vdp calls for concrete measures to strengthen the competitiveness of the banking sector

• Heading in the right direction: European Commission’s latest communication highlights important need for reform; specific, tangible proposals are lacking
• Continuing increase in capital burden is not adequately addressed
• For German banks affected by the output floor, regulation already adopted threatens to impose a further increase in capital requirements of around 20% between today and 2032.
• vdp calls for the output floor to be permanently set at 50% – effective, minimally invasive, without jeopardizing financial stability

The Association of German Pfandbrief Banks (vdp) welcomes in principle that the European Commission’s communication on the competitiveness of the European banking sector, published recently, accurately identifies numerous shortcomings in the existing regulatory framework. One especially positive aspect is that, for the first time, thoughts on reform go beyond a mere simplification, which is to say merely paring back excessive bureaucracy in regulation. That said, the Commission’s communication so far only highlights problem areas and possible courses of action in rather general terms, while failing to provide concrete solution approaches. Almost two years since the Draghi report, this neglects the urgent need to reform the excessive regulation of banking and the pace of developments witnessed in this area in other legislations.

It is incomprehensible, moreover, why the European Commission devotes a great deal of attention to the question of a possible consolidation within the European banking market, yet continues to address capital relief as a secondary issue. In this way in particular, the Commission turns a blind eye to developments in other regions of the world, notably in the US, and knowingly ignores the negative relationship between the amount or level of capital held and banks’ capability to grant loans.

“The European Commission so far fails to attach enough importance to the issue of the continuing increase in capital burdens in Europe, and so ignores developments in other regions of the world. This will not sufficiently strengthen European banks’ lending potential!”

said Jens Tolckmitt, Chief Executive of the vdp.

European banks are not calling for massive capital relief measures such as those currently granted to US credit institutions. The stability that has been achieved through reforms to date – above all, through Basel III – should not be called into question. However, if the European banking sector is today – explicitly also in the view of supervisory and regulatory authorities – already stable and well capitalized, decisive action must be taken to halt the further sharp increases in capital burdens expected in the years to come.

For the banks in Germany that are affected by the output floor, the regulation already adopted means a further hike in capital requirements of around 20% between today and 2032. This is not appropriate. One conceivable, minimally invasive solution would be to permanently set the output floor at its initial level of 50%.

This would prevent capital burdens from continuing to rise “in autopilot mode” and really strengthen the efficiency of European banks, without harming financial stability. In addition, the output floor would finally serve its original, intended purpose: a backstop for capital backing – instead of an all-defining control variable.

The need to change the treatment of capital backing for residential property loans and unrated corporate loans generally seems to have been recognized in the meantime. It is therefore appropriate and urgently necessary to make their regulatory privileged status, which has so far been limited in time, permanent. At the same time, similar treatment of certain commercial property loans that can be proven by means of hard testing to have identically low default rates is likewise necessary.

The prohibitive capital backing required for ADC exposures (Acquisition, Development and Construction – the form of financing typically employed for the new construction and renovation of properties) – also needs to be examined. This is a glaring flaw in the European implementation of Basel III. For the current treatment with a risk weighting equivalent to that of a defaulted loan is not only inappropriate – it is also diametrically opposed to the European political objectives of creating housing and of the sustainable transformation of the building stock.

The vdp now expects the Commission’s analyses to be quickly followed by concrete legislative proposals that will actually lead to stronger competitiveness. What is needed is an adjustment that makes banking regulation appropriate and risk-based, preserves the safety standards achieved thus far, and at the same time focusses on the banking sector’s competitiveness and – even more importantly – on its ability to serve the real economy.

“We are heading in the right direction. But the general analyses must now be quickly followed by concrete measures that will actually lead to considerably improved competitiveness,”

Jens Tolckmitt, Chief Executive of the vdp, stressed.

“A competitive European banking market needs a risk-sensitive and straightforward regulatory framework. Only then can banks fulfil their central task of financing investment, housing construction and sustainable transformation,” Tolckmitt concluded.