Understanding the banking sector capital framework in the European Union

This paper describes and evaluates the European Union (EU) banking sector capital framework, focusing on how the international standards set by the Basel Committee on Banking Supervision have been implemented within the EU. Using granular supervisory data for significant institutions under the Single Supervisory Mechanism (SSM), we quantify the capital impact of EU-specific regulatory choices, supervisory measures and macroprudential policies. We show that most EU capital requirements stem from Basel standards, which encompass both prescriptive “Pillar 1” components and elements that are expected to be designed and calibrated at the jurisdictional level. The paper describes the evolution of capital ratios and requirements since the inception of the SSM and discusses the relationship between changes in capital levels and indicators of banking sector performance. To provide a comparative perspective, a model-based counterfactual exercise compares capital requirements of EU banks with those that would arise if EU banks were subject to the main prudential regulations that currently apply in the United States, which vary depending on the size of the bank. The results show that for the largest EU banks, the current US rules would entail stricter requirements, whereas mid-sized EU banks would be subject to less stringent requirements. Our findings show that EU capital requirements are broadly comparable to those in other jurisdictions and are largely in line with international standards. When assessing broader indicators of bank performance, we highlight the importance of considering not only private costs and benefits, but also intended effects and broader societal objectives. [...] JEL Classification: G21, G28, F36