When the banking gets tough, the large get going: How capital regulation is driving consolidation

Abstract

In response to the Global Financial Crisis (2007-2009), the capital regulation was significantly enhanced through the adoption of regulatory measures aimed to improve the resilience of banks, among others, by increasing the required quantity and quality of capital held. Particular emphasis was placed on addressing the “too-big-to-fail” problem seeking to reduce the incentives for large banks to become ever larger and more systemically relevant. The present paper examines whether the banks’ size affects the level of applicable capital requirements and the amount of (CET1) capital that banks are required to hold. Based on an analysis of the capital requirements for 108 ECB-supervised banks, it is demonstrated that the arrangements governing the calibration of the bank-specific elements of capital requirements (i.e. Pillar 2 Requirement, systemic buffer, Pillar 2 Guidance), as well as other bank-specific characteristics relevant to capital requirements (i.e. banks’ ability to issue AT1 and Tier 2 instruments, RW density) tend to favour G-SIBs and other large banks with assets exceeding €200bn. On average, G-SIBs are subject to a CET1 requirement of c. 3pp lower than banks with assets less than €30bn, mainly due to the fact that they take advantage of the AT1 and Tier 2 allowances granted by CRR/CRDV. Also, given that large banks have a significantly lower RW density, for every billion of assets held, the amount of CET1 capital that G-SIBs are required to hold is nearly half the amount that small banks must keep under the applicable capital requirements. The discrepancies relating to the approach for the determination of the systemic buffer (i.e. highest of G-SII buffer, O-SII buffer, or systemic risk buffer), which is still determined at national level, contribute to the creation of an unlevel playing field in the Banking Union, as banks with similar asset size and systemic relevance are treated in a different manner because they are located in different Member States. Therefore, the SSMR should be amended to transfer the competence for the determination of the systemic buffer to the ECB to ensure that the Banking Union will be treated as a single jurisdiction and the determination of the systemic buffer will be made based on uniform conditions. As demonstrated in this analysis, the capital regulation functions as an incentive, rather than as an obstacle, to the further increase of banks’ size. In light of the need for further consolidation of the banking sector in the Banking Union, banks subject to lower (CET1) capital requirements, as is the case for large banks, need less CET1 capital to finance potential M&As, mostly by leveraging on their ability to tap capital markets for AT1 and Tier 2 issuances. Thus, from a capital requirements perspective, large banks have every incentive to expand their operations, either on domestic or cross-border basis, at the expense of smaller banks.