European banks urgently need regulatory rebalancing

European regulators should follow the lead of their US counterparts in focusing on streamlining services, rather than offering a one-size-fits-all approach

Author: Camillo Venesio, Vice President of the Italian Banking Association

September 28, 2017

With the eurozone finally back on the path to recovery across the bloc, EU policymakers should move on to the next pressing item on their agenda: financial regulation.

In the wake of the financial crisis, the authorities have introduced a set of requirements – applicable without distinction to the entire banking sector – which sometimes overlap, creating confusion and excessive burdens for lenders without additional advantages. European regulators should therefore follow the approach taken by their American counterpart and focus on streamlining these standards, particularly with regard to their unique implementation.

The need for balance
On June 12, the US Treasury Department released a report titled A Financial System That Creates Economic Opportunity: Banks and Credit Unions. The document was released in response to the executive order signed by President Trump on Feb. 3, which contained seven core principles aimed at improving banking and financial regulation and promoting economic growth.

This very detailed report recognizes the importance of adequate financial regulation in order to prevent new crises. However, it also condemns the complicated oversight structure currently in place, caused by the creation of multiple regulatory agencies with overlapping mandates. The authors of the papers therefore call for a “sense rebalancing” and offer 106 detailed and precise recommendations aimed at improving and simplifying the regulatory framework.

Banking regulations often overlap, creating confusion and excessive burdens for lenders with no added benefits

According to the report, this rebalancing is of crucial importance. The report explains that the implementation of these banking and financial regulations “has created a new set of obstacles to recovery by imposing a series of onerous regulatory requirements on banks and credit unions, most of which were not related to the resolution of the problems leading to the financial crisis or applied too prescriptively or too broadly”.

Moreover, according to the report: “The magnitude and additional costs imposed [by regulations] led to a slowdown in the growth rate of bank assets and loans. Additionally, “small business lending has been one of the most anemic sectors, barely recovering to 2008 levels. adaptation and imprecise calibration of capital and liquidity standards have reduced the flow of credit to meet loan demand”.

herd mentality
The authors devote a significant portion of the paper to community banks and credit unions (the US equivalent of less significant institutions (LSIs) in Europe, Banche di Credito Cooperativo in Italy, and Raiffeisenbanken in Germany and Austria), emphasizing their importance in financing and services to households and small and medium-sized enterprises (SMEs).

However, the definition already indicates another approach and respect for the banking sector in general, and local and regional banks in particular, which are among the main lenders to SMEs in Europe, as in the United States. But this is not enough: it is clear that each LSI does not present any systemic risk and could therefore overall be subject to simpler rules. However, recently the leaders of the Single Supervisory Mechanism have publicly declared that small banks are “systemic as a herd”.

Imagine the feelings of those who work in a small or medium European bank. In addition to being considered “less important”, they must also follow almost all the rules applied to a large group because they are part of such a herd. At the same time, the report notes that in the United States, “the Treasury strongly supports efforts to further empower our community banking and credit union sectors.” He also noted: “The Treasury recommends that the overall regulatory burden be significantly adjusted. This is appropriate given the minor complexity and lack of systemic risk of these financial institutions.

Banking rules really need to be adapted to the size and complexity of banks

Follow America’s lead
The very strong arguments in favor of a sensible rebalancing of the regulatory framework are consistent with the frequent arguments of bankers in close contact with the real economy. The regulations themselves are not the cause of a restriction of lending to smaller counterparties, but rather their excess, their overlapping, their inadequate coordination and their intention to greatly reduce banks’ risk taking. These factors are holding back the overall growth of the economy, with SMEs accounting for over 99% of the total number of businesses in Europe.

I therefore do not propose the non-application of Basel III standards and other rules for all banks with assets of less than 10 billion dollars, as indicated in the US Treasury report. I simply recommend the meaningful and concrete application of the principle of proportionality, namely that the rules must really be adapted to the size and complexity of the banks.

Also, the US has a slightly smaller population than the Eurozone, but twice as many lenders. Regardless of this situation, there is no mention in the report that the number of banks is excessive, assuming that the number of operators in any sector is determined by the market and not by regulators.

Thus, it appears that Article 119 of the Treaty of Lisbon is sometimes forgotten: the economic policies of EU Member States are “conducted in accordance with the principle of an open market economy with free competition”.

I sincerely hope that European political authorities will undertake the same in-depth study, rigorous analysis and engagement with different viewpoints as their American counterparts have. This will allow them to assess the potential revision of European banking and financial sector regulation, giving appropriate recommendations to regulatory authorities based on concrete evidence.