Banking Regulation 2025

Introduction

The year 2025 will be another exciting and difficult time for the global banking industry. Even though the effects of the COVID-19 pandemic may have ended, the industry still has to deal with a mix of economic, regulatory, and technological challenges. Political tensions and trade problems between major economies make things even more uncertain. Most banks must navigate the full implementation of Basel III standards by next year, which will increase capital requirements and leverage ratio standards. Additionally, the rise of open banking and advancements in artificial intelligence and blockchain technology will further disrupt traditional banking models. Furthermore, the growing importance of environmental, social, and governance (ESG) factors will compel banks in most jurisdictions to integrate sustainability into their business strategies and risk management frameworks.

Emerging Trends and Regulations

Digital transformation remains a top priority for banks as they strive to improve operational efficiency, enhance customer experience, and mitigate cyber threats. Investments in mobile banking, artificial intelligence, and cloud-based technologies are becoming increasingly essential for banks to remain competitive. Open banking, a trend that has gained significant momentum in recent years, will further disrupt the banking industry in 2025. By allowing third-party providers to access customer data, open banking has created new opportunities for innovation and competition which are now starting to materialise. Banks that can leverage open banking to offer enhanced products and services will be well-positioned to meet evolving customer expectations.

ESG factors are gaining prominence in the banking industry on a global level. The Basel Committee on Banking Supervision, which developed Basel III, has acknowledged the growing importance of ESG factors in the financial sector in the past years. This recognition has led to a focus on incorporating ESG risks into banks’ risk management frameworks and capital requirements by banks, particularly in the EU, with the introduction of CRR3 and CRD6 starting in 2025 (also referred to as Basel IV ESG). Next to regulatory pressures, investor demands and societal expectations are driving banks to integrate ESG considerations into their business strategies and risk management frameworks. Banks that can demonstrate a strong commitment to sustainability and ethical practices may benefit from enhanced reputation and increased investor confidence in certain parts of the world. Emerging markets as well as – to a certain extent – the UK and the USA are less stringent in implementing requirements for ESG measures at banks and as such a lack of consensus remains on a global level.

Cryptocurrency and blockchain technology continue to evolve, presenting both opportunities and challenges for banks. While some banks are exploring ways to integrate these technologies into their offerings, others remain cautious about the associated risks. The potential impact of cryptocurrencies and blockchain on the traditional banking system remains a subject of ongoing debate in the banking industry. Of particular interest in 2025 will be the rise of e-money tokens and asset-referenced tokens pegged to major currencies such as the US dollar or the EU euro. With 83.5 billion USDT stablecoins in circulation in 2024, stablecoins play a big role in the US market and a similar trend is visible in other parts of the world. Bolstered by new regulations in the EU, these types of stablecoins are also expected to play a significant role as an alternative means of payments by fintechs in the EU without the need for banks to ensure payment finality. Consequently, banks that continue to rely heavily on traditional payment methods may find themselves at a competitive disadvantage in the long run.

Interest Rate Prospects

Central banks worldwide are carefully balancing the need to manage inflation with the goal of supporting economic growth. As of late 2024, the outlook for interest rates remains uncertain, despite a recent trend of rate cuts. While many central banks were raising interest rates to combat inflation in the preceding years, this trend reversed in 2024, with several central banks opting to lower rates instead. However, the exact trajectory of rates in 2025 will depend on various economic factors, including inflation, economic growth, and geopolitical developments. This uncertainty about the future direction of monetary policy means that banks need to be prepared for both scenarios and manage their interest rate risk accordingly. This includes using hedging strategies and carefully managing asset and liability portfolios.

Basel III Standards Fully Implemented

Capital adequacy remains a critical concern for banks, as they must ensure they meet regulatory requirements and maintain financial stability. The full implementation of Basel III standards, including the Basel III.1 revisions, in most jurisdictions by early next year will strengthen capital requirements, meaning that banks must continue to manage their capital levels prudently. Banks are working to comply with the increased capital requirements and leverage ratio standards.

With the end of the leverage ratio relief for EU banks following the COVID-19 pandemic, deposit-heavy banks with small lending books may struggle in 2025 to meet the leverage ratio, as relief is not expected in the EU any time soon. Although the Basel Committee’s recommendations are intended to serve as internationally agreed-upon minimum standards, individual regulators have the discretion to diverge from and exceed these standards within their respective countries’ regulations. For instance, the Prudential Regulation Authority (PRA) in the UK announced that it is reviewing the leverage ratio requirements thresholds and is offering relief by consent (provided certain conditions are met) for certain banks. By contrast, the Federal Reserve Board in recent regulatory proposals suggests that the leverage ratio may be further tightened to strengthen the banking system in the USA, despite reiterated calls from the US banking sector to exclude excess reserves held in the Federal Reserve system from the leverage ratio. Overall, we do not expect a “race to the bottom”, where regulators weaken their rules to remain competitive.

Asset quality is another key area of focus, particularly in the context of uncertainty around interest rates rising or falling and potential economic downturns. Banks are closely monitoring loan portfolios and implementing strategies to mitigate credit risk under these circumstances. This includes measures such as stress testing, provisioning, and loan restructuring. Adequate liquidity is essential for banks to withstand market shocks and meet customer demands. Banks are focusing even more on strengthening their liquidity management practices and maintaining sufficient liquidity buffers. This involves careful monitoring of cash flows, managing funding sources, and implementing effective liquidity risk management frameworks. Banks across these jurisdictions thus need to carefully assess the impact of their ratios and adjust their business strategies as needed.

Global Considerations and Geopolitical Tensions

The ongoing geopolitical tensions, resulting from ongoing conflicts in Eastern Europe, the Middle East and trade disputes between major economies, have created a complex and uncertain environment for the banking industry. These conflicts have led to increased economic uncertainty, disrupted supply chains, and heightened geopolitical risks. Banks operating in or with exposure to these regions have faced significant challenges, including increased credit risk, operational disruptions, and reputational damage. Moreover, the broader geopolitical instability has contributed to market volatility, impacting investor sentiment and the overall health of the global financial system. Looking ahead to 2025, banks should anticipate that these geopolitical tensions may persist or even escalate. To navigate this uncertain environment, banks need to be proactively addressing these challenges to improve their resilience and position themselves in an increasingly uncertain geopolitical environment.

Technological Advancements and Changing Customer Expectations

The rapid pace of technological advancements continues to transform the banking industry. Artificial intelligence (AI), machine learning, and big data analytics are being used to improve customer experiences, enhance risk management, and optimise operations. Banks that can effectively leverage these technologies will have a competitive advantage. In the UK and the EU, competition within the banking sector is also intensifying. The rise of fintech firms and the increasing popularity of digital banking services are challenging traditional banking models. Some banks might double down on existing client relationship models, while others must adapt to this changing competitive landscape by offering innovative products and services, improving customer experience, and leveraging technology to their advantage. Customer expectations are evolving rapidly, driven by digitalisation and increased competition from non-traditional financial services providers. Consultancy firms around the globe report extensively about what banks must do to address these challenges, but no hard and fast rule seems to apply for all banks next year.

Conclusion

In 2025, the global banking industry will face many challenges and opportunities. The full implementation of Basel III standards will require banks to carefully manage their capital and liquidity to meet new regulatory requirements. Changes in leverage ratio requirements will also necessitate strategic adjustments to maintain financial stability, particularly as some regions tighten these standards while others offer relief. Technological advancements like AI, blockchain, and open banking will push banks to innovate and improve their services, creating a dynamic and competitive environment. The rise of stablecoins, bolstered by new EU regulations, will further disrupt traditional payment methods, compelling banks to adapt or risk falling behind. With 83.5 billion USDT stablecoins in circulation in 2024, this trend is expected to grow, offering new opportunities for fintechs and posing challenges for traditional banks.

The growing importance of ESG factors will encourage banks to integrate sustainability into their operations, enhancing their reputation and attracting investors. Regulatory pressures, investor demands, and societal expectations will drive this integration, particularly in the EU with the introduction of CRR3 and CRD6. However, a lack of consensus on ESG measures remains globally, with emerging markets and regions like the UK and the USA being less stringent. Amidst uncertain interest rate prospects, with central banks balancing inflation management and economic growth, banks need to be prepared for both rising and falling rates. This includes using hedging strategies and carefully managing asset and liability portfolios.

Geopolitical tensions and trade disputes between major economies add another layer of complexity, creating economic uncertainty and market volatility. Banks operating in or with exposure to conflict regions will need to manage increased credit risk, operational disruptions, and reputational damage. To navigate this uncertain environment, banks must proactively address these challenges to improve their resilience and position themselves advantageously. By staying agile and proactive, banks can successfully navigate these multifaceted challenges and seize new opportunities in the evolving financial landscape of 2025.