The European Commission is preparing to implement permanent revisions to the rules governing how banks calculate capital requirements for trading risks, signaling a strategic pivot to ensure European lenders remain competitive against their American peers.
The move, confirmed by a spokesperson for the legislator, indicates that the European Commission plans permanent changes to FRTB (the Fundamental Review of the Trading Book) to align more closely with a divergent regulatory path taken by the United States. This shift comes after U.S. Regulators introduced a draft framework—often referred to as the “Basel III Endgame”—that deviates significantly from the global standards originally set by the Basel Committee on Banking Supervision.
For the global banking sector, the “trading book” is where the most volatile activity happens. It encompasses the financial instruments banks hold for short-term trading rather than long-term investment. FRTB is the complex set of rules designed to ensure banks hold enough capital to survive a sudden market crash without requiring a taxpayer bailout. When these rules vary between jurisdictions, it creates a “level playing field” problem: banks in one region may be forced to lock away more capital than those in another, limiting their ability to lend or trade profitably.
In April, the European Commission took an initial step by publishing a draft delegated act that introduced temporary adjustments to these rules. However, the decision to move toward permanent revisions suggests that the discrepancy between the U.S. And EU approaches is not a passing glitch, but a structural divide that requires a long-term legislative response.
The battle over the ‘level playing field’
The tension stems from a fundamental disagreement over how to measure risk. The global standards established by the Basel Committee on Banking Supervision were intended to create a uniform global baseline. However, the U.S. Proposal for the “Endgame” rules shifted the goalposts, particularly regarding how banks can use their own internal models to calculate risk.
Under the original global framework, banks with sophisticated risk-management systems were encouraged to use the Internal Models Approach (IMA). This allows them to use their own data to prove their risks are low, thereby reducing the amount of capital they must hold. The U.S. Draft, however, leans more heavily toward a “standardized approach,” which is more rigid and often requires higher capital buffers for certain types of trading.
If the European Union had strictly adhered to the global standards while the U.S. Adopted a different, potentially more lenient or simply different set of calculations for specific assets, EU banks could find themselves at a competitive disadvantage. By adjusting the FRTB rules, the Commission is attempting to prevent “regulatory arbitrage,” where trading activity migrates to the jurisdiction with the least restrictive capital requirements.
What FRTB changes mean for bank balance sheets
To understand why these permanent changes are so critical, one must look at the mechanics of bank capital. Capital adequacy is essentially a safety cushion. If a bank has $100 in risky trading assets and a 10% capital requirement, it must hold $10 in reserve. If a regulatory change pushes that requirement to 12%, the bank must find another $2 in capital, which could otherwise be used for loans to businesses or investments in growth.
The FRTB framework introduces several technical hurdles that banks are currently navigating:
- The P&L Attribution Test: A rigorous check to ensure that a bank’s internal risk model matches the actual profit and loss (P&L) it experiences. If the model fails, the bank is forced back onto the more expensive standardized approach.
- Risk Factor Eligibility: Rules on which market data can be used to justify lower capital requirements.
- Boundary Issues: Strict definitions of what constitutes a “trading” asset versus a “banking” asset to prevent banks from shifting assets between books to hide risk.
The European Commission’s move toward permanent revisions will likely focus on these technicalities, easing some of the burdens that the global standards imposed but which the U.S. Has already mitigated in its own draft.
Timeline of regulatory divergence
The path to these permanent changes has been a sequence of reactive measures. The following table outlines the progression of the current regulatory friction:
| Phase | Action | Primary Objective |
|---|---|---|
| Global Baseline | Basel Committee publishes FRTB standards | Create a uniform global risk framework |
| U.S. Divergence | U.S. Regulators release “Endgame” draft | Adapt global rules to U.S. Market specifics |
| EU Interim | EC publishes draft delegated act (April) | Provide temporary relief to EU banks |
| EU Permanent | Planned permanent FRTB revisions | Ensure long-term parity with U.S. Rules |
Who is affected and what comes next
The primary stakeholders in this shift are the “Global Systemically Essential Banks” (G-SIBs). These are the massive institutions whose failure could trigger a global crisis. For these banks, even a small percentage change in capital requirements can translate into billions of euros in liquidity.
Smaller regional banks are less affected, as they typically do not have the complex trading desks that trigger the most stringent FRTB requirements. However, the broader market—including hedge funds and corporate treasuries—will feel the ripple effects. If EU banks have more capital flexibility, they can offer more competitive pricing on derivatives and hedging products.
The next phase of this process will involve the European Commission beginning formal work on the new rules later this year. This will likely involve a period of consultation with industry lobbyists and the European Central Bank (ECB), which oversees the direct supervision of the Eurozone’s largest banks.
Industry observers will be watching for the specific “delegated acts” that will codify these changes. The goal will be to find a balance: providing enough relief to remain competitive with the U.S. Without eroding the safety buffers that were the entire purpose of the Basel III project following the 2008 financial crisis.
Disclaimer: This article is for informational purposes only and does not constitute financial, legal, or investment advice.
The Commission is expected to provide further updates on the legislative timeline for these permanent revisions in the coming months as it coordinates with the Directorate-General for Financial Stability, Financial Services and Capital Markets Union.
Do you think the EU is right to follow the U.S. Lead on capital rules, or should it stick to the global Basel standards? Let us know in the comments or share this story with your network.
