ECB on European Banks: Profitability, Fragmentation, and Future Competitiveness

Sep 8, 2026 European banks have shown significant improvement in recent years, with profitability catching up to US banks since the pandemic and cost-to-income ratios in the EU now better than in the US, according to the European Central Bank. Asset quality has also improved, with the non-performing loan ratio falling from 6% in 2015 to 2%, and mergers appear to be accelerating. The ECB's latest supervisory statistics, due to be published next week, will confirm this positive trend. The valuation gap with US banks has narrowed, with the average price-to-book ratio of European banks now close to 1.5. This demonstrates that resilience, competitiveness, and profitability are not conflicting objectives but reinforce one another. Banks that are both resilient and competitive can withstand shocks while continuing to finance households and businesses, as seen during the pandemic and the energy shock following Russia's war against Ukraine. The more pressing question is whether European banks will remain competitive in the future. Competitiveness depends on resilience, efficiency, innovation, timely deployment of new technologies, and a regulatory environment that enables investment and adaptation. The ECB has identified persisting fragmentation along national lines as the main constraint to long-term competitiveness. Banks grant around 80% of their loans to domestic households and firms, less than 2% of bank deposits are held in another country, and cross-border merger activity has fallen sharply since pre-crisis years. Fragmentation limits the ability of euro area banks to build pan-European business models and scale up, putting them at a disadvantage in mobilizing large investments needed for digitalization, AI, cyber resilience, and innovative services. It also reduces the ability to channel savings efficiently across Europe and support investment for digital and green transitions, defense spending, and strategic priorities. The EU faces huge investment needs, with an ECB analysis estimating around EUR1.2 trillion annually until 2030 to meet green, digital, and defense goals. Financing this requires banks that can operate seamlessly across borders, diversify risks, and allocate capital productively. A time-bound roadmap towards completing the Single Market is essential, including synchronised progress on the banking union, with concrete steps towards a European deposit insurance scheme and a clear implementation timetable. Banks are indispensable providers of credit, especially for households and SMEs, but many investments require risk-bearing capital. Deepening capital market integration is equally important, and banks would benefit from greater opportunities to develop market-based financing and diversify to fee-based business. There is little evidence of a credit crunch, and the bigger challenge to credit comes from the demand side. Firms need reasons to invest, and lowering capital requirements would not automatically deliver competitiveness gains or unlock lending. European capital requirements are aligned with the Basel framework and broadly comparable to other major jurisdictions, with no evidence that they have constrained lending. Strong capital positions are essential for banks to withstand shocks while providing financing. In Germany, the Bundesbank does not find evidence that higher capital requirements hamper lending. Banks with a CET1 ratio above 14% increased lending by up to 3.6% during the pandemic and energy price shock, compared with 2.6% for banks with a CET1 ratio below 12%. Capital appears to be an important foundation for lending, not a barrier. The European Commission's report on banking sector competitiveness, published on 17 July, correctly diagnoses that European banks are held back by fragmentation, unwarranted complexity, and lack of full financial market integration. The largest gains would come from reducing fragmentation and making the Single Market work more effectively. Simplification and integration are mutually reinforcing, and any serious competitiveness agenda must make them move in parallel. Taking concrete steps towards finalising a European deposit insurance scheme with a clear timeline remains paramount. Interim steps, such as allowing the largest and most internationally active banks to first join a single deposit guarantee scheme, could ease home-host concerns and foster financial stability. Consolidation is a promising path for euro area banks to improve efficiency and reap economies of scale, and supervisors will not obstruct well-executed cross-border mergers provided regulatory criteria are met. Internal barriers within the Single Market are estimated to be equivalent to a tariff of around 110% for services, according to the IMF, with OECD and ECB estimates showing costs above 90% for services and above 60% for financial services. These obstacles are of Europe's own making, and there is no excuse for delay. Simplification is about making the framework more efficient while preserving prudential objectives. It is not about lowering resilience or changing capital requirements. Shifting from directives to directly applicable regulations would support a genuinely single market and prevent national gold-plating. The risk-based capital stack in the EU is complex, with up to nine layers of requirements and buffers, and there is room for simplification, such as merging the five existing macroprudential buffers into two. The Single Supervisory Mechanism is driving forward an ambitious simplification agenda, with shorter timelines, faster decisions, fewer requests for non-essential information, and more focused assessments. Processing times for capital-related decisions have been reduced from several months to an average of less than six days in the second quarter of this year. Approval of simple securitisation transactions has been reduced from three months to around seven days. On-site inspections are now completed around 10% faster than before 2026. The number of data points for stress testing has been reduced by around 55%, and the short-term exercise has been streamlined by around 20%. Digital tools and AI are used in fit and proper assessments to shorten timelines. Around 40 supervisory publications have been discontinued, and others revised. A tiered follow-up process for supervisory findings focuses on material issues. Assessments of acquisitions and licence extensions now follow a risk-based framework, covering around 50% of ECB decisions. Proportionality is deeply embedded in the regulatory approach, with small and non-complex institutions (SNCIs) required to report up to 30% of the data that large banks must report. Around 75% of less significant institutions in the euro area are classed as SNCIs. Options to embrace proportionality further include raising the total assets threshold in the SNCI definition from EUR5 billion to as high as EUR10 billion, reducing the frequency and granularity of supervisory activities, and exempting SNCIs from regular bottom-up stress tests. Reporting initiatives include adding the SNCI category in the ECB FINREP Regulation, reducing data points to approximately 700 versus around 13,500 for full reporting. Any simpler regime must be accompanied by a credible crisis management framework. Integration is particularly relevant for German banks, which are deeply embedded in local communities with a tradition of relationship banking. Local presence and European integration are not mutually exclusive; they can reinforce one another. By operating more seamlessly across borders, banks can spread fixed investment costs, diversify risks, and unlock efficiencies. Cyber resilience is a concrete example where scale can make investments easier to achieve. Europe has abundant savings, world-class talent, innovative firms, strong institutions, and the rule of law, but lacks a truly integrated financial system. Completing the banking union and advancing capital market integration would strengthen Europe's capacity to shape its own future in a more fragmented world.