How the 72.5% Output Floor Compresses European Bank Capital

The US negotiating position at the Basel Committee on Banking Supervision in 2017 locked a hard floor into the post-crisis capital framework. That floor now forces European regulators to reconcile internal-model risk weights with the standardised approach. For the region's largest lenders, the result is a structural increase in capital requirements that changes the risk calculus for the sector.

The 72.5% Floor and How It Works

The output floor sets a minimum for the ratio of risk-weighted assets (RWA) calculated under internal models to RWA calculated under the standardised approach. If a bank's internal-model RWA falls below 72.5% of the standardised RWA, the bank must top up the difference. That cap on model benefit directly affects European banks that rely heavily on internal models for credit, market, and operational risk.

US negotiators insisted on the floor to stop banks from gaming internal-model outputs. European regulators had supported a more flexible calibration. The US position won. Now national regulators across Europe must transpose the standard into local law. The timeline for full effect depends on their decisions.

Which European Lenders Feel the Squeeze

Large universal banks with investment banking operations and extensive internal model approvals are most exposed. Their current internal-model RWA totals often sit well below the standardised benchmark. The floor will push RWA higher when it fully phases in. The result is a compression of CET1 ratios – the core equity buffer regulators use for stress tests.

Banks with simpler balance sheets, such as retail-focused lenders, use the standardised approach already and will see little change. The gap is concentrated in cross-border, multi-asset firms. Those same banks are also the biggest issuers of contingent convertible bonds (CoCos). If capital pressure rises, CoCo spreads may widen, reflecting a higher risk of coupons being skipped or conversion triggered.

The Phase-In Timeline Changes Everything

Three factors can soften the floor's impact. Transitional arrangements that phase in the floor over a longer period than the current five-year schedule would help. Waivers or local flexibility that allow banks to adjust their internal models to narrow the gap with standardised outputs could also reduce the bite. Strong earnings that rebuild capital buffers organically would absorb the RWA increase.

Three factors would make it worse. Strict, uniform implementation across all European jurisdictions with no transitional relief would compress CET1 ratios faster. A simultaneous earnings downturn would leave banks unable to grow capital while RWA rises. A regulatory push to accelerate the floor's full effect would shorten the phase-in schedule and tighten the capital constraint.

Single Most Important Marker: National Rule Adoption

The key catalyst to watch is the finalisation of implementing rules by European banking regulators. Several EU member states have yet to publish their transposition legislation. When they do, the specific calibration of the floor's phase-in will determine how quickly capital pressure builds. The first quarterly disclosures under the new RWA calculations will then show the real-world impact on CET1 ratios.

For investors tracking European bank equities, the output floor transforms the sector's capital story from a slow drip to a measurable constraint. Stock market analysis of the sector should now factor in a baseline assumption of higher RWA density for multi-asset banks. The floor does not threaten solvency. It removes a cushion that management teams used to justify returns on equity. Whether that cushion disappears in 2025 or 2028 depends entirely on the national rule book.

Longer term, the floor may shift competitive dynamics. Banks with simpler models face no RWA increase. Their universal competitors absorb a capital drag. That could encourage a round of balance-sheet restructuring or asset sales. Best stock brokers are already fielding questions from clients on which European lenders can best absorb the new floor without cutting dividends.

How the 72.5% Output Floor Compresses European Bank Capital

The 72.5% Floor and How It Works

Which European Lenders Feel the Squeeze

The Phase-In Timeline Changes Everything

Single Most Important Marker: National Rule Adoption

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