Financial deregulation: Europe on its guard

“Any deregulation in the United States could have major consequences if it leads to instability. American banks are among the largest and most systemic in the world. A major banking crisis in the US would inevitably have international repercussions, including in Europe.”

Dominique Laboureix, chairman of the Single Resolution Board, which is responsible for resolving banking crises in the eurozone, summed up the feelings of the European authorities when faced with the prospect of financial deregulation in the United States. Donald Trump’s return to the White House has raised fears of a possible domino effect and a race to the bottom in terms of regulation, threatening the solidity of the global financial system.

During his first term (2017-2021), the Republican president implemented a policy of deregulating the financial sector, notably by recalibrating the thresholds defining systemic banks, modifying stress test requirements and relaxing the Volcker rule, which governed proprietary trading. Notably, the Biden administration did not reset these measures, believing them to be appropriate for the US economy.

Basel rules in the firing line

Trump’s re-election has given US banks wings. Their wishlist includes the repeal of a number of rules on predatory lending and credit card fees, as well as easier mergers. “But the most important item on the list is certainly the one they were buying Super Bowl ads for earlier this year: the so-called Basel III Endgame rules,” pointed out the Financial Times.

This refers to the final phase of the Basel III reforms, a set of international standards designed to strengthen the resilience of the banking sector following the 2008 financial crisis. These reforms, finalised in 2017, aim to “restore credibility in the calculation of risk-weighted assets (RWAs) and improve the comparability of banks’ capital ratios”, according to the Basel Committee on Banking Supervision. The EU plans to implement the majority of the new rules from January 2025, while the US is aiming for gradual implementation between 2025 and 2028. However, delays are possible.

Competitiveness at stake

Even before the presidential election, the US authorities had already expressed their desire to adjust Basel III, notably by introducing greater proportionality. Nothing of the sort from the EU: “It will be Basel III, all of Basel III and nothing but Basel III”, according to the official line. European banks are not having it. By increasing their capital requirements, they believe these reforms will limit their ability to support the economy and harm their competitiveness with American institutions. They are calling for a moratorium on the adoption of new regulations.

According to some of these financial institutions, Trump’s previous reforms between 2017 and 2021 attracted capital to the US by encouraging investors to favour American banks. This could explain their better overall profitability. Market participants are also quick to make the link between this regulatory divergence and the valuation gap between banks in the eurozone and those in the US. While the former are trading below par, with a price-to-book ratio of less than 1, the reverse is true on the other side of the Atlantic.

Authorities’ response

From the authorities’ point of view, the competitiveness argument must be handled with caution. Globally important systemic institutions (G-SIBs) are subject to the same rules in the US as in the EU. And they are the ones competing on international markets. According to this logic, whatever decisions Trump has taken have not affected G-SIBs because the standards applicable to them are harmonised at global level.

As for investment flows to the US, the authorities say they have only anecdotal evidence, but acknowledge that regulation may have encouraged US banks to engage in higher-risk or higher-return activities, which may have influenced market conditions. This may have influenced market conditions and contributed to last year’s banking turmoil.

As for the difference in bank valuations, this can be explained by the profound regional disparities between the United States and Europe: distinct economic cycles, divergent monetary policies and different economic structures. In the US, economies of scale are fostered by an advanced securitisation market, while in Europe, economic and financial integration remains weak, with heterogeneous regulations between countries.

In other words, according to the authorities, the competitiveness gap between the US and Europe is not due to financial regulation. They believe that completing the banking and capital markets union will reduce this gap, making the system more competitive. This would encourage cross-border transactions and fair competition, while giving banks more freedom to invest according to economic criteria, without having to deal with the many constraints and barriers currently in the system.

A moratorium on Basel III would not send a good signal to the market or to the international community, according to European financial stability bodies. They affirm their determination to continue implementing these rules, which are considered essential, and emphasise the solidity of European banks during recent crises, notably the covid-19 pandemic and the energy crisis.

On the record, the European authorities are sticking to “wait and see”. “I don’t want to comment on decisions that have not yet been taken, especially in such a politicised context”, commented Laboureix. “What is essential is that each region of the world, including Europe, does what is necessary for its own financial stability. This means that Europe must continue to apply solid rules to protect its financial system, irrespective of the choices made by others.”

As for the US, Europeans are pinning their hopes on an institutional framework that is considered to be very solid. With the Federal Reserve, Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency as safeguards.

Excessive focus on Trump

Carlo Lombardini, a lawyer in Geneva and professor of banking law at the University of Lausanne, believes that the debate on financial deregulation is being distorted by an excessive focus on Donald Trump. “Even if he has been more active on this issue than other presidents, there is a certain continuity in the American approach: the United States generally cares little about international rules and adapts their application according to its own interests”, he pointed out.

At the same time, Lombardini observed that in the UK, despite the initial promise to ease financial regulations after Brexit, the implementation of these changes has remained limited. “The only concrete example that I have been able to identify where the British have deviated from the European framework is the relaxation of the rules on variable pay in the financial sector. Generally speaking, banking supervision in London remains very intense.”

Read the original French-language version of this report /