The European Central Bank (ECB) Banking Supervision has published draft guidance clarifying the takeover rules within the current regulatory framework to boost the consolidation of banks.

The ECB rolled out the guidance as part of its strategy to make the merger approach more predictable and transparent.

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The guidance outlines certain supervisory principles which determine whether the consolidation ensures sound management and covers the risks of the banks involved.

A final version of the guidance will be published after the stakeholders involved in a merger provide their feedback on the draft guidance – which will be available until October 2020.

Key aspects outlined

The guidance explains how the regulator will handle banking deals in three key areas; the setting of capital requirements, treatment of negative goodwill or “badwill”, and the use of internal models.

ECB said that the banks involved in a merger with high capital requirements will not be penalised.

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Instead, the initial capital of the newly merged entity will be based on the weighted average of either party’s Pillar 2 capital requirements.

Second, ECB pledges to mitigate the impact of badwill on the consolidated business by, for instance, increasing the provisions of the non-performing loans, and cover transaction costs or other investments.

Lastly, ECB has agreed to the temporary usage of existing internal models for calculating capital requirements by the newly formed entity – subject to various conditions and approvals.

In a release, ECB said: “Our proposed supervisory approach acknowledges that the benefits and synergies of consolidation may take time to materialise and that consolidation transactions also involve some risks.

“In this context, it is all the more crucial to monitor the implementation of the integration plan and to take swift supervisory action, where justified, in the case of a deviation from the agreed plan and timeline.”