Financial regulation has gone too far and European banks are at risk

Algirdas Brochard // 28 July 2017

Since the last financial crisis, the EU has gradually increased its financial regulation. This has now gone too far and it contributes to the ongoing decline of European banks on a global as well as on a European level, something that in turn threatens the European economy.


The size of the increased regulation can be hard to fathom: the Markets in Financial Instruments Directive (MiFID II), the rules governing how financial markets function, has more than 1.4m paragraphs. With months to go until the regulation enter into force at the beginning of 2018, JWG estimates that a third of the rules have not been formalised. The costs of implementing MiFID II are also staggering:  management consultancy firm Optimas estimates those at over €2.5 billion, with over €700 million per year over the next five years required to just maintain compliance.


MiFID II is far from being the only additional burden throw onto European banks. The European Parliament is currently considering legislative proposals to implement the Basel III framework. Basel III is a set of regulatory measures agreed upon by central banks and authorities responsible for banking supervision from around the world. Theoretically, these measures must be adopted globally. However, a recent report by the Bank for International Settlements (BIS) shows that, while European Institutions have already implemented or are planning to introduce new legislative proposals for all the measures agreed in Basel III, the United States have not published draft legislation for a number of proposals.


Indeed, the current climate in the US is moving towards a simplification of the existing rules. The newly elected American president has ordered the Treasury to publish reports detailing how the regulatory framework can be simplified. While some of the recommendations in the first (of four) reports that was published on 12th June 2017 need to now pass through Congress (and are thus unlikely to be adopted because of the difficulties of passing a bill in the Senate) the majority of the changes could be enacted as soon as President Trump completes the nomination of the heads of the different regulatory agencies.


Coming up next are the so-called Basel IV measures. These new rules seek to limit banks’ ability to use internal models to evaluate assets’ risks, thus determining minimum capital requirements. They would require banks to use globally observed averages rather than country specific risks. In Europe, contrary to the US, banks do not offload their loans onto government-sponsored agencies but keep them on their balance sheets. As a result, European banks, which have so far adopted more rigorous assessments of their customers’ creditworthiness, risk being severely damaged compared to their American counterparts.


The proposed Basel IV regulation would not take into account the measures that European Banks have taken to lower the risks. Analysts at Deutsche Bank have estimated that Europe’s largest listed banks’ core capital needs would increase by about €160bn. Furthermore, it is interesting to note that, even though the US is pushing for these measure at the Basel committee level, it is highly unlikely they will enforce these rules at home.


The increasing regulatory burden has been one important factor contributing to the decline of European Banks. On a global scale, in 2010, European investment banks (including Swiss banks) held a 35% market share. In 2015, this share decreased to 30%. During the same period, their North American counterparts (American and Canadian banks) saw their market share increasing from 58% to 62%. In European, Middle Eastern and African (EMEA) markets, in 2011, European investment banks (excluding Swiss banks) held a 53.7% market share. By 2015, this share dropped to 46%. During the same period, US banks increased their market share by 10% points, from 34.7% to 44.6%.


While the increased share of American banks might not sound alarming, it is important to recall that, during the 2007-2008 financial crisis, these institutions came under intense pressure to reduce their European assets. This is a very important fact to highlight because, contrary to the US, where corporations finance themselves mainly via the market (they do so in 70% of cases), 80% of Europe corporations’ financing needs are met by bank loans.


Consequently, if European companies have restricted access to capital while other competitors around the world have more options to fund themselves, European companies will be at serious disadvantage. Measures aimed to greatly increase European banks’ capital requirements will limit their ability to fund the European economy and would primarily impact first-time buyers.


Europe has strongly tightened its regulation since the financial crisis. The Commission and the European Parliament must now realise that this process has gone too far and that new rules will severely threaten the whole European economy.

EPICENTER publications and contributions from our member think tanks are designed to promote the discussion of economic issues and the role of markets in solving economic and social problems. As with all EPICENTER publications, the views expressed here are those of the author and not EPICENTER or its member think tanks (which have no corporate view).


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