Lower capital requirements are no shortcut to European competitiveness

The European banking sector is known for high regulatory complexity, market fragmentation, and uneven implementation of international standards. However, this column argues that across-the-board reductions in capital requirements are not the solution. European requirements are not uniformly higher than US requirements, and capital rules do not mainly explain the past gap in return on equity, which is now largely closed. Lower capital requirements are also unlikely to unlock additional lending for early-stage technologies and innovative firms. Instead, reforms should focus on simplifying the interaction between different requirements, streamlining reporting, and completing the Banking Union.

Europe faces substantial investment needs in defence, energy, and innovation. Geopolitical tensions have made these needs more urgent, particularly in defence and energy security (Vissers et al. 2025). Given Europe’s heavy reliance on bank financing, banks are expected to play a key role. The European Commission’s report on the competitiveness of Europe’s banking sector highlights regulatory complexity, market fragmentation, and uneven implementation of international standards. This has revived a contentious question: are prudential rules holding European banks back? The debate has gained urgency as the US has renewed efforts to roll back parts of its post-crisis regulatory framework under the second Trump administration (European Commission 2026).

The European Banking Federation argues that EU-specific additions to international standards, supervisory add-ons, and national buffers unnecessarily constrain banks’ lending capacity, and calls for supervisory add-ons and national buffers to be reduced (European Banking Federation 2026). Industry analysis has also argued that regulatory requirements contribute to European banks’ historically lower profitability relative to their US peers (Oliver Wyman 2023, European Banking Federation 2026). Assessing that case requires separating three questions. Are capital requirements generally higher for European banks than for US banks? Do they explain European banks’ historically lower profitability? And would lowering them generate more lending, especially for Europe’s investment priorities? The answers differ in detail, but they do not add up to a case for an across-the-board reduction.

Are European capital requirements higher than US requirements?

Headline capital ratios cannot answer this question. European and US banks calculate risk-weighted assets differently and face different stress tests, leverage constraints, and supervisory requirements. US banks generally face higher risk weights, so the same loan portfolio results in more risk-weighted assets. A lower required capital ratio in the US can therefore still require as much or more capital against that portfolio than a higher European ratio. 

Recent comparisons that take these differences into account do not find that European capital requirements are generally higher. A counterfactual application of current US rules to EU banks finds that the largest EU banks would face stricter requirements under US rules whereas mid-sized ones would face lighter ones. Whether US or EU requirements are more demanding depends on bank size and the interaction of risk weights, add-ons, and leverage constraints (Bank of England 2025, Baudino et al. 2026, Dzezulskis et al. 2026). Current US proposals would narrow rather than overturn this picture: requirements for the largest US banks would fall, but are not expected to fall below those of comparable EU banks (Bank of England 2026, Theurer 2026).

Do capital requirements explain lower European bank profitability?

The profitability claim starts from the way banks are funded. Equity investors generally demand a higher return than depositors and senior creditors, because they bear greater downside risk. More equity can therefore appear to raise funding costs. More equity also lowers leverage and, for a given amount of net income, mechanically lowers measured return on equity because that income is spread over a larger equity base. This helps explain why retur-on-equity figures feature prominently in calls for lower requirements. However, this is not the whole story. Reducing leverage also makes equity less risky, as gains and losses on the bank’s assets translate into smaller fluctuations in returns to shareholders. This lower risk, in turn, reduces the return investors require on equity. In addition, it increases a bank’s capacity to absorb large losses in times of crisis, thereby reducing risks for bondholders and debt funding costs.

More important for the current debate, however, is whether capital requirements explain the gap in return on equity between European and US banks. European banks had substantially lower return on equity than US banks after the Global Crisis. Yet the gap largely disappeared as European interest margins recovered, even though capital requirements were not eased (Figure 1). In 2025, banks in both regions recorded returns on equity of about 10–12% on average (Hoendervangers et al. 2026). This development is a result of different underlying business models: large US banks earn more from fees and trading in deeper capital markets, while large euro area banks depend more on interest income and were therefore more exposed to very low and negative rates (Di Vito et al. 2023). Bank-level evidence finds no indication that lower capital requirements make banks more efficient at generating profits. If anything, higher actual capital ratios tend to be associated with greater efficiency for less well-capitalised banks (Behn and Reghezza 2025). Capital rules affect funding choices and measured returns, but they do not appear to be the main reason European banks historically lagged their US peers.

Figure 1 The US–EU bank return-on-equity gap largely closed as ECB rates rose

Source: Hoendervangers et al. (2026).

Would lower capital requirements translate into more lending?

The idea that lower capital requirements automatically free up money for new lending rests on a mistaken image of bank capital. Capital is not cash that banks must set aside; it is a source of funding: the equity-financed part of a bank’s balance sheet. A bank can fund the same loans with more equity and less debt. Lowering its capital requirement therefore does not directly release money for new loans.

Lower capital requirements can support lending only when requirements genuinely bind and banks cannot or do not want to raise equity or retain earnings. Whether these conditions hold in practice is therefore crucial. Studies generally find that higher capital requirements have only a modest effect on lending over the longer term (Basel Committee on Banking Supervision 2022). The effect tends to be larger when banks have little spare capital or during periods of financial stress. Looking at the recent post-pandemic increases in capital buffers, Behn et al. (2024) find no statistically significant change in corporate lending by the average euro area bank. Banks with less headroom experienced slower loan growth, but firms partly replaced the affected credit with loans from elsewhere. That the effect is concentrated among banks with little headroom is unsurprising: capital requirements are meant to ensure that additional risk-taking is backed by sufficient capacity to absorb losses. In this case, the effect on particular bank–borrower relationships did not translate into a material reduction in aggregate corporate lending.

Broadly binding capital constraints, however, do not describe Europe’s banking sector today. Banks are profitable, hold capital above regulatory minima, and made record payouts to shareholders in 2025 (European Banking Authority 2026, Vissers et al. 2026). Any additional headroom created by lower requirements could support more lending, but it could also enable further payouts or investment in other assets. More headroom does not itself create viable loans: firms must want to borrow, and banks must expect returns that justify the credit risks.

Finally, reducing bank capital can impose broader social costs and also affect lending in periods of market stress. Better-capitalised banks are less likely to fail and draw on public funds, and are better able to continue lending after losses (Soederhuizen et al. 2021, Basel Committee on Banking Supervision 2022). The idea behind releasable buffers is precisely to allow banks to absorb losses in a downturn without cutting credit (Basel Committee on Banking Supervision 2022, Miettinen and Nier 2025).

Would lower capital requirements help finance the EU’s investment priorities?

Even if capital requirements were binding and lowering them increased lending, the additional credit would not necessarily finance the investments at the centre of the EU agenda. Banks are well suited to provide loans backed by collateral and predictable cash flows. Some defence, energy, and infrastructure projects meet those conditions. Early-stage technologies and innovative firms often do not: they have uncertain returns, few tangible assets, and a greater need for investors who share the firms’ risk (Brouwer et al. 2026). Lower capital requirements would not turn these projects into suitable bank debt. Deeper equity markets, well-designed securitisation, and targeted risk-sharing are needed for these investments instead (Vissers et al. 2025).

Simpler rules, not a lower common denominator

Across-the-board capital relief is poorly matched to Europe’s competitiveness problems. European requirements are not uniformly higher than US requirements, and capital rules do not mainly explain the past gap in return on equity. Lower capital requirements are also unlikely to unlock additional lending, especially the risk-bearing finance needed for innovative and strategic projects.

There is nevertheless substantial scope for reform. Simplifying the interaction between different capital requirements could make buffers easier to use in periods of stress, while more consistent implementation and streamlined reporting would lower the cost of operating across borders (European Commission 2026, European Central Bank 2026, Miettinen and Nier 2025). Reform also needs to go beyond prudential rules: completing the Banking Union would help banks achieve cross-border scale, while the Savings and Investments Union could expand risk-bearing finance for projects that do not fit bank balance sheets. The relevant distinction is between simplifying the framework and weakening it. The Eurosystem has argued that unnecessary complexity can be reduced while preserving the banking system’s overall resilience (European Central Bank 2026). Lower capital requirements are no substitute for reforms that address fragmentation, scale, and Europe’s shortage of risk-bearing finance.

Source : VOXeu