By David Barwick – FRANKFURT (Econostream) – European banks are being held back by fragmented markets rather than prudential requirements, European Central Bank Executive Board member Frank Elderson said Tuesday, arguing that simplifying regulation should not mean lowering capital standards.

"European banks are not held back by resilience, they are held back by fragmentation, unwarranted complexity and the fact that Europe’s financial market is still not fully integrated," Elderson said during a fireside chat at an event organised by the Hertie School in Berlin.

Elderson, who is also Vice-Chair of the ECB's Supervisory Board, said European banks were in a strong position, with return on equity having recovered and stabilised at around 10%, while their average price-to-book ratio had risen to close to 1.5. The ECB's latest supervisory statistics, due next week, would confirm the positive profitability trend, he said.

But he said the longer-term issue was whether banks could remain competitive as they faced large investment needs in digitalisation, artificial intelligence and cyber resilience. Around 80% of bank lending to households and firms remains within banks' home countries, while less than 2% of deposits are held cross-border, illustrating the continuing fragmentation of the European banking market, he said.

The EU requires around €1.2 trillion in investment every year through 2030 to meet its green, digital and defence objectives, Elderson said, adding that financing investment on that scale required banks able to operate seamlessly across borders and allocate capital where it was most productive.

Any serious competitiveness strategy therefore needed a "time-bound roadmap" towards completion of the Single Market, including concrete steps towards a European deposit insurance scheme, he said.

Without abandoning the objective of a fully fledged European deposit insurance scheme, policymakers could consider an interim step under which the largest and most internationally active banks, including their subsidiaries, were allowed initially to join a single deposit guarantee scheme, Elderson said. Such a move could ease tensions between home and host authorities and facilitate cross-border integration, he said.

Elderson rejected arguments that reducing bank capital requirements was needed to stimulate lending, saying the ECB saw no evidence that existing requirements had constrained credit supply.

"We do not see any evidence that current capital requirements have constrained lending," he said, adding that stronger capital positions enabled banks to withstand shocks while continuing to finance households and firms.

For Germany specifically, banks with common equity tier one ratios above 14% increased lending to the real economy by as much as 3.6% during the pandemic and subsequent energy-price shock, compared with 2.6% for banks with CET1 ratios below 12%, Elderson said, citing Bundesbank analysis.

Lowering prudential requirements would not necessarily generate additional lending and could instead result in higher shareholder payouts, he said. Weak investment demand and uncertainty in the real economy were more fundamental constraints on credit growth, he said.

Elderson nevertheless backed efforts to simplify European bank regulation and supervision, stressing that this should mean "simpler requirements, not lower requirements." He cited the possibility of reducing five existing macroprudential buffers to two and said a more holistic assessment of overall capital demand at the system level "may merit some consideration going forward."

He also pointed to recent efforts by ECB Banking Supervision to reduce procedural burdens. Processing times for capital-related decisions fell from several months to an average of less than six days in the second quarter, while approvals for standardised, less risky securitisations now take around seven days rather than three months. On-site inspections are being completed around 10% faster, and the number of data points banks must provide for stress tests has been cut by around 55%, he said.

Elderson also indicated scope for greater proportionality for smaller banks. European supervisors have suggested allowing national authorities to raise the asset threshold for classification as a small and non-complex institution to as much as €10 billion from €5 billion, while such institutions could potentially be exempted from regular bottom-up supervisory stress tests, he noted.

But proportionality should not be confused with reducing prudential standards, Elderson said, arguing that depositors in smaller institutions should have the same confidence in banks' risk management as depositors in larger ones.