Rethinking EU Banking Regulation and Supervision

This blog post reflects on the current approach to the European Union (EU) regulation and supervision of banks, which was developed based on the post-Great Financial Crisis (GFC) de Larosiere Report. The practical implementation of the recommendations in this report was based on three pillars: [a] the adoption of an EU Single Rulebook; [b] a certain degree of centralized supervision; and [c] supervisory convergence (henceforth referred collectively to as the de Larosiere Doctrine). Given the recent Mario Draghi report, it is opportune to discuss a process for refining and recalibrating the EU’s approach to regulation and supervision.

The central argument of the blog post is that while the de Larosière Doctrine has bolstered the stability of the EU's financial system during critical periods, its current application could lead to over-regulation, potentially hindering competition, innovation, and consumer choice. Instead of rehashing familiar arguments by the industry about regulatory and supervisory burdens, this blog post aims to refine and build on a proposal for a more proportionate framework for banking regulation and supervision made in one of the authors’ article entitled: ‘Proportionality in EU financial regulation: A case for a two-tier EU Single Rulebook | The Malta Business Weekly’, published on 12 September 2024 in the Malta Business Weekly.

This blog post is based on a speech one of the authors delivered during the MFSA Annual Banking Conference, held on 11 November 2024.

1. Background:

Our proposal is to introduce different chapters within the EU Single Rulebook, each of which would address different types of institutions. It is, however, essential that the same Rulebook is applied across all the EU Member States, such that it still meets the purpose of eliminating legislative differences between these States and ensuring a level playing field—a ‘Two-Tier Single Rule Book.’

In light of these considerations, our proposal differentiates among banks on the basis of size, complexity of the business model, connection to other institutions, and risk profile. Banks that are of significant size, have a complex structure or business model, are highly interconnected, and operate a high-risk profile are termed ‘Large Complex Banks’. Banks that are not complex, are small, and operate a low-risk model based on simple local transactions are termed ‘Less Complex Banks’. It is noteworthy that the UK Prudential Regulatory Authority makes such a distinction based on a £20 billion threshold.

2. Regulation

It is proposed that large complex banks continue being governed by the full EU Single Rulebook to ensure consistency and uniformity across multiple EU Member States. This approach ensures systemic stability and strengthens mutual understanding and trust between Member States, allowing such banks to operate without facing regulatory barriers to cross-border business. The EU Single Rulebook, already in force, would continue to eliminate complexities arising from divergent national regulations and foster a more integrated European banking market. Proportionality requirements would need better application and implementation depending on the nature, scale, and complexity of each bank’s business model, particularly by, for example, setting a dedicated EU Single Rulebook for Less Complex Banks.

For Less Complex Banks operating primarily within national borders, a principle-based approach is suggested, implemented through a new chapter within the EU Single Rulebook. This approach would be more respectful of the subsidiarity principle and ensures that national regulation can address specific domestic risks while adhering to a set of common minimum prudential standards across the EU. This method maintains regulatory cohesion while providing the flexibility to address local conditions. The principle-based approach could entail, inter alia, a minimum regulatory capital allocation, adherence to minimum liquidity thresholds, disclosures, governance requirements, remuneration, and regulatory reporting. This approach would build upon the existing proportionality consideration in regulations such as the EU Capital Requirements Regulation and the EU Capital Requirements Directive.

The proposed framework can also be applied in the field of resolution, particularly as it is likely that Less Complex Banks would fall under the definition of a liquidation bank and not a resolution bank. This would relieve minimum requirements for own funds and eligible liabilities requirements for banks that operate only domestically, the failure of which would not affect the EU.

3. Dual-layered Structure for Financial Supervision

A critical review of the criteria for designating significant institutions for European Central Bank (ECB) supervision under the framework for a Single Supervisory Mechanism (SSM) is necessary. Currently, a minimum threshold requires at least three banks from each member jurisdiction to be categorized as significant, leading to disproportionate supervision of a number of banks, which would otherwise be considered as small, while some larger banks remain under national supervision. Reconsidering these selection criteria would ensure that supervisory resources are directed where they are most needed, optimizing the efficiency and effectiveness of supervisory practices and would address the anomaly whereby banks having, for example, € 5 billion in assets, are put in the same bucket as banks which have more than € 1.3 trillion of assets.

Large Complex Banks would continue falling under the SSM framework for supervision, calibrated to the size and business model of each bank, and including centralized supervision depending on redefined criteria as proposed above. This acknowledges the varying systemic importance and risk profiles across institutions.

The new chapter of the EU Single Rulebook applicable to less complex banks would emphasize proportionate supervisory convergence. Supervision would be scaled according to each bank's size and risk profile, avoiding a one-size-fits-all approach. This would promote alignment in supervisory standards while considering the unique characteristics of domestic banks. The framework would need to accommodate transitions from the national supervisory framework to the EU framework to provide for situations where a bank eventually becomes a Large Complex Bank.

4. Conclusion

In the aftermath of the GFC, the EU has significantly advanced its financial regulation and supervision, with efforts centered on harmonization, centralized supervision, and supervisory convergence. Key regulatory frameworks such as the EU Single Rulebook, alongside entities like the European Supervisory Authorities and the European Central Bank, aim to bolster the stability and resilience of the EU's financial system. While the de Larosiere Doctrine has improved financial stability and consistency in supervisory practices, it also poses challenges, particularly for smaller institutions that struggle under a system primarily designed to cater to all banks uniformly.

Recognizing these challenges, the proposal advocates for a shift from a one-size-fits-all regulation towards a nuanced and more proportionate model. This new approach seeks to maintain the de Larosiere Doctrine's emphasis on cohesion and stability while embracing proportionality and subsidiarity principles. By doing so, it aims to lessen the regulatory burden on Less Complex Banks, ensuring that compliance costs do not stifle innovation or competition. Adapting regulatory standards to the unique characteristics of each institution can help the EU remain agile and responsive, fostering a dynamic and inclusive financial sector that aligns with the evolving demands of the banking landscape.

Christopher P Buttigieg is an Associate Professor at the University of Malta, the Chief Officer—Supervision at the MFSA, a member of the Board of Supervisors of the European Banking Authority (EBA) and European Securities and Markets Authority, and the Chair of the ESMA Proportionality and Coordination Committee.

Anabel Armeni Cauchi is the MFSA’s Deputy Head of Banking Supervision, the high-level alternate of the EBA Board of Supervisors, as well as the main member of the ECB's Senior Management Network and EBA SUPRISC.