FILE PHOTO: A view of European Central Bank (ECB) headquarters in Frankfurt, Germany July 18, 2024. REUTERS/Jana Rodenbusch/File Photo

By Balazs Koranyi

FRANKFURT, Dec 11 (Reuters) - The European Central Bank proposed to simplify bank regulation on Thursday, looking to prune a complex rulebook without easing the overall financial burdens, prompting criticism from lenders hoping for greater relief.

Banks have long complained that the supervision has become onerous and some countries, particularly the United States, are now pushing to cut regulation and soften capital rules on the premise that the supervision constrains bank activity.

But the ECB stuck to its premise that simplification cannot mean lower capital requirements and Thursday's proposals are focused on fewer - rather than lower - capital buffers lenders must hold to be ready for potential shocks.

"Simplification efforts should maintain banks' resilience and by banks' resilience, we mean the level of capital," ECB Vice President Luis de Guindos said. "We do not want to try to undermine the present situation of capital of the European banks."

The European Banking Federation welcomed the ECB's report but said "concrete and determined steps must now follow to enhance the global competitiveness of the EU's financial sector".

The umbrella group for German banking associations, Deutsche Kreditwirtschaft, also welcomed the proposed simplification and called for its rapid implementation but also said the ECB did not go far enough, especially in light of easier regulation elsewhere.

"The question arises whether these are sufficient in light of the regulatory relief measures in the U.S. and the UK," Heiner Herkenhoff, the head of the German Bankers Association said. "We urge the EU Commission to be more decisive."

The group said that simplification for smaller banks also did not go far enough.

Shares in European banks rose more than 1% on Thursday, well ahead of the gains in the wider market.

FEWER, NOT LOWER BUFFERS

The ECB's number one recommendation is to simplify the design of banks' capital requirements and buffers, called the capital stack, as Reuters reported earlier.

The ECB aims to merge existing layers of buffers into just two: a non-releasable and a releasable buffer which authorities can lower in bad times.

The new releasable buffer would result from merging the countercyclical capital buffer with the systemic risk buffer, which are normally built up during periods of calm and released during downturns.

However, the non-binding Pillar 2 guidance on capital levels would be kept separate, on top of the releasable buffer.

The ECB also wants to reduce the leverage ratio framework from four elements to two, to include a 3% minimum requirement and a single buffer, which could be set to zero for smaller banks, the bank said in a statement.

The ECB also proposed expanding the so-called "small banks regime" so more lenders would fall under simpler supervision requirements.

CONVERTIBLE BOND REFORM?

The ECB also argued that the loss-absorbing capacity of convertible bonds called Additional Tier 1 (AT1) instruments is doubtful, because banks rarely use these to actually absorb losses and they should be reformed in a way that it is closer to equity, de Guindos said.

The instruments made headlines in 2023 when Credit Suisse wiped out 16.5 billion francs worth of such bonds during the state-engineered takeover by its rival UBS. The move was later ruled illegal by a Swiss court, though an appeal is still pending.

"You can improve the loss absorption capacity and what we are saying, at the end of the day, is that AT1s should be closer to equity."

Under one proposal, AT1 instruments could be enhanced to further ensure their loss-absorbing capacity but the role of the instrument itself would not be modified.

A "more radical" alternative would be to completely remove the bonds from the going-concern capital stack. That, however, may not be compliant with Basel rules, and may go against the principles of simplification, leading to changes in the regulatory capital demand, the ECB said.

Still, both proposals had support in the ECB's task force looking through regulation, de Guindos said, a nod to differences between French and German views, according to people close to the discussion.

The ECB also called for a reform of the scope and methodology of EU-wide bank stress tests to make them more useful both for banks and from a systemic perspective.

The recommendations, endorsed by the ECB's Governing Council, will now be presented to the European Commission for consideration and any actual change could still take months if not years.

For a factbox on specific measures, click here.

(Reporting by Balazs Koranyi; Additional reporting by Tommy Reggiori Wilkes, Tom Sims and Jesus Aguado; Editing by Toby Chopra, William Maclean and Tomasz Janowski)