European banks show ample capital buffers as Basel III reforms near conclusion

Europe's largest banks are holding on to substantial excess capital with about 18 months to go until implementation of the final post-global financial crisis rules.

Banks must brace for rising capital requirements from 2025, when the final batch of the Basel III reforms is expected to be phased in. The European Council and Parliament reached a provisional agreement on the EU-specific implementation of the final Basel III rules on June 27, while UK and US authorities are yet to agree on their approach.

Big European banks will be hit harder than global peers by the reforms primarily due to the introduction of the so-called output floor, which limits the use of internal models to assess credit risk. Minimum requirements for big European banks will rise by 15.9% at full implementation of the reforms, compared to a 3.9% decline estimated for banks in the rest of the world, the latest Basel Committee data shows.

Banks across continental Europe and the UK hold ample capital buffers that boost their core capital ratios well above minimum requirements, S&P Global Market Intelligence data shows. On average, buffers across 22 of the largest banks stood 445 basis points above minimum capital requirements in the first quarter of 2023.

Common equity Tier 1 (CET1) ratios — a key measure of solvency and capital strength — at the largest European banks were well above regulatory minimums in the three years to 2022, the data shows. Nearly half of the banks booked year-over-year increases in the buffers held above minimums in 2022.

Lenders across Europe and the UK have made strong progress toward meeting the final Basel rules as the implementation deadline nears, a recent EY survey of 45 global banks across 17 markets showed. All surveyed UK banks and 61% of European banks said they have mobilized a Basel III reform program.

The area where most banks lack preparation is around the output floor, with 83% of the UK and 67% of the European banks saying they have not yet determined their approach to allocating its impact on capital, the survey found.

The output floor is one of the key components of the final Basel III rules. It restricts the use of internal models to determine the level of risk-weighted assets (RWAs) on bank balance sheets. RWAs are used to calculate the CET1 ratio.

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European banks' greater reliance on internal models to assess credit risk makes them more exposed to the final Basel reforms than peers in the US and elsewhere in the world. EU authorities said June 27 they have agreed on "appropriate transitional arrangements to allow sufficient time for market players to adapt" to the floor.

The output floor will account for almost half of the minimum requirements increase for large European banks, according to the Basel Committee estimates.