Wall Street's profit boom has Europe ripping up its banking rulebook

U.S. investment banks have toasted a record quarter, as their European rivals continue to lag — but now a major pivot towards deregulation across the Atlantic could provide a much-needed shot in the arm for the continent's beleaguered banks.

At stake is whether Europe can build banks with the scale and firepower to compete with U.S. giants that have spent more than a decade taking market share in trading, investment banking and capital markets. A major EU deregulation push could lower capital burdens, free up balance sheets and clear the way for more cross-border mergers — potentially reshaping a banking sector long seen as too fragmented to challenge Wall Street.

The European Commission will outline its proposals in a report on banking competitiveness, due Friday, setting out legislative changes for the sector for 2027.

It is reportedly preparing to ditch parts of its "Pillar 2" capital requirements rules on leverage ratios as part of a sweeping regulatory overhaul aimed at boosting banks' competitiveness. These rules allow national supervisors to impose additional discretionary add-ons on top of the EU's basic 3% leverage ratio rule.

Stoxx 600 Banks Index.

Taken together, the measures would be a seismic shift in the way European banks are regulated. They follow similar plans by U.S. and U.K. regulators to relax certain banking rules, including U.S. proposals to cut capital requirements for the largest banks by nearly 5%.

"European authorities are mindful of the regulatory developments in the U.K. and the U.S. and simply do not want to put the banking sector at a disadvantage," said Jakub Lichwa, a member of the multi-sector bond portfolio management team at TwentyFour Asset Management.

Lichwa said a lower amount of capital held by banks would make it easier to deliver a higher return on equity, making shares of European banks more attractive to investors. "In and of itself, lower capital requirements do not necessarily lead to operational improvements of the sector, but at a margin could facilitate better competition with global peers," he told CNBC via email.

U.S. investment banks are enjoying a stellar second-quarter earnings season, with JPMorgan Chase, Bank of America, Citigroup, Wells Fargo and Goldman Sachs all beating expectations with bumper trading revenues and a rebound in dealmaking.

Now, as European bank earnings come into focus — with Santander, UniCredit, UBS and Deutsche Bank all set to report later this month — a change in policy from the EU will be key in prompting more action and confidence in European bank boardrooms, said Andrew Stimpson, head of European banks research at KBW.

"Europe has realized that it is competing globally and that its focus so far on just "simplifying" bank rules is not going to achieve its strategic objectives," Stimpson said.

He noted that European leaders increasingly recognize the continent's strategic weaknesses, and the importance of defense, AI infrastructure, and energy infrastructure investment — all of which are capital-intensive projects.

"To fix those weaknesses, Europe needs its banks and the capital markets to help finance these projects. Telling a bank it can fill in one form rather than 20 forms does not get any of these projects built."

UniCredit.

As a result, Friday's report on bank competitiveness will be key, he said.

"It is going to talk about some deregulation, but also about changing rules and laws to make cross-border consolidation more likely, which in turn should allow Europe to have some banks with real scale and the ability to compete domestically and internationally."

With the continent's banking landscape historically fragmented, cross-border consolidation is widely seen as essential to creating a pan-European banking champion capable of competing with U.S. giants. That chimes with the European Central Bank's ambition of a single banking jurisdiction, with capital and liquidity able to move freely within cross-border groups and depositors enjoying equal protection.

But one notable example of a potential pan-regional tie-up — Italian lender UniCredit's push to build a controlling stake in Commerzbank — has run into legal and political resistance in Germany, where the federal government remains the German lender's second-largest shareholder.

"The U.S. peers have a huge scale advantage and have been taking market share from European banks for about 15 years, particularly in capital markets," Stimpson said. "It's possible to catch up — but it will need some genuinely large cross-border consolidation within Europe, and all of these things will take time."

Caroline Liesegang, head of capital and risk management at the Association for Financial Markets in Europe, said fragmentation, trapped capital and liquidity, and regulatory complexity continue to hamper banks' ability to support growth and investment across Europe's single market.

She called on the Commission to take an ambitious approach to remove what she called "unnecessary barriers" and improve the efficiency of capital allocation across Europe.

"The focus must now shift from diagnosis to delivery," Liesegang told CNBC via email. "Legislative proposals, expected in early 2027, represent a critical opportunity to move the dial on the competitiveness of the EU banking sector."