The European Central Bank is once again stepping into controversial territory, proposing that banks incorporate credit data from the region’s financial crises into their risk models. Ostensibly aimed at preventing rose-tinted projections of future defaults, this move could significantly dent the capital buffers of some lenders—particularly those that have spent years scrubbing their balance sheets clean.

The plan, floated during a presentation last November, suggests banks use credit data from 2008 to 2018, a decade marked by banking turmoil across Europe, especially in Southern nations like Spain, Italy, and Greece. Naturally, the proposal has ruffled feathers. Some banks argue this approach disregards the recent, more favourable years, leading to unnecessarily pessimistic forecasts and possibly reducing their regulatory capital ratios.

Predictably, the ECB declined to comment, but the tension is palpable.
In true bureaucratic fashion, the ECB is positioning its plan to avoid undue optimism among lenders. The regulator claims this period reflects a “full economic cycle,” but banks see it differently. The suggested timeline paints a bleak picture for them, conveniently omitting the improvements achieved post-2018.
Adding to the irony, many lenders have already weathered a painstaking review of their risk models under the ECB’s “Targeted Review of Internal Models.” For the ECB to pivot and introduce new criteria so soon feels to some like being dragged back into a classroom after just passing a gruelling exam.

The implications are starkest for Southern European banks, whose once-distressed balance sheets have seen marked improvement. Non-performing loans (NPLs) have plummeted, but the ECB isn’t buying the rosy picture. Officials argue that recent credit data has been distorted by government intervention during the pandemic and energy crises, inflating the resilience of bank portfolios. According to ECB banking supervisor Claudia Buch, the low current risk levels are partly artificial, reflecting public aid rather than genuine creditworthiness.

For banks, tighter assumptions in risk models mean holding more capital as a cushion, potentially crimping their ability to invest or reward shareholders. Unsurprisingly, many lenders are lobbying furiously through trade associations to soften the ECB’s stance, hiring advisors to assess the financial hit they might face.

Adding fuel to the fire, EU banks have long harboured resentment over what they see as excessive regulation, especially compared to their U.S. counterparts, who’ve benefited from a regulatory rollback under the Trump administration. The sense of a competitive disadvantage has only deepened, with some European bankers viewing the ECB’s proposals as another heavy-handed overreach.

To the ECB’s credit—or blame, depending on your perspective—it has a habit of tackling systemic risks with bureaucratic zeal. Yet its insistence on revisiting old crises risks alienating the institutions it seeks to protect. While the regulator is expected to interpret these rules formally mid-year, some banks may still wiggle free if they can convincingly argue that the proposed timeline is ill-suited to their risk profiles.

The debate underscores a broader tension: the ECB’s mission to ensure financial stability versus banks’ frustration at being hemmed in by ever-changing rules. Whether this is sound policy or bureaucratic overreach remains to be seen. Still, one thing is clear—European banks and their regulators remain locked in a love-hate relationship that shows no signs of abating.