Prof. Christopher P. Buttigieg is chief officer Supervision at the Malta Financial Services Authority
The European banking sector is marked by diversity, in size and complexity of business models. At present, the EU employs a quasi-uniform Single Rulebook for all banks, which may not adequately apply the principle of proportionality. This approach can be disproportionately burdensome for less complex banks.
Small banks with similar business models may collectively become systemically significant, especially at a national level, where these are exposed to similar risks. Consequently, some suggest that applying a lighter regulatory regime for smaller banks might introduce systemic vulnerabilities. Others have raised concerns about the creation of an unlevel playing field in the EU’s banking sector.
When properly implemented, the principle of proportionality can preserve the stability of the financial system while also enhancing the competitiveness of the European banking sector. The article makes a proposal for a Two-Tier EU Single Rulebook for banking, with the existing EU Single Rulebook applying to large cross-border and complex banks, while a simplified version would be tailored to less complex institutions.
Complexity of regulation is not necessarily a good indicator of resilience. The article argues that simplifying the complexity of regulation for less complex banks may still achieve resilience and stability in the financial system.
Financial stability and competition
Financial crisis demonstrated that small banks are not inherently less risky and may still have a systemic impact. In this regard, demands for a wider application of the principle of proportionality is, at times, perceived as an excuse for relaxing regulatory requirements, which may threaten the stability of the financial system. Another point frequently raised is that a more proportionate approach through simplified regulation for a certain category of the industry could distort competition within the sector, potentially disrupting the level playing field of the EU single market.
These arguments often neglect proportionality’s capacity to enhance financial stability, as imposing overly burdensome regulations on small institutions can undermine a diverse financial landscape and, in turn, competition. When small banks exit the market due to high compliance costs – creating a segment of the financial sector that is “too small to comply” – financial stability is threatened. This scenario can also lead to less competition, increased risk concentration and the continued rise of “too big to fail” institutions.
Proportionality and the Single Rulebook
The EU Single Rulebook was introduced following the 2008 financial crisis, based on the 2009 de Larosière Report, with the aim of establishing a harmonised regulatory framework across the EU. It has since become the cornerstone of financial regulation, developed and further amplified by the European Supervisory Authorities. Current EU regulations, such as the Capital Requirements Regulation and the Markets in Financial Instruments Directive, are accompanied by numerous delegated acts and technical standards, making the framework exceedingly complex for both the industry and supervisors.
This increasing complexity in regulation can be attributed to the more complex financial environment and the diverse business models that banks are now adopting. As banks move away from traditional banking models and markets become more globalised, they are entering new risk areas. Consequently, policymakers and regulators develop regulation that address these changes. The challenge for regulators becomes that of achieving proportionality and avoiding a “one-size-fits-all” approach.
The current quasi-uniform EU financial regulations disproportionately affect small and large banks, imposing relatively higher costs on less complex banks. Although some proportionality is evident, such as more lenient reporting requirements for small banks compared to large ones, there is a need for a more comprehensive differentiation in regulatory requirements. This can be achieved through distinct rules tailored for different types of institutions, considering the size and complexity of their operations.
Proposed Two-Tier EU Single Rulebook
The application of a Two-Tier EU Single Rulebook that distinguishes between large cross-border and complex banks and less complex banks would aim at granting policymakers and legislators the ability to implement a calibrated set of rules tailored to various categories of banks. This approach is similar to the existing framework under the Single Supervisory Mechanism (SSM), which discriminates between significant and non-significant institutions based on specific criteria. Unlike the SSM, however, under the proposed Two-Tier EU Single Rulebook, size alone would not determine the applicable rule set, other factors such as the complexity of the bank’s business model and the extent of cross-border operations would also be part of the consideration.
It may be argued that the implementation of a Two-Tier EU Single Rulebook could potentially result in an unfair level playing field between large cross-border and complex banks and their simpler counterparts. To address this concern, the Rulebook should clearly define the regulatory elements applicable to each category, ensuring that institutions are subject to appropriate regulation depending on the nature, size and complexity of their business.
The proposed EU Rulebook for less complex banks should reduce the sophistication and complexity of the regulatory requirements applicable to them. This would involve, for example, allowing these banks to have leaner governance structures that are more commensurate to the risk profile of the entity, simplified calculation of capital requirements, less sophisticated internal processes and simplified stress test procedures, along with significantly reduced reporting requirements.
Conclusion
Adopting a Two-Tier EU Single Rulebook is a strategic move towards achieving a more effective level of proportionality in EU financial regulation. As the European Commission prepares for its upcoming mandate, a critical reassessment of the current Single Rulebook approach is crucial. Future actions should involve a comprehensive evaluation process that could lead to a shift in strategy. Prioritising proportionality is essential, not only for ensuring financial stability but also for enhancing the EU’s global competitiveness. By focusing on proportionality, the EU can foster the development of more competitive and resilient banks, strengthening their position on the international stage.