Since the financial crisis, European banks have adapted to a wide-ranging reform agenda. Presumably, no other sector has ever faced such an in-depth regulatory upheaval in such a short time in modern history. The financial crisis resulted in a market which did not fully trust the robustness of financial institutions as expressed in capital ratios. Therefore, the market also paid attention to the leverage of the banks. Even credit ratings, formerly the most reliable indicator of riskiness, were seen as too slow in responding to changes in economic circumstances.
Hence, the EU banking sector started a process of deleveraging, including retaining earnings and raising additional capital and downsizing its balance sheets. The reason for deleveraging and decreased risk appetite was twofold: On one hand the markets pushed banks to reduce risks and demanded higher capitalisation levels. On the other hand there was (an anticipation of) stricter supervision and regulatory requirements.
As a result of the increasing regulation and the stricter supervision, the process of deleveraging, building up capital and the shift towards less risky assets following the financial crisis in 2007 was reinforced. Often these trends were also driven by political decisions.
At the time this response is drafted, the Basel Committee and the EBA have published their reports on monitoring the implementation of Basel III with data as of end of 2014. The capital shortfall of the EU banking system is now virtually nil, meaning that the ambitious recapitalisation program set out by the BCBS in 2010 has been completed. It is time to focus on other priorities; financing the economy is the main one.
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