Despite much talk about simplification, European banks still wade through thickets of regulation. Last December the European Central Bank’s Governing Council published a plan to prune that undergrowth. It may be just the right time, economists say, even as critics grumble the proposal goes nowhere near deep enough.
The ECB wants fewer capital buffers, a leaner leverage ratio and lighter treatment for smaller lenders. At the plan‘s centre sits the vexed question of additional tier-one securities, or AT1s. These hybrid instruments—created after the financial crisis to meet Basel III rules—promise fat coupons in calm weather.
In a storm, AT1s can be switched into shares or wiped out, soothing regulators by absorbing losses. They now account for more than €140bn of capital across the bloc. But they also symbolise everything that has gone wrong with Europe’s rulebook: ingenious on paper, knotty in practice, and increasingly distrusted by markets.
Take the scalpel
“If the EU desires a dynamic and resilient banking system, there’s no simpler guarantor than equity capital — funding from investors who automatically share in gains and losses,“ Bloomberg summarised expert views on the matter on 18 February. “The more banks have, the better they’re able to take risks without inviting failure.” The article concludes that the best cure for AT1 headaches is the scalpel: scrap them, raise ordinary equity instead and be done with the contortions.
AT1s certainly deserve their reputation for complexity. They have no maturity date, coupons can vanish at a supervisor’s whim, and a trigger lurks deep in the prospectus: slip below a set capital ratio and the bonds convert into shares or disappear altogether.
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That design was supposed to reassure taxpayers. Instead, confidence crumbled when Switzerland wiped out CHF 16.5bn of Credit Suisse AT1s during the lender’s shotgun wedding with UBS in 2023. “They actually erode equity when it’s most needed, because banks typically keep paying for fear of angering investors. Their loss thresholds kick in far too late to avert failures. Uncertainty over how and when they’ll be triggered has contributed to distress,” warns Bloomberg.
A tangled capital stack
Many investors have drawn the same conclusion and demanded heftier yields, inflating costs for the issuers. As a result, Swiss regulators remain embroiled in courtroom skirmishes. “The write-down was part of an overall package to stabilise Credit Suisse via a merger with UBS Group AG, for which extraordinary state support measures were necessary,” commented Finma, the country’s financial watchdog.
The legal saga could drag on for years, but the reputational damage landed instantly. Prices of other AT1s wilted, and bankers quietly shelved several offerings. What began as a stabilising tool now threatens to sap credibility whenever the next bank wobbles.
European harmonisation and financial integration should be fostered. — ECB Governing Council
The ECB’s task-force wants to fix more than hybrid capital. It proposes merging a patchwork of buffers into two clean layers, a non-releasable shield for all seasons and a releasable cushion to soften recessions. It also suggests cutting four leverage-ratio elements to two. The Council insists that “European harmonisation and financial integration should be fostered” and urges the completion of banking union to slash national quirks. Simplification, it argues, will reinforce resilience rather than dilute it.
A spaghetti bowl of rules
The industry’s lobbying arm agrees on the goal but not on the route. “The volume has become so vast that it is hard to keep track,” groans the Association for Financial Markets in Europe. Worse, says the group, “The result: European banks are less agile, less competitive, and constantly navigating overlapping obligations, duplicated reporting requirements, and shifting supervisory expectations — all without a clear understanding of the true cost or effectiveness of each rule and their cumulative impact.”
AFME wants Brussels to pause non-essential rulemaking, scrap obsolete mandates and develop a proper stock-take of every edict since the crisis. That, it claims, would free expertise to tackle game-changers such as digital assets rather than totting up ever thicker binders of compliance.
The ECB plan also recommends broadening a small-banks regime, aligning failure rules for all lenders with those applied to giants, and turning more directives into directly applicable regulations. Supervisors would gain flexibility in model reviews, and stress tests would shrink to focus on what matters.
Yet another reform push
Each item looks sensible on its own. Together they promise a regulatory refresh, if politicians dare to back it. Merging buffers, for instance, will bruise national authorities that relish bespoke tools. Boosting equity in place of AT1s will hurt executives fond of debt-fuelled returns.
Replacing hybrids will also take time. Converting €140bn of existing instruments into common equity cannot happen overnight without shocking funding markets. The Governing Council hints at a glide path, perhaps by letting legacy notes die on their first call dates. Bankers grumble that higher equity will raise their cost of capital. Regulators retort that fragile balance-sheets cost more in the long run. Investors, for their part, would welcome a simpler hierarchy they can price with fewer legal surprises.
European banks are (…) without a clear understanding of the true cost or effectiveness of each rule and their cumulative impact. — Association for Financial Markets in Europe
Politics will decide the outcome. Upcoming elections risk kicking the dossier into the long grass. National capitals may demand carve-outs before surrendering cherished discretions. Yet an opportunity beckons. The combination of legal doubts swirling around AT1s, a faltering economy and public fatigue with financial arcana has created rare momentum for pruning the rulebook.
The case for clarity
AT1s illustrate how good intentions can curdle. Designed as loss-absorbing shock absorbers, they morphed into pricey liabilities loaded with legal uncertainty. Their supposed strength—automatic conversion—proved their undoing when investors noticed supervisors could rewrite the script at the worst moment.
Old-fashioned equity, dull as it seems, delivers certainty. It needs no trigger, pays dividends only when profits allow and sits squarely at the bottom of the capital stack. Simpler rules would direct bankers toward that truth rather than towards instruments that promise miracles.
Europe’s regulators deserve some credit. They built a robust system after 2008 and have kept most banks solvent since. But robustness has come bundled with layers of detail, each drafted in haste and seldom trimmed.
A ‘bold reset’
The ECB’s blueprint, coupled with AFME’s calls for a “bold reset”, sketches a way to keep the strength while shedding the fat. Removing AT1s, streamlining buffers and synchronising supervision will not make headlines like bail-outs do. Yet those dull deeds could prove more valuable than any crisis heroics.
Supporters of the latest ECB policy shift say the plan marks the first serious effort to end the confusion that sprang from the rushed reforms of the post-2008 era. Detractors fear more delay than delivery. Either way, the debate has finally reached the heart of the Brussels machine. That is a fine place to start, most of those in the know agree.
