In a speech on Tuesday, European Central Bank (ECB) supervisory board member Pedro Machado warned that simplification of banking regulation should not lead to softer capital requirements for banks in the Eurozone, adding that such a policy would not boost the region’s competitiveness.

Amid an environment in which European banks are lobbying to reduce the regulation on their industry, Machado said that while simplification was important, it is vital to define what this means and how it can be done without weakening the foundations that make European banks resilient.

A common refrain from larger banks is a desire for the reduction of minimum capital requirements, he continued. Two arguments are regularly made in support of this move: that it would support lending, and that it would boost competitiveness.

In reality, Machado said, this is only true in specific circumstances. While reducing capital requirements during economic downturns does boost lending, the impact in “normal times” is limited.

On the other hand, higher capital requirements have substantial benefits over the medium term by reducing the risk and severity of banking crises, which can have catastrophic costs, he explained.

The ECB’s capital requirements are also not in fact more stringent for large banks than those in the US, Machado continued, despite this being claimed often. The EU’s largest banks would in fact require around eight per cent more capital under US rules, while smaller significant institutions would see a modest reduction of around five per cent.

Machado also spoke in favour of the output floor, which is the “backstop that limits how far internal models can push capital below what the standardised approaches would require.” Although it “ranks high” among the concerns of large banks, Machado said, it is vital in ensuring that banks cannot overly arbitrage their risk profiles.

Instead of focusing on lowering capital requirements, Machado said, the ECB should focus on reducing the costs of capital supervision through programmes it has rolled out such as faster capital decisions, supervisory guide reviews and shorter inspections.

He also advocated for further unification of a banking union within the EU, which would allow more European banks to operate across multiple countries.

Machado closed his speech with a warning that it is often in periods of sustained, stable profitability, such as the present, that the ability to see risk is the weakest. While the system is robust today, it is facing building uncertainty. This means that “any relaxation of capital requirements should be approached with the utmost caution,” to avoid repeating the mistakes of the past, he said.

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