Capital Regulation as a Driver for Further Consolidation in the Banking Union

In the period following the Global Financial Crisis (2007-2009), the EU bank capital regulation was significantly enhanced through the introduction of stringent requirements aimed to improve the resilience of banks, particularly of the systemically important ones. Today, banks are required to hold more capital and of better quality, mostly in the form of equity (ie, Common Equity Tier 1 or CET1). Nonetheless, the level and composition of CET1 capital requirements differ among banks due to (i) bank-specific capital components (ie, Pillar 2 Requirement (P2R), systemic buffer, Pillar 2 Guidance (P2G)), and (ii) bank-specific characteristics relating to banks’ ability to tap capital markets for the issuance of Additional Tier 1 (AT1) and Tier 2 instruments and the riskiness of their assets, as reflected in their Risk Weight (RW) density. 

In a recent paper, I examine whether the banks’ size affects the level of applicable capital requirements, particularly as regards the amount of CET1 capital. The paper focuses on the capital requirements of 108 ECB-supervised banks with particular emphasis placed on the P2R and P2G rates assigned by the ECB and the systemic buffer set by national authorities. In addition, the paper examines the banks’ RW density, which affects the absolute amount of required capital, and to what extent banks have used the option to issue AT1 and Tier 2 instruments to cover part of their capital requirements. 

The analysis demonstrates that all the aforementioned determinants tend to favour Global Systemically Important Banks (G-SIBs) and other large banks (with assets exceeding €200bn). In relation to the capital components set by the ECB, the most critical refers to the P2R. Under the annual Supervisory Review and Evaluation Process cycle, the ECB assesses large banks as less risky compared to medium-sized and small banks. On average, P2R becomes smaller the larger a bank is. This assessment benefits large banks in two ways. Firstly, a lower P2R results in decreased capital requirements. Secondly, the ECB’s assessment about the (lower) riskiness of large banks should be considered a strong signal to investors about the creditworthiness of those banks. The reduced riskiness of large banks strengthens the market demand for capital instruments issued by them resulting in lower funding costs. Hence, large banks start from a better place when issuing AT1 and Tier 2 capital instruments in order to cover the non-CET1 components of their capital requirements.

Furthermore, the national discrepancies in the determination of the systemic buffer contribute to the creation of an unlevel playing field within the Banking Union: banks with similar asset size and systemic relevance are treated in a different manner because of their location in different Member States. Some national authorities have set the upper bound of the systemic buffer at a low level, thus providing a capital benefit to the systemically important banks located in their jurisdictions, including most of the G-SIBs and other large banks (with assets exceeding €200bn) of the Banking Union. On the contrary, other national authorities have opted for a more conservative approach, mainly driven by the risks that a bank failure could pose to national financial stability. This applies particularly to some small Member States in which the relevant banks are mostly subsidiaries of banking groups headquartered in other Member States. This inconsistency is a significant source of preferential treatment for those large banks. Specifically, G-SIBs and other large banks with assets exceeding €200bn are subject to an average systemic buffer rate of 1.2%, which is equal to the respective rate for banks with assets less than €30bn. 

In total, G-SIBs are subject to an average CET1 requirement of ca 3pp lower than small banks (with assets less than €30bn), mainly due to the fact that they take advantage of the AT1 and Tier 2 allowances granted by CRR/CRD V. Further, given that large banks have a significantly lower RW density, for every billion of assets held, the amount of CET1 capital that G-SIBs are required to hold is nearly half the amount that small banks must keep under the applicable capital requirements. 

In principle, the post-crisis reforms aimed at addressing the ‘too-big-to-fail’ problem through the introduction of stringent regulatory measures for large banks. These measures intended to disincentivise these banks from becoming ever larger and more systemically relevant. However, as shown in my analysis, the existing regulatory framework seems to function as an incentive, rather than as an obstacle, for the further increase of banks’ size. 

From a capital requirements perspective, large banks have every incentive to expand their operations, either on domestic or cross-border basis, at the expense of smaller banks. Banks subject to lower CET1 capital requirements, as is the case for large banks, can finance an expansion of their balance sheet, either in an organic way or through mergers & acquisitions, in a more capital-efficient way. Large banks can finance their acquisitions with less CET1 capital, mostly by leveraging on their ability to tap capital markets for AT1 and Tier 2 capital. Hence, I argue that the EU bank capital regulation promotes the further consolidation and concentration of the banking sector, though this development may in fact aggravate the ‘too-big-to-fail’ problem in the Banking Union. 

Nikos Maragopoulos is an Associate Researcher at the European Banking Institute.