ECB Study Finds High Bank Capital Requirements Do Not Harm Profit Efficiency
SDG 9: Industry, Innovation and Infrastructure | SDG 16: Peace, Justice and Strong Institutions
Institutions: Ministry of Finance | Reserve Bank of India (RBI)
A new occasional paper from the European Central Bank (ECB) examined the widely debated claim that stringent capital requirements undermine bank competitiveness, measured by profit efficiency. The study, using supervisory data for listed euro area banks, found no statistically significant relationship between total capital requirements (OCR) and a bankβs ability to generate profits efficiently. This evidence directly challenges industry arguments that current capital rules are a key constraint on banking profitability.
The analysis did uncover a significant, but non-linear, inverted U-shaped relationship between a bankβs own capital level (CET1 ratio) and its efficiency. Profit efficiency was found to improve as capital increased, but only up to an estimated threshold of around 18% CET1. For banks that hold excessively high capital (above 18%), further increases were associated with a decline in profit efficiency, possibly due to excessive risk aversion.
The findings support the current regulatory philosophy that maintaining strong capital buffers serves the long-term stability and resilience of the financial sector without imposing a meaningful trade-off in terms of short-term profit efficiency.
What is the Common Equity Tier 1 (CET1) Ratio? β The CET1 ratio is a key measure of a bankβs financial strength and resilience, representing the core capital, primarily common stock and retained earnings, as a percentage of its risk-weighted assets. It is the highest quality form of capital, designed to absorb losses and maintain stability, as mandated by the global Basel framework of banking regulation.
Follow the full update here: https://www.ecb.europa.eu/pub/pdf/scpops/ecb.op376.en.pdf