Resilient banks, resilient economy

Introduction

As a follow-up to the Draghi agenda, the European Commission is expected to publish a report on competitiveness in the Single Banking Market in 2026.^[1] The European Commission has promised to assess the overall situation of the banking system, including evaluating banking sector competitiveness. It has noted the need to avoid a global regulatory race to the bottom in banking regulation, to reduce barriers to market integration and undue administrative burdens, and to avoid penalising EU banks that compete on international markets.

The core aim of the Draghi report is to raise productivity growth for the whole EU economy, as a pre-condition for increasing the Union’s strategic autonomy. As banks are the major source of private financing in the EU, the hope is that by reviewing EU bank regulation, simpler rules and improved market access will help banks to increase their lending to support this goal.

This presents a carefully balanced mandate for the simplification of bank regulation. The European Commission must find ways to improve the single banking market while at the same time evaluating (not promoting or facilitating) the competitiveness of the banking sector. Success should be defined as the EU having a strong and resilient banking sector: as the EU’s funding needs increase, the financing capacity of banks will need to increase, which requires them to have a strong capital base. As external and internal threats to financial stability multiply,^[2] the resilience of EU banks must also stay strong, because the EU can ill afford a major banking crisis now, politically or economically.

Stronger and simpler financial regulation can thus build market stability and certainty, which the EU needs to raise its productivity growth and strategic autonomy.

However, it cannot be ignored that some financial sector lobbyists have conflated Draghi’s goal of strengthening the EU’s competitiveness with strengthening the banking sector’s own competitiveness, which, they suggest, can be achieved by weakening the EU’s rules on bank capital.^[3] They may have been encouraged by the Draghi report’s observation that bank profitability can support lending,^[4] forgetting that (a) EU banks have enjoyed an extraordinary run of profits, dividends and share buybacks in recent years and (b) bank profits only increase lending to the extent that they are retained as capital to fund more bank lending. In fact, there is no problem with EU banks’ profits.

Policymakers are used to special interest lobbying and can weigh such interventions on their merits. As the European Central Bank’s (ECB) supervisory board chair, Claudia Buch, said, “the perspective of banks and their shareholders may not fully reflect the perspective of society more broadly”.^[5]

Numerous regulators and supervisors have also spoken recently to confirm that competitiveness and simplification should not mean deregulation, for example:

• “Any proposal to change the EU prudential framework should sustain current levels of resilience,” First Principle of the ECB’s High-Level Task Force on Simplification.^[6]
• “By strengthening resilience, we don’t weaken competitiveness. We enable it. Resilience is not a constraint on competition – it is the foundation that makes it possible,” ECB Supervisory Board member, Sharon Donnery.^[7]
• “The message for governments and financial regulators is clear: now is not the time for deregulation,” ECB Executive Board Member, Isabel Schnabel.^[8]

The task facing the European Commission is, in simple terms, to simplify bank regulation without weakening it. This position paper addresses some of the false narratives around simplification and competitiveness in the banking market and introduces Finance Watch’s recommendations for this agenda.

I. EU banks are profitable

The ability of European banks to maintain profitability and attract investors has not been affected by regulation, contrary to what some may claim.^[9] As this section shows, European banks are booming and could have grown even faster, had they not chosen to increase their profit payout ratios.

European bank profits have soared in recent years: the combined annual net profits of significant institutions in the Single Supervisory Mechanism (SSM) more than doubled to EUR 187bn between December 2019 and December 2025.^[10] With non-performing loans (NPL) down, thanks to previous regulatory intervention, and interest rates up, there is no evidence that banks are having difficulty in maintaining profitability.

Over this time, SSM banks increased their ratio of profits paid out in dividends and share buybacks from 44%^[11] of profits before the pandemic to 53%^[12] of (a larger amount of) profits in the years after. The ECB’s Financial Stability Review November 2025 noted that the share prices of euro area banks have been “driven by sustained strong earnings momentum and record profit distributions (dividends and buybacks) in recent months, with price-to-book ratios rising to new post-financial crisis highs and gradually catching up with those of US peers”.^[13] This was reflected in strong investor sentiment, with the EURO STOXX index of share prices for European banks nearly quadrupling since 2019. There is no difficulty in attracting investors.

It is true that there has been a historical difference in return on equity rates between EU Global Systemically Important Banks (G-SIBs) and their US peers. However, this has been largely explained by other factors. An ECB analysis puts the difference down to larger US banks having more trading and fee income in a more market-based financial system, more investment in technology and expertise that enabled US banks to dominate the lucrative investment banking business globally, more domestic market concentration and pricing power, and access to a larger single domestic market than peers in the EU (with its 27 countries and 24 official languages).^[14] These structural differences are beyond the reach of most prudential regulation, although the completion of the Banking Union may increase market share for some EU players. EU bank profits had also been weighed down by NPLs, which are less of an issue now: the NPL ratio including central bank balances among eurozone significant institutions has fallen from a high of 7.5% in 2015 to 1.9% in Q4 2025.^[15]

The banking industry’s claim that regulation has affected its ability to finance the economy can also be challenged by the data. As mentioned, European banks in the SSM system have increased their profit distributions in recent years. With the remaining profits, they were able to add a cumulative EUR 300bn^[16] in common equity tier 1 capital (CET1) over the six years from December 2019 to December 2025, raising average CET1 ratios from 12% to 15% and increasing loans and advances by 18%.^[17] That is good news, but if banks had chosen to distribute fewer profits, they could have added three times as much CET1 and increased their lending capacity accordingly, assuming sufficient demand for credit. If banks really do have limited ability to finance the economy, it mainly reflects their own preferences. In summary, EU banks are profitable, investable and could already increase their real economy financing if they choose.

II. How EU bank regulation compares with the US

A commonly seen claim is that the EU should level down its prudential regulation to help European banks compete with international rivals, especially in the US. This section shows why this claim is ill founded: G-SIB rules are actually weaker in the EU than the US and could be levelled up, while O-SIIs (Other Systemically Important Institutions) are better protected in the EU than US peers and should stay that way.

A. Requirements on G-SIBs are weaker in the EU

European G-SIBs operate under a less stringent regulatory framework than their US peers. That is true now and, as shown below, seems set to remain so after planned changes to US banking regulation, for both risk-based and leverage requirements.^[18] For G-SIBs, there is nothing to level down to; if anything the EU should be levelling up.

At first glance, current US risk-based requirements appear to be more relaxed than in the EU because of lower headline ratios. But these ratios are applied to risk-based assets, which are higher in the US than the EU because of the so-called Collins Floor.^[19] Before these standards can be compared internationally, it is necessary to adjust for this discrepancy; as the Bank of England said in December, “an unadjusted comparison is misleading, especially relative to the US”.^[20] Unfortunately, this did not stop the banking lobby from publishing unadjusted comparisons and giving the misleading impression that European capital standards for G-SIBs were higher than in the US.^[21]

When the ECB adjusted for the Collins Floor in 2023,^[22] it found that “the average requirement for European banking union significant institutions as a whole would be somewhat higher under the US rules”. The Bank of England’s adjusted comparison from December 2025 also found that “US banks’ risk weights continue to be higher than those of UK [and EU] banks”.^[23] To put a number on this, the Bank of England’s report shows in its Chart 5 (reproduced below) that adjusted risk-based requirements for G-SIBs are around 8-9% higher in the US (i.e. 9.8% CET1 requirements versus 9.0% in the EU).

Source: Bank of England, December 2025, Financial Stability in Focus^[24]

This is the current situation. In March 2026, the US Federal Reserve proposed a series of reforms to US capital regulations.^[25] The proposals are complex and fall outside the scope of this paper. However, the accompanying Memo to the Board of Governors of the Federal Reserve System summarises that “the cumulative impact of all proposals on risk-based capital requirements – including proposed stress testing changes – would lower the common equity tier 1 capital requirements of Category I and II firms by 4.8%” (relative to current levels).^[26] As this is smaller than the existing 8-9% difference in CET1 requirements between the US and EU calculated by the Bank of England, this suggests that the US will continue to have slightly more stringent capital rules for G-SIBs than the EU, even if the proposed US rules are implemented in full (please note, the percentages represent the relative changes in capital required, not changes to the ratios themselves).

The picture is similar with leverage requirements. US G-SIBs will on average be subject to a 3.7% leverage requirement, after a planned reduction in the US’s enhanced supplementary leverage ratio has been implemented, versus 3.3% in the EU, excluding P2G, according to the same Bank of England report.

The conclusion for G-SIBs is that EU standards are on the low side as compared to the US and could, if anything, be levelled up.

B. Other Systemically Important Institutions (O-SIIs)

O-SIIs in the EU are subject to the same 3% leverage requirement as their US equivalents (Category II and III banks, under the US Tailoring Rule^[27]), according to the Bank of England. For risk-based capital, O-SIIs in the EU are subject to an average CET1 requirement of 8.9% versus 8.3% for their US peers. The difference is because the EU applies systemic buffers to O-SIIs as well as G-SIBs, while the US opted to apply systemic buffers only to G-SIBs. As the failure of Silicon Valley Bank (a Category IV bank when it failed) showed, even a small bank failure can cause widespread losses and systemic threats. The US banking system has been left dangerously exposed by this gap. Finance Watch concludes that the EU should keep its O-SII buffers and keep them strong.

Regardless of the discussion above, policymakers should, on principle, not be using capital requirements to give EU banks a competitive advantage over international rivals. Supervisors must be free to rely on Basel minimums to avoid a regulatory race to the bottom and to set higher local standards where necessary to reflect prudential threats and market characteristics in their jurisdiction.

III. The importance of bank capital for financing the economy

As there are conflicting (and sometimes incorrect) narratives promoted around bank capital, this section revisits how capital provides resilience and enables credit growth. It explains why credit growth from a strong capital base is financially sustainable and protects the system, unlike credit growth from reduced capital requirements, which is one-off and harms resilience. It also suggests a mechanism to ensure that any changes to capital requirements actually deliver the benefits used to justify them.

A. Capital improves resilience

Estimates suggest that a full-blown banking crisis could cost an enormous 43% to 63% of GDP, on a net present value basis.^[28] A large part of this comes from the loss of credit supply when banks are under-capitalised going into a crisis and extend “much less credit for several years after a crisis”, leading to economically sizable social costs.^[29] Capital also helps banks to fail safely in normal times, which is important for their social licence and for citizens to maintain trust in a market economy.

B. Capital improves lending capacity

Banks with more capital have more lending capacity, which directly benefits the economy when used to finance productive activities. The Draghi report identified an annual funding gap of EUR 800bn to meet the EU’s decarbonisation, digitalisation, defence and productivity needs, to which it hopes banks can contribute.^[30] As the European Savings and Retail Banking Group manifesto put it, “well capitalized responsible banks are the best guarantee for SMEs to flourish.”^[31] The same is true for larger borrowers.

The credit growth mechanism works as follows: As demand for loans increases, banks fund their credit expansion by taking on more debt themselves, which is easier and cheaper to do when banks have more equity. Conversely, it may be difficult or impossible for banks to increase credit if they have too little capital. As the new lending generates profits, banks can retain a portion of profits to rebuild capital ratios, and the cycle can begin again. Equity is the starting point and the enabler for sustained and resilient credit expansion.

When Bank for International Settlements (BIS) head of research, Hyun-Song Shin, analysed the data behind this mechanism, he concluded: “the elasticity of total lending with respect to book equity is very close to one… If the objective of central bankers is to encourage greater lending, then equity is key, not more debt.”^[32] On this basis, any reductions to the capital strength of banks are likely to weaken the long-term funding capacity of the EU’s banking system, which is surely not an outcome that policymakers wish for.

C. Cutting capital is no guarantee of increased lending

While capital is the basis for lending and its growth, it is also true that cutting capital requirements can provide a one-off increase in lending, depending on how banks deploy the freed-up capital. This short-lived mechanism is what financial industry representatives promote to policymakers in support of deregulation. However, credit growth achieved this way reduces future capacity for lending growth, which is essential for the banking sector to contribute to closing the EU’s funding gap. With banks paying out more than half of their profits in dividends and share buybacks, there would be a strong incentive for banks to simply pay out any capital released if requirements were lowered. That would be a lose-lose outcome for the Draghi agenda: less resilience and no gain in financing capacity.

If some of the capital were retained to support an increase in bank assets, there is still no guarantee of how much it would close the funding gap. ECB data for loans by monetary financial institutions (i.e. banks) to the private sector show that, between 2019 and 2025, EU banks increased their lending to financial firms such as hedge funds, private credit, private equity, and real estate funds 2.5x faster than they increased their lending to real economy businesses. The result was that loans to non-financial companies – the sector where most productivity growth happens – fell to only 14.6% of total bank assets by the end of this period, continuing a worrying long-term downward trend.

Source: ECB data for euro area MFIs (Loans to the private sector^[33], Balance sheets of MFIs^[34])

Industry-sponsored studies tend to assume that all changes to capital requirements feed straight through to higher real economy lending, often at multiples between 10x and 20x, leading to wild claims about trillions in additional lending. As explained above, there are good reasons to treat such estimates with caution. In addition, any increase in lending that does result from deregulation is likely to reflect an underpricing of risk, storing up problems for the future. The better route to increase bank lending in the EU is to nurture a banking sector with the capital strength to grow sustainably and organically from its own profits, not from one-off capital reliefs.

D. Changes to capital requirements need supervisory mechanisms to deliver benefits

If capital requirements were to be weakened, a move that Finance Watch advises against, it would be essential for supervisors to ensure that (a) banks do not pay out the “freed-up” capital in profits and (b) that “freed-up” capital is deployed in support of real economy lending. That would at least help to ensure that the loss of resilience and capacity for banks to grow their future lending could be offset, at least in part, by a one-off gain in productive financing.

Past deregulations have not had such mechanisms, even when they have been justified as improving real economy financing.^[35] However, the precedent exists. Careful supervision during the implementation of Basel III ensured that EU banks built capital to meet new requirements by retaining profits and not deleveraging, thus maintaining credit supply.^[36] It should be possible to develop a formal supervisory mechanism to oversee all changes to capital requirements, whether upwards or downwards, to capture the public benefits and ensure that regulatory changes deliver the outcomes used to justify them.

IV. Finance Watch’s recommendations for simplifying bank regulation

This section summarises Finance Watch’s proposals to simplify prudential rules and improve the operational environment, so that banks can more easily serve the economy. Other improvements could include reducing market fragmentation, completing the Banking Union and Capital Markets Union, harmonising supervision, and removing national divergences in the implementation of EU law (the move from Directives to Regulations).

Conclusion 

To be internationally competitive, the EU must consider not only how to simplify bank regulation but also how to maintain bank resilience. Strong regulation and supervision leads to resilient banks, sustainable lending growth, and a strong and resilient economy. Policymakers should also set KPIs for the banking sector to link the outcomes of bank financing to the real economy.