08 March 2023

EBF's Mijs To fuel sustainable growth in Europe, we must rethink the banking regulatory framework

A review of the current capital requirements and supervisory processes for EU banks could provide capacity for around €4tn in additional bank lending to finance the green and digital transitions, and strengthen the competitiveness of the EU economy. By Wim Mijs, CEO, European Banking Federation

A decade of accomplishments

The European banking system has carried out a series of Herculean tasks since the global financial crisis. The region’s banks have brought their capital and liquidity reserves up to the highest levels across all regions. Enduring the fallout of the euro area crisis, the sector successfully reduced the non-performing loan (NPL) ratio from 6.5% in 2014 to the current 1.8% in the EU. It showed resilience and continued to lend to the economy throughout the Covid-19 pandemic.

Europe’s banks faced these challenges while implementing a massive regulatory framework and participating in the establishment of a new supervisor in the eurozone. However, there are still obstacles to overcome on the way to Olympus.

Higher regulatory requirements, less market value

Twelve years of capital reserve accumulation has put the European banking system at the top of the global ranking of capital ratios, from 7.5% in 2011. A decade later, Europe held the highest capital ratio of 20%, compared with the Americas at 16% and 17.5% throughout the rest of the world.

However, the European peak in capital ratios has not been followed by market value, which stands at €1.4tn, while the US banking system has grown by €1tn since 2012. European banks’ profitability has been below the cost of capital for more than a decade, while US banks have been able to generate more than enough return to cover their funding costs. 

This inverse relationship between regulatory ratios and market value has been a recurrent theme in the debate between banks, investors, regulators and supervisors. To shed light on this debate and open doors to potential solutions, the European Banking Federation commissioned a study on the EU banking regulatory and supervisory framework and its impact on banks and economy.  

Rethinking the regulatory framework

European banking legislation has gone above and beyond global standards in scope, complexity and requirements, covering international and local banks. Overlapping prudential rules between Pillar 1, Pillar 2 and macroprudential tools, as well as the allocation of powers to EU authorities, national authorities and supervisors, make the system overly complex. Overall requirements for capital and resolution funds are higher than in peer jurisdictions. A complex structure of EU and national buffers as well as discretionary decisions like dividend bans or Pillar 2 additional layers, hamper the predictability of capital management.   

An enormous opportunity lies in store if the EU streamlines its banking regulatory and supervisory framework, making it more efficient and equally sound. Financial regulation has a direct impact on the banking sector’s ability to support the economy. A study conducted by Oliver Wyman concluded that a review of current capital requirements and supervisory processes could provide capacity for around €4tn of additional bank lending to finance the green and digital transitions and strengthen the competitiveness of the EU economy.

Adjusting the framework

Decisive action is necessary on various fronts to adjust or conclude regulatory initiatives that can help release much-needed additional financing for European businesses.

Policy-makers should simplify the current complex and costly resolution regime. Supervisors should place greater emphasis on streamlining and making key processes more efficient (such as the Supervisory Review and Evaluation Process or stress testing).

As Basel III is fully implemented, authorities must ensure that EU banks do not have a disadvantage on the global playing field. As mandated by the G20, the impact should not be significant. 

Fostering the securitisation market could free up huge financing resources that are trapped on the balance sheet of European banks. The regulation should be urgently revised to stimulate greater issuance and the supervision should be much more efficient in terms of time to market.

Finally, policy-makers should redouble their efforts to complete the banking and capital markets unions...

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