updates after the previous iterations, Basel I and Basel II.
Following the delay caused by the COVID-19 pandemic, the European Commission has published its long-awaited proposal on implementing the final Basel III reforms. These reforms were required to be implemented in European law by January 1st, 2023.
What is the Goal of the Basel Framework?
The end goal has been clearly stated since the Basel I agreement:
“Taking a major step towards European unification by completing an EU-wide finance union and trying to prevent a continent-wide economic collapse by strengthening bank capital requirements, increasing minimum capital requirements, mandating the holdings of high-quality liquid assets, and decreasing bank leverage dynamically.”
This has proved to be controversial from the start. To address the presented concerns, the Commission is expected to launch a public consultation on the review of the Bank Recovery and Resolution Directive (BRRD), and the Deposit Guarantee Schemes Directive (DGSD). The implementation of the Basel III reforms is another major milestone towards the goals of the Commission.
Ongoing Issues in Implementing the Basel Framework
The impact of the COVID-19 pandemic, and the persistent inflation stemming from the extremely stimulatory monetary policy practiced by the European Central Bank (ECB) since the 2008 financial crisis, is far from over. It is likely to fuel arguments in favour of allowing more divergence in European law from the Basel III standard. For example, Nordic banks are currently operating at noticeably lower risk levels than major French and south European banks.
The Nordic banks have more of their assets tied to mortgages that are already stress-tested to 6% Euribor rates, instead of holding large quantities of sovereign debt from highly indebted southern European countries. In addition, the mortgages are typically valued at 70% of their face value, compared to 100% of the face value of sovereign debt. This is because the current regulation allows the assumption that a sovereign state cannot become insolvent – until of course one does, like Sri Lanka recently. EU-wide stress tests clearly reflect the difference in resilience. If this difference will not be reflected in the regulatory environment, then banks that have historically operated at higher risk than their competitors – by, for example, not diversifying their assets clearly across asset classes – could gain an unfair advantage. We will see whether the inevitable Basel IV will address these concerns.
For private investors, not all of the changes have been positive. For example, artificially limiting access to non-EU markets and financial instruments helps to keep the fees of European brokers at much higher levels than their American and Asian counterparts. In addition, some EU countries continue to blatantly ignore both European law and national one-to-one agreements on taxation, instead pushing all the burden to correct double taxation to the private investors themselves. They are now faced with complex legal procedures in foreign languages with little to no help from the national authorities – who were supposed to handle everything automatically already, years ago.
Remote Identity Proofing
Many could argue therefore that the changes have been without a net benefit so far, but there is one positive change on the horizon. This change is about allowing one to create a strong digital identity via remote connection, without already possessing a strong electronic ID (eID). This is called remote identity proofing, and it could potentially change the fintech landscape dramatically throughout the whole European Union, by allowing its more than 300 million residents to utilise financial services in all of the 27 member states, without having to physically travel.
The identity verification process is necessary to fulfil the legal requirements of Know Your Customer (KYC) and Anti-Money Laundering (AML) legislation. Despite the common misunderstanding, identity verification does not, by itself, represent any kind of trustworthy relationship between the end user and the organisation. Unlike the verifiable LEI, for example.
How Remote Identity Proofing Works
The verification would traditionally be carried out in person, by verifying a physical identity document and comparing the photograph of the holder of the document to their face in real life. For remote identity proofing, the European Telecommunications Standards Institute (ETSI), an independent organisation that standardises norms at the European level, has created a standard framework for remote identity proofing.
The standard recognises identification through video in a live stream, with the recording of the entire process, as the only way that remote identity proofing can have the same level of legal compliance as a physical face-to-face verification. This repeats what is already stipulated in the eIDAS regulation for the European Digital Identity Wallet (EUDI, often referred to as EU ID or EUID). This is as opposed to using still photographs or selfies, which have high fraud rates and therefore are not eIDAS compliant.
The first national launches of the EUDI are scheduled for 2024, and a continent-wide rollout will hopefully follow soon after. That will bring strong individual identities to the masses, then it’s time for the other half: strong organisational identities. Discover more about digital identities in finance or strong organisational identities below: