US Basel equivalence questioned as EU patience wears thin

MEPs say unfaithful US implementation of Basel III could trigger review of third-country capital treatment

Patience is a virtue, but there’s sometimes a limit to its practicality.

Progress in the US to implement internationally agreed capital reforms has come to a standstill, and comments from newly appointed officials don’t offer much in the way of reassurance.

It’s a source of frustration to members of the European Parliament (MEPs), who say the time is coming for the European Commission (EC) to reconsider its verdict that US rules are equivalent to those in the European Union – a reversal that would affect the capital requirements for US exposures in EU banks’ books.

“If Basel implementation becomes worse [in the US], maybe we should evaluate the decisions the European Commission provides to American banks under the equivalence regime, to avoid importing risks from US banks and keep our banking industry safe,” says Jonás Fernández, an MEP who represented the parliament in negotiations over the EU’s Capital Requirements Regulation (CRR). Fernández is a member of the  S&D group – the Progressive Alliance of Socialists and Democrats – the second largest in the European Parliament.

If the USA does not implement Basel, there is a good case to be made that the US framework is not at an equivalent level to the European one

Markus Ferber, MEP

The Basel Committee on Banking Supervision finished drafting most of the final elements of its post-financial crisis reforms in 2017. Later amendments were made to its new trading book capital rules in 2019. Now, the suite of reforms known as Basel III includes a new floor on the amount of capital savings banks’ internal models can generate when determining capital requirements.

And while the EU implemented its version of Basel III at the start of 2025, US transposition remains shrouded in uncertainty – and Europeans are considering how the Union should respond to an unfaithful US implementation.

The CRR contains various provisions that allow better capital treatment for exposures in jurisdictions where prudential standards are equivalent to those in the EU. The US currently receives the full sweep of positive CRR determinations from the EC, which is the arbiter of equivalence. But MEPs say these decisions should be reviewed if the US doesn’t make progress towards implementing Basel III.

“After all, if the USA does not implement Basel, there is a good case to be made that the US framework is not at an equivalent level to the European one,” says Markus Ferber, an MEP from the European People’s Party (EPP), the largest political grouping in parliament.

© European Union 2017 - Source : EP

Jonás Fernández, MEP

Yet, while the withdrawal of equivalence would punish the US for abandoning Basel, it could in practice also be painful for European banks, as the determinations dictate the amount of capital they must hold against exposures to foreign institutions.

“If these equivalence decisions were revoked, it would be a bit ironic,” says Christian Saß, an associate director at the Association of German Banks. “The US not implementing the Basel rules gives us a competitive disadvantage in the first place, and then the commission revoking the equivalence decisions will lead to even higher capital requirements for us,” says Saß. “A double hit.”

And withdrawing equivalence isn’t the only way the EU could respond to the unfaithful implementation of Basel III in the US. If the goal is to ensure competitive parity between the EU and US banking system, some say an alternative would be for the EU to revise its standards to restore parity. The EPP’s Ferber says the EU could either revoke equivalence or change its own rules – or combine the two.

“As it becomes clearer and clearer that we cannot expect a faithful implementation of the Basel rules, it would be time for the European Commission to come up with a comprehensive European response,” he says.

The EC declined to provide comment for this story.

Silence speaks volumes

In 2023, US banks lashed out at US regulators’ proposals to incorporate Basel III into their laws, forcing them back to the drawing board. But there has been a halt in rulemaking since the November elections, and doubts are growing that the US will faithfully implement Basel III, given the new administration is critical of regulations and international co-operation.

Nor do the US Treasury Secretary Scott Bessent’s April 9 remarks provide any reassurance. Bessent criticised the Basel III package, stating there was little rationale for some of the rules.

“We should conduct our own analysis from the ground up to determine a regulatory framework that is in the interests of the United States,” said Bessent. “To the extent that the [Basel III] standards can provide inspiration, we could borrow selectively from them.”

I really don’t think the EU has a lot of leverage over the US to influence how it may or may not behave

Etay Katz, Ashurst

The following day, Federal Reserve governor Michelle Bowman, set out her priorities to the Senate Banking Committee, should she be confirmed as the next vice-chair for supervision at the Fed. Not once in her remarks did she list implementing Basel III as a priority, instead focusing on reforming supervision and tailoring standards to offer more relaxed rules to regional banks.

There are varying degrees on the Basel III scale to which US regulators could subject their capital laws. The purest application of Basel III would be a full and straight transposition, while a slightly less intense approach would be to tweak some of the rules. Alternatively, they could opt for a much more diluted version by choosing not to implement entire sections – or, at the extreme, not to apply it at all.

“The EC would have to review equivalence because it is not a decision you only take once,” says Ana Rubio González, head of financial regulation at Spanish bank BBVA. “You compare the two regulations, and say they’re equivalent, then you give them equivalence. You have to revise your analysis if there’s a significant change to one of the parts …  and not applying Basel III is a significant part.”

The EC’s equivalence determinations aren’t only linked to the degree of similarity between jurisdictions’ rules. Politics can be a prominent consideration. Despite the UK’s rules very closely resembling the EU’s, for example, the EC has not granted the country CRR equivalence since it left the bloc in 2020.

But just because it can penalise jurisdictions in this way, doesn’t mean it’s a good idea.

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“I really don’t think the EU has a lot of leverage over the US to influence how it may or may not behave,” says Etay Katz, a partner at law firm Ashurst in the UK. “And the significance of US institutions for finance in Europe is so large that to do something like this would have wide-ranging implications.”

Tensions between the US and EU have been evident since April 4, when US president Donald Trump unveiled tariffs on trading partners around the world, although they eased slightly in light of a 90-day pause to full tariffs on most countries. Given the delicacy of the  situation, a senior regulatory expert at a European bank believes the EC would be “more circumspect about opening new avenues of confrontation”. If a negative equivalence determination gets wrapped up in Trump’s tariff considerations, the US could have more powerful ammunition with which to hurt Europe’s financial sector.

But for Fernández, taking away the US’s positive determination is not a political move wrapped up in Trump’s tariff onslaught. He believes it would be a step towards mitigating contagion risk from the US banking sector. He points to the 2008 financial crisis, when Europe was burnt by banks’ exposures to mortgage-backed securities issued by US banks with little regard for the poor quality of the underlying mortgages.

Higher capital requirements for some types of US exposures would deter EU banks from carrying those risks.

“When I think of what we suffered in the last financial crisis due to exposure to the US financial sector – and given that the United States does not have a date to implement the Basel recommendations – I think we need to analyse properly the probability of financial contagion from the US to European banks,” says Fernández.

Shake it off

It is also possible to overstate the eventual impact on European banks if the US is no longer recognised as equivalent.

Equivalence status determines the level of risk weights banks can assign to exposures under the standardised approaches for calculating credit risk arising from banks’ lending books as well as from derivatives and repo exposures. Smaller EU banks rely on a standardised approach to calculating capital requirements, while many of the larger banks use an internal models approach for credit risk arising from loans, and counterparty credit risk from derivatives and repos.

Larger banks will still be affected, however, as the standardised approach (SA) determines the level of the floor on the amount of capital savings internal models can generate. Once fully phased in, EU banks’ risk-based capital requirements must be no lower than 72.5% of the output from standardised approaches. Higher risk weights for some exposures will increase the gap between the output of internal models and standardised approaches, which raises the floor.

The large money centres have a very substantial footprint in Europe. Anything that disrupts that equilibrium will be significant

Etay Katz, Ashurst

The SA for counterparty credit risk also informs another capital requirement, known as the leverage ratio, which requires a bank to hold a minimum amount of capital relative to its total assets. The measure is supposed to be risk-neutral, but regulators opted to use the risk-based SA-CCR to quantify derivatives.

The SA outlines different risk weights for different types of borrowers or counterparties. For capital requirement purposes, EU banks can characterise foreign banks from an equivalent jurisdiction as financial institutions, but must find another appropriate characterisation for banks from a non-equivalent jurisdiction from the available exposure types. For foreign banks, that characterisation is most likely to be as corporates, because they cannot realistically be classified as governments or retail borrowers. 

For the most part, financial institutions’ exposures carry lower risk weights than those of corporates.

The lowest risk weights for institutions and corporates – given to entities rated AA- and higher – are set at the same level. Withdrawal of equivalence would therefore have no impact for capital requirements set for highly rated banks. Some of the largest US banks, such as JP Morgan and Morgan Stanley, fall within this category, but the lower a company’s credit rating, the more the gap between the risk weights for the two entity types opens up.

EU banks could avoid the risk weight by trading with US banks’ EU subsidiaries rather than their US trading hubs or EU-based branches linked to their US headquarters.

This still poses problems for the US subsidiaries of EU banks, however. Although their subsidiaries’ capital requirements would be dictated by US rules, their headquarters must include all exposures throughout the group in their capital calculations.

Back-to-back transactions flowing between US and EU entities would also take a hit for one entity. In the case of US banking groups, their EU subsidiaries would face higher capital requirements for exporting risks to their home jurisdiction and the collateral they post against it. In addition, for EU banking groups, any exposures at their US subsidiaries that are booked into their headquarters could also end up with higher capital requirements.

“Any move of the needle can have very dramatic implications for those entities,” says Ashurst’s Katz. “The large money centres have a very substantial footprint in Europe. Anything that disrupts that equilibrium will be significant.”

Choose your weapons

There is a future where derecognition leads to an even greater impact, but it hinges on the unlikely event of the US Treasury’s credit rating declining.

The CRR allows exposures to foreign governments to receive a 0% risk weight if their credit rating is within the highest risk-weight bucket for sovereigns, or if a foreign government issuer allows its banks to apply a 0% risk weight and its capital standards are deemed to be equivalent.

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Stripping the US of equivalence would still mean holdings of US Treasuries would receive a 0% risk weight, since the US government currently has a credit rating of AA+ from major rating agencies. If its rating was to decline below AA- , however, this would lead to a 20% risk-weighting.

It’s common for European banks to have large holdings of the world’s supposedly safest asset to post as collateral as well as dollar liquidity reserves that can be quickly converted into cash.

BBVA’s Rubio González says the repercussions of a 20% risk weight would be “very significant” since “the holding of US sovereign debt by European banks may become more expensive”.

It’s possible, however, for the EC to pick and choose between equivalence determinations within CRR, since they are laid out in separate articles. The EC could remove equivalence for US banks, for example, while keeping it for US Treasuries.

And there are other ways the EU could respond to an unfaithful implementation of Basel III, such as by matching any deviations the US makes.

The EC is already proposing temporary changes to a revamp of trading book capital rules, given that the US won’t be implementing the rules at the same time as the EU is scheduled to, in January next year. Since there are fewer cross-border restrictions to trading in financial markets, EU legislators are more understanding of fears the Fundamental Review of the Trading Book could place EU dealers at a disadvantage. The EC could resolve the disparity by further delaying the rules by a year or enacting temporary changes.

There are nonetheless calls for the EC to review the wider capital framework in case differences in other jurisdictions’ rules lead to competitive distortions. But regulators would rather not see a race to the bottom on prudential standards, since that could increase systemic risks. For now, the EU is likely to sit tight until US plans become crystal clear.  

Editing by Louise Marshall