Why European regulations are pushing aviation banks towards riskier deals

A group of French Aviation banks are in talks, through various channels, with the European Banking Authority (EBA) to delay or potentially modify part of the incoming Basel 3.1 banking regulations over concerns they are pushing banks to chase riskier deals, and potentially deter some institutions away from the sector.

For specialised lending sectors like aviation finance and project finance, Basel 3.1 looks to restrict the use of internal model-based approaches, as well as introduce a capital floor to limit the capital gain associated with the use of internal models.

Different regional and national banking authorities are responsible for how the Basel III recommendations are adopted and how quickly.

The EBA looks to be one of the first regulators to insist on the new regulations. It is in the process of adopting the CRR3/CRD6 banking package which applies the Basel III revisions to the advanced internal risk models, and which came into effect in the EU at the start of the year.

Specifically, Ishka understands that European aviation banks are looking to address two specific elements:  the 2025CRR3 article 495b: EBA mandate on SL, and the 2025CRR3 article 181(5): discount rate EBA mandate.
 

The EBA mandate on specialised lending (SL)

For specialised lending sectors like aviation finance and project finance, Basel 3.1 looks to restrict the use of internal model-based approaches, as well as introduce a capital floor to limit the capital gain associated with the use of internal models.

Different regional and national banking authorities are responsible for how the Basel III recommendations are adopted and how quickly.

The EBA looks to be one of the first regulators to insist on the new regulations and is in the process of adopting the CRR3/CRD6 banking package, which applies the Basel III revisions to the advanced internal risk models and has been adopted by the EU since January 1, 2025.

The proposals in front of the EBA would see current loss given default (LGD) floors, the projected level of losses banks would face in the case of a default, which will progressively increase from its current level at 7.5% up to 15% or 25%.

But sources warn that the new LGD floor being imposed on banks is simply too high and does not reflect the level of historical defaults. According to GCD a non-profit bank association that collects bank default and losses data, recovery rates for secured aircraft loans between 2000 to 2023 are around 89% due to the large secondary market for aircraft assets.

The new proposed average LGD floors are simply too high, argue banks, and are higher than 73% of actually realised losses according to GCD data between 2000 and 2023.   Being forced to use an overstated LGD floor makes it very difficult, or often impossible, to finance low-risk transactions.

"Putting up the risk weights will compel banks to search for higher margins, margins by the way which do not exist in the commercial aircraft market at the moment. So, we are seeing some banks move towards other segments, and that's of concern for the OEMs like Airbus and Boeing.  We see many banks not being able to finance new planes, which is a real concern for ESG and fleet transition," reflects one financier.

In addition, Basel III also affects how insurance is treated for capital relief purposes. Previously, banks could use internal models for insurance, but since January there's been a fixed LGD of 40% for insurance-covered exposure, reducing the capital relief that private non-payment insurance offers. “Basel kills the insurance market... they don't recognise the part that is insured by insurance. There is no recognition of collateral, almost nothing," reflects one financier.  However, ECA cover will continue to offer banks some capital relief.

The EBA is currently in the process of evaluating its implementation of these proposals, and aviation bankers are hoping to convince the regulator to delay or halt the planned calendar of LGD floor increases, and put forward new thresholds based on actual default data from 2000-2023.

Please note that Ishka data has been used by banks in recent talks with regulators to demonstrate current risk-adjusted margins.

 

The Ishka View

Bank regulations serve a vital role in helping preserve the financial system as a whole. However, the new Basel 3.1 measures are being applied at different speeds and unevenly, with European banks facing a stricter and faster implementation of Basel 3.1 compared to US or UK banks.

The new LGD floors being suggested by the EBA sit at odds with the historical GCD data for aircraft finance, and if implemented, will see many European banks unable to compete to fund new aircraft deals, particularly on loans aimed at better credits. Some aviation banks are already adapting by chasing riskier credits or shortening tenors to reduce capital requirements

High fixed LGD floors incentivise banks to take on riskier transactions since they're already required to set aside the same capital regardless of the actual risk level. As one source comments: "if you don't recognise the security you have in connection by putting a floor on your LGD... Why would you bother?"

The real concern is that some banks might leave the sector. Several French banks are already being forced to narrow the scope of their lending to mostly finance new aircraft under their ESG policies. Basel regulations are putting additional pressure on these banks. Ishka notes a contraction in the number of dedicated aviation banks since the pandemic.

The counterargument is that while there may be fewer dedicated aviation banks, a number of alternative aviation lenders have been set up, which could offer airlines and lessors financing for new deliveries. Bankers argue that this misses the point, which states that regulations shouldn’t force airlines and lessors to go to the private credit market.

 

 

 

Comments:

Sign in to post a comment. If you don't have an account register here.