Brussels wakes up to the fact that the EU banking system is not competitive

Two years after the publication of the 2024 Letta and Draghi reports on the competitiveness of the European economy, the European Commission has just published a ‘Communication’ – a sort of white paper – on the banking sector. The initial reaction might be: better late than never! A definitive assessment, however, can only be made once the legislative proposals, due by the end of 2026, have been put forward. It remains to be seen whether the Member States will accept these proposals, in order to definitively remove the obstacles to the creation of a truly integrated European financial market.

However, the Commission’s document introduces some important new developments. The first is the open acknowledgement that the European banking system has developed a competitiveness problem. This may seem a trivial statement, yet this fact has long been denied, particularly by the European Central Bank. On various occasions, not least during the consultation organised by the European Commission prior to drafting its Communication, representatives of the Single Supervisory Mechanism had argued that “competitiveness is not a problem for the (European) banking system, but rather for individual banks”. The rather original argument that ‘the competitiveness of the banking system should not be measured on the basis of profitability or share prices’ is also refuted. In addition to acknowledging the evidence that the European system has lost competitiveness, particularly compared with the US system, the Commission considers that one of the main causes lies precisely in regulation, which has allowed the market to become fragmented. This means that European regulation, adopted in particular under the Basel Accords, must no longer be regarded as off-limits. It can – and must – be re-examined from a fresh perspective, taking into account European experience and interests. This is a view that has so far been rejected in Frankfurt.

One example of outdated and distorting regulation concerns macroprudential rules, which have so far allowed national authorities to impose capital buffers that vary from country to country, based on criteria that are not only different but often inconsistent. Another example is the rules that allow national supervisory authorities to block the flow of liquidity and capital within countries, rather than allowing them to flow throughout the entire area.

The third new development in the Commission’s document is the recognition of a close and complementary link between the competitiveness of the financial system and that of the real economy. Market fragmentation not only weakens the banking system but also acts as an obstacle to Europe’s economic growth. Without an integrated banking market, households and businesses have less access to credit, which makes the European economy less competitive.

Finally, the Commission highlights how, particularly in light of events over the past two years, government action – often in breach of European legislation – has contributed to exacerbating market fragmentation. In particular, this has hindered the growth in scale of banks, which is necessary to compete with the major US operators that already dominate strategic sectors of the European financial market. Moreover, these actions have not yielded any benefits for the intermediaries they were intended to protect. It is no coincidence that the European banks currently subject to unsolicited takeover bids are precisely those in which the state has remained – perhaps for too long – a shareholder.

Overall, the European Commission’s Communication has the merit of explaining that the European economy cannot be competitive unless it is competitive in every sector, including the financial sector. It is not enough for the banking system to be sound and well-capitalised. Unless it is also efficient and competitive, it cannot support European economic development. In pursuing the priority objective of financial stability, European regulatory and supervisory authorities can no longer ignore the consequences of their actions on the competitiveness of the European banking system. This is already the case in other countries, starting with the United Kingdom. It is unclear why it should not be the case in the European Union as well.