The EU had enough of toeing US’ line on banking

The US may have gone too far in pushing the European banking industry to play by American rules. Justified or not, these efforts are causing a protectionist pushback that probably won’t do global finance any good.

European banks have been losing market share to US ones, especially in investment banking, for years. Today, US financial institutions are responsible for more than half of global investment banking revenue, leaving European Union-based ones with less than a third; in 2006, their shares were 49 per cent and 42 per cent, respectively.

Much of the realignment has occurred in the European market, where US banks have almost caught up with the locals.

In part, this was the natural consequence of regulation that aimed to restore the balance between the size of banks and the national economies that they serve. The US is far bigger than any European nation, so it can sustain bigger banks.

The EU is not a country; despite recent efforts to unify the regulation of big banks, national banking systems are still, to a large extent, separate.

In recent years, however, the US has also been deliberately tough on foreign banks. In 2014, it introduced new rules for foreign lenders, requiring them to capitalise their US subsidiaries separately so that American regulators could essentially oversee them as separate entities.

The oversight by various US regulators has been a heavy burden: According to Corlytics, which maintains a database of regulatory fines, EU-based banks were fined a total of $32 billion between 2009 and 2015, about 20 per cent of all fines imposed on banks.

The EU has not demanded that US banks ring-fence their European operations, and the U., Europe’s biggest financial market, has only fined US lenders $1 billion between 2009 and 2015. But more recently European patience seems to have worn thin.

The US Justice Department’s intention to fine Deutsche Bank $14 billion and a recent push for tougher capital requirements under the Basel framework of international banking rules — spearheaded by US regulators such as the Federal Deposit Insurance Corporation’s Thomas Hoenig — appear to have pushed the Europeans over the limit.

The Basel Committee is expected to discuss new rules that would restrict banks’ use of internal risk models — a device that has allowed European banks to pretend their assets are low-risk and maintain a lower capitalisation level than their US competitors.

Taken at face value, this is an indefensible practice. European banks hold far more non-performing loans in their portfolios than US ones — on average, slightly less than 6 per cent compared with less than 2 per cent.

Yet if a level playing field with the US competition forces the European banks to raise more capital, they don’t want a level playing field.

Deutsche Bank is at the forefront of the counterattack. At a banking conference in Frankfurt, its CEO John Cryan, said the new rules only benefited US banks. “I think it’s about time that Europe started introducing rules that benefited Europe and didn’t play to some policy of global harmonisation that sounds good on paper but is not relevant to anything,” he added.

EU bureaucrats agree. Valdis Dombrovskis, the European Commissioner for finance, told the European Parliament that the Basel Committee would do well to “find a solution which would not unduly weigh on the financing of the broader economy in Europe” and “put our banks at a disadvantage compared to our global competitors”.

The continent’s finance industry, he said, had certain “specificities” that needed to be respected in order not to stymie growth. Among these is the fact that European banks hold more mortgages than US banks, which can sell theirs to government agencies, helping them reduce their portfolio risks.

Behind the polite wording is the possibility that the EU simply would simply refuse to enact the new rules. The rating agency Fitch has warned that insistence on tougher rules might lead to divergence in banking standards in the US and the EU — unless a compromise is achieved.

In parallel to this dispute, the EU has reportedly included a requirement for US banks to capitalise their European operations separately — a direct response to the 2014 US measure — in a financial reform package that Dombrovskis presented.

The European threat is somewhat asymmetrical to the US requirement because of Brexit: US banks potentially face two different supervisors in Europe, one in the UK and the other in the EU, which might force them to maintain separate, fully capitalised entities in both jurisdictions.

European regulators know this would be a hostile move, but the escalation is still avoidable. Donald Trump’s election and the expected weakening of bank regulation, while it might be a step backward from the achievements of the post-crisis years, could help the US avoid a direct confrontation with the EU.

“US regulators’ bargaining power in global discussions over tougher capital requirements could be undermined should President-elect Trump follow through with plans to halt further financial regulation,” Bloomberg Intelligence analysts Jonathan Tyce and Arjun Bowry wrote. “Under such a scenario, European banks are likely to be the major beneficiaries.”

Forcing banks to maintain high capital levels and keeping them to the highest integrity standards are noble missions. As US regulators pursue them, however, they need to keep the international politics in mind.

To Europeans, giving up their market to US banks — the way they’ve allowed US tech companies to take over — is not an attractive option. Continuing to push them is hardly the most productive approach from Washington.