The European Central Bank published an Occasional Paper assessing whether capital requirements and capital ratios affect euro area bank competitiveness, proxied by banks’ profit efficiency. Using supervisory data for significant institutions directly supervised by the ECB, the authors find no statistically significant relationship between overall capital requirements and profit efficiency, challenging claims that higher requirements systematically constrain banks’ ability to generate profits efficiently. The analysis covers 35 listed significant institutions in ten euro area countries from the first quarter of 2019 to the fourth quarter of 2024, estimating profit efficiency with data envelopment analysis and testing associations via panel regressions. Splitting overall capital requirements into microprudential requirements (total supervisory review and evaluation process capital requirement) and macroprudential buffers (combined buffer requirement) also yields statistically insignificant effects, and a separate test around the macroprudential tightening wave starting in early 2022 likewise finds no significant impact. By contrast, capital ratios show a statistically significant inverted U-shaped relationship with profit efficiency, with efficiency increasing up to a common equity tier 1 ratio of around 18% and declining beyond that level, particularly for banks above 25%; a one percentage point higher CET1 ratio is associated with roughly a four basis point reduction in interest expenses and a five basis point reduction in return-on-assets volatility. The paper notes that sample medians for capital requirements (around 11%) and CET1 ratios (around 16%) sit below the estimated profit-efficiency-maximising level, and reports robustness to alternative efficiency measures and an expanded sample including unlisted banks.
European Central Bank 2025-10-09
European Central Bank research finds capital requirements do not hinder euro area bank profit efficiency and identifies an 18% CET1 turning point
The European Central Bank's Occasional Paper finds no significant link between overall capital requirements and euro area banks' profit efficiency, challenging claims that higher requirements constrain profitability. The study, covering 35 significant institutions from 2019 to 2024, reveals an inverted U-shaped relationship between capital ratios and profit efficiency, peaking at a common equity tier 1 ratio of around 18%. The findings are robust across alternative efficiency measures and an expanded sample including unlisted banks.