European banks’ capital buffers declined to a four-year low in Q1 2025, following the first-time implementation of the final Basel three rules according to analysts. However, strong profitability and RWA optimization including via SRT have supported capital creation and dividend distributions.
According to the latest research from Scope ratings, banks maintain adequate regulatory capital buffers although they fell to a four-year low in Q1 2025, mainly due to rising shareholder distributions and the impacts of Basel III finalisation. However, strong profitability and RWA optimisation, partly via significant risk transfers, support capital creation.
Figure 1-EU banks Maximum Distributable Amount
Source: Scope ratings
Moreover, the phase-in timeline for the Basel output floor gives banks time to make adjustments. The final output floor of 72.5% of risk weighted assets calculated using the standardized method is phased-in over a six-year horizon. The phase-in period started on 1 January 2025 with a coefficient of 50%. Moreover, some exceptions on RWA calculation will remain until 2033.
Figure 2-EU banks shareholder distribution
Source: Scope ratings
The output floor is not a constraining factor with some exceptions. Scope ratings explains: ‘’For most banks in our sample, the phase-in of the new rules will have no capital impacts before 2029, except for a handful of banks that will see impacts before then’’
The agency continues: ‘’We expect banks to proactively manage their balance sheet to mitigate RWA impacts. Banks have both the time and the earnings capacity to adjust to the new framework. Our base case is that all banks will proactively manage balance sheets and capital distribution to maintain a safe distance to regulatory requirements.”
Meanwhile, profitability has remained resilient, Scope ratings states that ECB rate cuts –from 4% to the current 2% -have curbed European banks’ earnings growth. Nonetheless, Q1 2025 results were still strong, reflecting resilient net interest income, growing fees and trading income, costs under control and very low credit losses.
Scope ratings concludes: ”In our base case, return on equity will decline in 2025, albeit less than previously forecast, after the strong Q1 and given the expectation that the macroeconomic environment will remain supportive for revenue growth despite geopolitics and a trade war.”
