How can the EU improve the competitiveness of its megabanks?

Insufficient bank capital was at the core of the 2007-2008 financial crisis and subsequent euro-area crisis of the early 2010s, when banking sector fragility fed a contagious, vicious circle between banks and sovereigns. Since then, the mandatory requirements on banks to maintain sufficient capital, central to modern bank prudential frameworks, have been raised. But there are now vocal advocates for easing these capital requirements again, particularly for the system’s largest banks (‘megabanks’). 

A common argument for lowering capital requirements claims that the United States is going down this road already, creating unfair competition for European Union megabanks, and that lower requirements would help European competitiveness. Our new paper, however, sheds doubt on such narratives. 

Notably, US megabanks have gained market share from their EU peers in the last two decades while being subject to higher capital requirements. Moreover, while requirements on US megabanks are now being relaxed by the Trump administration, this has in practice moved them closer to previously lower EU levels rather than materially undercutting these. 

What hampers EU megabanks’ competitiveness is not an overly demanding capital framework but EU banking-policy fragmentation, which in turns keeps the banking market fragmented. To address that, the EU must complete the banking union project it started 14 years ago. This means integrating decision-making on macroprudential buffers and crisis response, building on the proven success of the euro area’s single supervisory mechanism.

This week, the European Commission will publish its strategy on banking policy. Hopefully that will catalyse decisive reform to end banking policy fragmentation. Simplification of the capital framework should be part of the reform drive, but without any decrease in banks’ safety and soundness. 

The Why Axis is a weekly newsletter distributed by Bruegel, bringing you the latest research on European economic policy. 

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