Prudential rules do not hinder bank financing for EU priorities

The European Union faces strategic challenges requiring annual financing of around €1.2 trillion. This sizeable amount, estimated by the ECB, is equivalent to around 7.5% of EU GDP. These investments are needed to meet Europe’s objectives in the areas of the green transition, digitalisation and higher defence spending. The private financing component is estimated at €690 billion per year, with banks likely to act as important providers of finance. Banks play a dominant role in financing firms in the EU, while capital market financing remains relatively limited. At the same time, other sources of finance will also be needed to meet the investment challenge.

Banks can contribute in several ways

The required investments differ in terms of risk profile, maturity and legal structure. Part of the strategic investment challenge consists of risky investment projects with challenging characteristics. These include investments in technologies that are still under development or in business models that have yet to prove themselves. Such investments can be capital-intensive, with long payback periods, greater uncertainty about future cash flows and/or limited collateral. At the same time, the financing challenge also includes lower-risk investments, such as sustainability technologies or digitalisation within existing business operations, where risks and returns can be assessed more effectively.

Banks use different financing structures to finance investments. Traditional corporate lending is well suited to relatively straightforward investment projects with a low to moderate risk profile. For larger, more complex or riskier financing needs, syndicated loans or project finance, possibly combined with public guarantees, may provide a solution. Securitisation can also help banks limit their exposures and transfer credit risk to other parties. In such cases, banks can still play an important role as arrangers and screeners of financing. For very high-risk investments, venture capital and equity financing are often more appropriate. Non-bank entities and capital markets play an important role in providing such risk-bearing capital.

Prudential regulation has made banks more resilient…

Following the 2008 financial crisis, the prudential framework was reformed to reduce the likelihood of systemic crises. Banks play a central role in the economy, but their interconnectedness and business model give rise to inherent vulnerabilities and various forms of market failure. The crisis demonstrated the social costs that these vulnerabilities can entail. To address market failures and vulnerabilities in banking and reduce the social costs of financial crises, capital and liquidity requirements were raised and resolution frameworks were developed, among other measures. In this way, prudential regulation and supervision contribute to financial stability and confidence in the continuity of financial services.

The reforms have clearly strengthened banks’ resilience. For example, the risk-weighted capital ratios of Dutch banks are now well above pre-crisis levels, and the leverage ratio of the banking sector has doubled from around 3% in 2007 to approximately 6% in 2025. In addition, the liquidity position of European banks has improved significantly. Empirical research also shows that higher capital levels contribute to a more stable financial system. Better-capitalised banks are more resilient during periods of financial stress and better able to maintain lending. The economic benefits of preventing systemic financial crises are also considerable.

…while the impact on lending is limited

The economic costs of prudential regulation are limited. Higher capital requirements have only a limited impact on lending rates and total credit growth in the longer term. Prudential regulation does, however, influence the allocation and pricing of credit. Partly because riskier financing is subject to stricter requirements, banks have shifted their exposures towards lower-risk segments. For riskier projects, this has also contributed to temporarily higher pricing. Yet the scale of these effects is limited, especially where banks are well capitalised.

The availability of bank financing is not determined by prudential requirements alone. The prudential framework is based on the principle that riskier loans require higher prudential requirements. At the same time, the pricing and allocation of credit are also influenced by expected losses, internal risk assessments and commercial return targets. Available expertise, policy uncertainty and fragmentation across European markets also play a role. In addition, many European banks hold significant capital in excess of requirements (headroom) and regularly distribute dividends. This suggests that banks currently have sufficient capital available and that capital requirements do not, in themselves, constitute a material obstacle to lending.

More private financing requires deeper financial integration in Europe

Unlocking more private financing for the strategic financing challenge requires better risk-sharing and deeper financial integration. Lowering capital and liquidity requirements is expected to generate little additional lending and would primarily weaken the resilience of the banking sector. Removing barriers in the European single market and completing the Banking Union could, by contrast, strengthen the role of banks. However, banks cannot finance everything. Deeper European capital markets are therefore essential to increase the volume and diversity of available private financing. The European Commission’s Savings and Investments Union agenda provides important avenues for progress. Public guarantees, subsidies and the involvement of public investment banks can also improve the risk-return profile. The gains therefore lie not in easing prudential rules, with the associated risks to financial stability, but in European measures that enhance the diversity and allocation of capital.