European Commission Outlines Banking Reform Agenda

The European Commission’s Communication on the competitiveness of the EU banking sector[1] (the “Communication”) is a central pillar of the EU’s Savings and Investments Union strategy. It is a policy roadmap setting out the measures the Commission intends to bring forward in the first quarter of 2027 to boost the competitiveness of the EU banking sector and advance the Banking Union. The Communication notes that EU bank consolidation since the Great Financial Crisis has occurred almost exclusively within national borders, producing banking groups that are large relative to their home economies but not relative to the EU or their international competitors. The contemplated measures, which are of particular significance for EU cross-border banking groups and prospective acquirers, would among other things:

• facilitate the management of capital and liquidity at group level within EU cross-border banking groups, coupled with supervisory powers aimed at ensuring resources remain available to subsidiaries when required;
• replace the 2015 proposal for a European Deposit Insurance Scheme[2] (“EDIS”), which was never finalised, with a new simplified structure of the deposit insurance framework in the Banking Union;
• mitigate disincentives for cross-border M&A related to national gold-plating and differing national implementation of EU rules;
• address complex and overlapping requirements in the Pillar 2 framework, including removing the Pillar 2 capital requirements for the leverage ratio;
• revise aspects of EU implementation of international prudential standards, including adapting the output floor for the use of internal models in capital calculations and adopting a long-term strategic approach to market risk in light of market risk frameworks implemented in other jurisdictions;
• introduce a more proportionate approach to prudential requirements based on the size, complexity and international activity of banks, moving away from the existing one-size-fits-all approach;
• simplify loss-absorption and resolution planning requirements and macroprudential rules; and
• reduce reporting burdens.

The Commission expects that these changes will improve EU banking competitiveness. The Staff Working Document[3] that accompanied the Communication observes that European banking remains fragmented into national markets, which reduces economies of scale, duplicates infrastructure and compliance, traps capital and liquidity within borders and inhibits the emergence of institutions capable of competing with the large U.S. banks in key markets in the EU and elsewhere. The Draghi report[4] estimates that the EU economy requires EUR 1,200 billion of additional annual investment and frames the Commission’s ambition: larger, more integrated banking groups deploying resources freely across the EU are expected to deploy capital more efficiently, diversify earnings geographically and finance strategic sectors such as defence and artificial intelligence.

The scope and effect of the proposed reforms will depend on the legislative proposals, which the Commission intends to publish before the end of Q1 2027, and their subsequent negotiation by the European Parliament and the Council. For prospective acquirers, these measures – together with a commitment to use the Commission’s enforcement powers to reduce the prevalence of “unjustified interventions at the national level” that seek to prevent cross-border bank mergers – would substantially reduce the structural impediments that have historically limited pan-European banking consolidation. At the same time, moving to increased parent-level capital and liquidity management and the introduction of group-wide supervisor downstreaming powers necessarily shift risk and responsibility further towards collective European arrangements.

Principal Elements of the Communication

1. Capital and Liquidity to be Managed at Parent (Topco) Level

Under the current EU framework, EU banking groups must comply with capital and liquidity requirements both on a consolidated basis and at the level of each subsidiary. The Communication explains that the prudential requirements give assurance to Member States hosting a subsidiary (referred to in this note as “host states”) regarding local financial stability concerns. However, this prevents EU banking groups from managing resources at group level, limiting efficiency, which, among other things, impedes intra-EU cross-border mergers. The Commission Staff Working Document notes that over the last 20 years, M&A in the EU banking sector has declined, and most M&A occurs within Member States. The end result is that EU cross-border banking groups are not realising the benefits of the EU’s single market and the potential for scale across it. EU liquidity waivers exist on a cross-border basis but in practice are available mainly where the subsidiary and parent are located in the same Member State. Member State authorities in host states have used these requirements – in substance a form of ring-fencing – to secure local resources against the possibility of a group failure resulting in a Member State having to deal with the subsidiary in a disorderly manner.

The Commission proposes to invert this architecture to permit cross-border banking groups within the EU to allocate capital and liquidity more efficiently. Group-wide supervisors responsible for the cross-border group would have the power to ensure that requirements are met at the level of the parent entity, and – as the counterpart protection for host states – the power to require the parent to allocate sufficient resources to its subsidiaries in a timely and enforceable manner, both in going concern and in crisis situations. Exercise of these powers would take account of the diversity of cross-border groups, the resilience of the relevant subsidiaries and the level of integration and commitments within the group, and would be supported by safeguards for creditors and depositors. Significantly, the Communication states that the manner in which cross-border groups structure their operations should be a commercial decision, “and should not be subject to unjustified interference by national authorities”.

To further alleviate the restrictions on allocation of funds in banking groups, the Commission proposes that intragroup exposures crossing internal EU borders receive the same regulatory treatment as domestic intragroup exposures. The Communication also states that in the absence of a full fiscal union, further measures are required to address excessive concentration of sovereign exposures and to encourage more diversification of sovereign bond portfolios.

The quantum at stake is substantial: the European Central Bank (“ECB”) estimates that removing constraints on transferability of liquidity held in the cross-border subsidiaries of EU banking groups would release around EUR 230 billion of high-quality liquid assets. The Communication explains that easing the limitations on allocation of funds in banking groups should encourage economies of scale and improve risk diversification.

2. Deposit Guarantee Schemes: EDIS Withdrawn, Liabilities Realigned

Following the Great Financial Crisis, the EU established the Banking Union for banks in euro area Member States. The three pillars of the Banking Union are:

• the Single Supervisory Mechanism[5] (“SSM”), under which the ECB authorises all banks in the Banking Union and directly supervises 111 significant banks in coordination with national competent authorities (“NCAs”);
• the Single Resolution Mechanism[6] (“SRM”), comprising the Single Resolution Board (“SRB”) and a Single Resolution Fund (“SRF”) which now exceeds EUR 81 billion;[7] and
• the proposed EDIS, tabled in 2015, which has not been implemented.

The Communication states that the 2015 EDIS proposal will be replaced by a new simplified vision of the deposit insurance framework for Member States in the Banking Union which, among other things, is intended to:

• ensure that failure of a cross-border banking group is conducted at a European level so that the cost does not sit with an individual Member State;[8]
• better align the responsibilities for and financing of crisis management and deposit insurance measures;
• address liquidity shortfall vulnerabilities of national Deposit Guarantee Schemes (“DGSs”);
• ensure that the failure of an EU cross-border group does not impact individual Member States or liabilities to DGSs and national budgets; and
• ensure that covered deposits are equally protected throughout the Banking Union.

The Communication states that the Commission will give due consideration for Member States not in the Banking Union that operate under different EU institutional arrangements.

The Commission will additionally propose measures to improve the predictability of group resolution strategies and support a more integrated allocation of funds within cross-border groups in times of stress, and will support work across all EU and Banking Union institutions and Member States on credible backstop funding mechanisms for liquidity in resolution.

The Communication presents these reforms as pursuing an objective of simplification rather than mutualisation. The Commission’s legislative proposals should indicate whether the successor framework is intended to achieve through realignment of liabilities what EDIS could not achieve. The substance of the commitment – that a cross-border failure should generate no liability to DGSs or national budgets and that costs will not be borne alone by an individual Member State – will depend on whether the corresponding exposure sits somewhere else, namely at the group and European level.

3. Curbing National Interference in Bank Mergers

The Commission states that “national interventions in bank mergers prevent banks from acquiring scale at EU level”, including through cross-border mergers, and commits to using its enforcement powers where it identifies breaches of Union law, particularly in relation to interventions by national authorities to prevent cross-border M&A. Its new draft merger guidelines[9] give Member States clearer guidance on the limited circumstances (other than the protection from competition) in which they may intervene in transactions subject to EU merger control: interventions must be limited to what is strictly necessary to protect genuine legitimate interests, and respect proportionality and non-discrimination.

4. International Standards, EU Specificities and Proportionality

The Communication commits to the Basel framework while signalling recalibration in light of implementation elsewhere. The Commission observes that “various approaches have been taken within third-country jurisdictions, including removing the output floor [for internally modelled capital requirements] altogether.” The Commission will:

• make proposals on the output floor and its transitional arrangements on unrated corporates and mortgage lending;
• pursue a long-term strategic EU approach to market risk capital requirements in light of implementation in other jurisdictions, having already proposed[10] targeted relief to mitigate until 2030 some of the effects of its implementation;
• evaluate the treatment of specialised lending, project finance and trade finance;
• revise the prudential treatment of software assets; and
• assess adjustments to the remuneration framework – including the bonus cap – to address competition for talent.

The EU also applies the Basel Standards to all EU banks, regardless of size, complexity and international footprint. To add proportionality into the regulatory framework, the Commission will propose amendments to reduce and adapt the prudential and resolution frameworks requirements for smaller, non-complex banks, including potentially new thresholds and criteria. Given the links between the prudential regime for banks and investment firms, the proposals will include targeted changes to the prudential regime for investment firms, including the threshold structure, governance and remuneration requirements, and recalibration of capital and liquidity requirements.

5. Simplification

The simplification agenda includes:

• a revised Minimum Requirement for Own Funds and Eligible Liabilities (“MREL”) framework aligned more closely with the Total Loss Absorbing Capacity (“TLAC”) standard, with simpler and more automatic and predictable calibration, and a streamlined prior permission process for buybacks of MREL instruments;
• removal of Pillar 2 leverage ratio capital requirements and improving the functioning of Pillar 2 guidance;
• more proportionate resolution planning;
• a simplified macroprudential framework with fewer buffers and a harmonized framework for other systemically important institutions (“O-SIIs”), focusing on the O-SII identification framework and buffer calibration;
• stronger coordination between microprudential, resolution and macroprudential authorities to address the limitations on buffer usability in light of overlapping requirements; and
• a substantial reduction of the reporting burden, which the European Banking Authority has estimated costs EUR 11.2 billion per year (including staff, IT, legal, audit, accounting and consultancy services), with the number of data points in EU reporting frameworks expected to be cut by half.

A comparative summary of the current regime against the proposed direction is contained in the Annex to this memo.

Implications for Prospective Cross-Border M&A Within the EU

For bank boards and chief executives contemplating cross-border European transactions, the package – if enacted in the form outlined – would alter the acquisition calculus. Institutions considering cross-border transactions may find that the proposals materially reduce the regulatory frictions that have historically complicated pan-European consolidation. They should equally recognise that the package continues the progressive transfer of responsibility for banking stability from Member States to EU institutions.

• Trapped capital and liquidity. The principal financial drag on cross-border ownership within the EU – duplicated capital and liquidity at subsidiary level – would be substantially reduced, improving the returns achievable on acquired businesses and releasing resources for redeployment. Moving to greater reliance on consolidated compliance would increase the importance of legal and operational arrangements through which resources may be transferred within a group during stress. Firms should analyse and assess the detail of the parent-level compliance regime and the conditions attached to the supervisory downstreaming power, including its enforceability and interaction with resolution measures. Transactions should also be considered alongside relevant national implementation of the changes to requirements for M&A transactions under CRD VI.[11]
• Intragroup arrangements. Acquirers should review whether existing intragroup funding, guarantees, support arrangements and governance processes would permit resources to be transferred within the group in a manner contemplated by the proposed framework, including during periods of stress.
• Group structuring. With intragroup exposures treated uniformly and compliance centred at topco level, the case for branch-based expansion relative to subsidiarisation shifts, and existing subsidiary structures may warrant review. The Commission has committed to ensuring supervisory neutrality between organisational models.
• Political risk in execution. The Commission’s commitment to enforcement against unjustified national interventions, combined with the draft merger guidelines, reduces – though will not eliminate – the risk that governments obstruct or condition transactions. Acquirers should nonetheless expect national resistance to persist until enforcement practice is established, and should structure timetables and conditions accordingly.
• Financing of common safety nets. The withdrawal of the 2015 EDIS proposal reflects the continuing political sensitivity of common deposit-insurance arrangements. The Commission’s successor proposal will therefore be closely examined for the extent to which it changes the allocation of funding responsibility among national DGSs, the SRF and other Banking Union mechanisms. The Communication does not propose a common fiscal deposit guarantee and financing arrangements for systemic stress remain to be developed.
• Resolution and MREL planning. Alignment of MREL with TLAC, more predictable calibration and streamlined permissions would simplify post-acquisition liability management and reduce the cost of restructuring inherited MREL stacks.
• Sovereign exposures. Any proposal in this area should be assessed alongside the existing capital, large exposures and liquidity treatment of sovereign debt. Changes to the location at which group capital and liquidity requirements are applied could also affect how banking groups manage sovereign exposures across entities.
• Legal and operational enforceability. More reliance on group-level resource allocation will increase the importance of legal enforceability and operational execution of intragroup support and downstreaming arrangements. Once the Commission publishes the legislative proposals, banking groups should assess how the new powers interact with applicable company, insolvency, resolution and collateral frameworks in relevant Member States.

The Communication is a further step in a process that is expected to result in legislative and non-legislative proposals by end-March 2027. Cross-border banking groups and prospective acquirers should follow the development of the proposals closely and assess their potential implications for group structure, intragroup funding, resolution planning, MREL, transaction modelling and post-acquisition integration. However, until legislation is finalised, transactions and capital-planning decisions continue to be governed by the existing consolidated level and subsidiary-level framework. Transactions signed in the interim should price the existing regime while preserving optionality – for example in integration planning and capital repatriation assumptions – for the reformed one.

Annex: Current Regime versus Proposed Direction (Q1 2027 Package)