The European Union should not water down bank capital standards

In the context of financial deregulation in the United States, it may be only a matter of time before President Trump’s administration proposes delays to the final parts of Basel III. Basel III is the set of measures developed by the Basel Committee on Banking Supervision in response to the financial crisis of 2007-2009. It aims to strengthen the regulation, supervision and risk management of banks worldwide. 

The weakening of US financial rules under President Trump has been previewed by, among others, the nominee director of the US Consumer Financial Protection Bureau (CFPB), Jonathan McKernan, who wants to be less aggressive toward financial institutions (Trump is also cutting CFPB staff and considering transferring some of its powers to other agencies). Meanwhile, the nominee to head the Commodity Futures Trading Commission, Brian Quintenz, worked for a crypto fund and aims to simplify rules on digital assets. The nominee to head of the Office of the Comptroller of the Currency (OCC), Jonathan Gould, advocates reducing the regulatory burden on small banks.

On 21 April, the Federal Deposit Insurance Corporation (FDIC) told staff that it planned to cut its workforce by around 20% as part of the Trump administration's efforts to reduce the number federal workers. The FDIC is responsible for resolution and deposit insurance and is one of the authorities in charge of banking supervision, playing an important role in the  financial stability of the US.

The OCC’s Gould wants to ease the ‘Volcker Rule’ that places certain limits on bank investment activities, and the FDIC has announced a review of regulations to promote a “dynamic and growing economy”. The US Department of Justice in April disbanded the National Cryptocurrency Enforcement Team, a group of prosecutors specialising in prosecuting cryptocurrency-related crimes (Basel III includes rules on the handling by banks of crypto assets).

US deregulation will pressure the European Union to follow. Even before the return of President Trump, the financial industry and the finance ministries of the largest EU countries were pushing the European Commission to take the competitiveness of the banking sector more into account when proposing financial regulation, and to level the playing field with other jurisdictions.

Already in July 2024, the Commission decided to postpone until January 2026 the implementation of some Basel III standards (known as the fundamental review of the trading book), which aim to align bank capital buffers better with the actual risks banks face when trading on capital markets. This was done to bring the EU in line with the US. The UK announced an even longer delay.

The European Commissioner responsible for the banking sector, Maria Luís Albuquerque, has the objective of reviewing the EU framework “to ensure that innovative, fast-growing European companies and start-ups can finance their expansion here in Europe, while ensuring financial stability.” There is no ranking of these objectives, but it would be a bad idea for the EU to follow the US down the road to weaker banking regulations.

The primary objective for regulation should be financial stability, in the same way that price stability is the primary objective of the European Central Bank, superseding all other objectives. The competitiveness of the financial sector should be the secondary goal. Moreover, while there might be trade-offs in the short run, in the longer term, financial stability is a precondition for a thriving financial sector.

Excessive deregulation could sow the seeds for a new global financial crisis. There is no convincing evidence that implementing the capital requirements necessary to support financial stability hampers long-term investment, growth or credit to the economy. 

Furthermore, a direct comparison suggests that US banks are in fact subject to higher capital requirements than EU banks. The famous floor on risk weights (which limits the freedom of banks to apply their own risk models to calculate capital) is already applied in the US. Finally, there is no sign that capital requirements on banks are a constraint at present in relation to credit.

The EU should resist pressure to follow the US on financial deregulation and further postponement of Basel III implementation. While there is scope for simplification, regulatory standards should not be lowered, and the EU should implement Basel III as planned. The Global Financial Crisis cost the EU 9% of GDP and this should not be repeated. Only well-capitalised banks can finance the EU economy, including during economic setbacks.