How Fit and Proper Regulation Shapes Strategic Adaptability in the EU Financial Sector

The cacophony of equivocal calls to simplify EU financial regulation has intensified in recent years. These calls typically frame simplification as necessary to enhance competitiveness and reduce administrative burdens. The debate tends to assume a relatively simple relationship between the absolute amount or complexity of regulation and firm performance. One in which ‘less regulation’ or ‘simpler regulation’ translates into greater adaptability and competitiveness. Yet this binary framing overlooks a more fundamental question: how does regulation actually influence the strategic management of firms?

In EU financial regulation, the ‘fit and proper’ test is traditionally seen as a gatekeeping mechanism designed to ensure that only competent individuals can become managers of banks and investment firms. This test has been constructed in the name of reducing excessive risk-taking by the firms. It has, however, a more nuanced influence on firms, which depend on their managers’ ability to drive strategic change. Regulating managers is, in effect, also a way of regulating firm strategy and the conditions under which strategic change occurs.

In a new paper, ‘Fit, Proper and Capable: How Regulation Shapes the Drivers of Dynamic Managerial Capabilities in the EU’, I argue that, based on the text of the fit and proper regulations, these regulations not only govern who can lead a financial institution but also shape the capabilities required for competing under changing circumstances.

This argument draws on Dynamic Managerial Capabilities (DMCs) theory, which argues, in simple terms, that the firm’s adaptability and performance hinge on the capacity of its managers to drive strategic change. This capacity, in turn, rests on three drivers which can be described on a general level as skills and experience (managerial human capital), networks and relationships (managerial social capital), and ways of thinking and judging as well as emotions (managerial cognition).

I propose that fit and proper regulations, although traditionally framed in terms of limiting excessive risk-taking, engage with all three. They do so in three distinct ways.

Firstly, they exert prescriptive influence by, for example, imposing explicit requirements on qualifications and experience. An otherwise impressive candidate from a managerial human capital perspective may be precluded from becoming a manager if they lack a specific kind of human capital comprising at least basic banking, risk management, and regulatory knowledge.

Secondly, they have a foreseeable influence by, for example, structuring managerial career trajectories. A simple example is the limit on managerial mandates. A manager who must devote sufficient time to one regulated firm may have to decline another mandate elsewhere. Over time, this affects not only how busy that manager is, but also the kinds of experience (managerial human capital), networks (managerial social capital), and information environments through which their strategic judgement develops (managerial cognition).

Finally, they may also exert a facilitative influence, in that certain forms of managerial human capital, social capital, and cognition can help a manager satisfy fit and proper requirements, even where the regulation does not directly require those features. For example, a manager who can respectfully challenge the consensus of a board, ask difficult questions, and resist groupthink may be better positioned to demonstrate independence of mind. The regulation does not necessarily prescribe one specific cognitive style, but certain forms of judgement and behaviour may facilitate compliance with its requirements better than others.

Taken together, these effects suggest that fit and proper regulations do not merely filter managers ex ante. They contribute to the formation and development of the drivers underlying dynamic managerial capabilities.

The primary focus of my paper is to contextualize the DMCs theory and show that the legal reality of the EU financial sector has a prominent role in shaping the potential managerial impact on strategic change of a firm. Nevertheless, it also provides a richer and broader understanding of the relevant regulations through the lens of strategic management. A field traditionally concerned with how firms gain and sustain competitive advantage.

The perspective adopted in the paper complicates prevailing regulatory debates centered on simplification. Rather than treating regulation as external to firm performance, it highlights how regulatory frameworks become embedded in the very capacities through which firms pursue and sustain competitive advantage. From this perspective, the effects of fit and proper regulations are not limited to constraining risk. They also shape the managerial capabilities in more nuanced ways.

For policymakers and regulators, this has important implications. Evaluating regulation primarily in terms of administrative costs risks overlooking its constitutive role in shaping managerial capability and, by extension, a firm’s ability to pursue competitive advantage. Fit and proper regulations are not a neutral screening device. They actively influence the kinds of leaders firms can appoint and the kinds of strategic change those leaders are equipped to pursue. 

My paper invites us to focus not only on how much regulation exists, but what kinds of capabilities it produces or constrains. From this perspective, regulatory discourse might usefully shift from a focus on burden towards a more fundamental and holistic inquiry. Hence, I ask: what if, instead of focusing on the amount of regulation, regulatory discourse focused on its effect on strategic adaptability?

The author’s paper is available here.

Julian Lagus is a University Instructor and Doctoral Researcher at the Faculty of Management and Business, Tampere University.