The Bank of England is preparing its first significant break from EU regulations with a proposal that would make bank capital rules tougher in the UK than on the continent.

The European Banking Authority decided late last year that lenders should be able to count investment in software towards their core capital levels. For example, if a bank spends €100m on a new trading system, much of that can now be counted as loss-absorbent capital.

But in a harsh verdict on the decision, the BoE’s Prudential Regulation Authority has said that it had “found no credible evidence that software assets can absorb losses effectively in stress” and is “therefore concerned . . . [the rule] could undermine the safety and soundness of UK firms”.

Christopher Cant, an analyst at Autonomous, said “the wording of the statement . . . is unusually strong” and it makes the PRA’s “dim view . . . on the non-deduction of software intangibles rather plain”.

In a pointed speech on Wednesday, BoE governor Andrew Bailey doubled down on this stance, saying the EU policy would “give a false picture of a bank’s loss absorbing capacity” and was in conflict with the internationally-accepted Basel standards. On Friday, the BoE began a consultation on scrapping the rule.

“It is staggeringly improbable when a bank gets into difficulty that those investments will have a realisable value,” said a person familiar with the UK supervisor’s thinking.

“The banks were lobbying them on this, arguing they needed to be liberated to invest in IT, defend themselves from fintechs and compete with big tech and American banks,” they added. “It convinced the European political machine, but not us.”

The BoE’s plans come as prospects fade that the EU will grant “equivalence” status to UK regulations — dashing the City of London’s hope of regaining significant access to European markets.

The regulator’s proposal will toughen the rules for British banks versus their European rivals and potentially reduce the amount they can pay in dividends. Shareholder payouts are already strictly capped by regulators to ensure they retain enough capital to absorb Covid-related loan losses and continue lending through the pandemic.

The EU regulation changes — known as CRR2 — would have had a roughly €20bn aggregate capital uplift across the EU banking sector — equivalent to roughly 30 basis points of core CET1 capital — according to an EBA report last year.

Of that, about €3.6bn related to the five largest UK banks, meaning the PRA’s proposed changes will result in a substantial hit to the likes of Lloyds — which will lose out on more than £1bn of capital relief — followed by Standard Chartered and Barclays.

Additionally, smaller challenger banks such as Virgin Money, Metro Bank and Close Brothers are “acutely exposed” to the change due to recent big IT projects, according to Cant, the Autonomous analyst. Virgin would have benefited by almost £100m in extra in capital under the EU changes.

EBA officials privately have some sympathy with the BoE’s position. In 2018, they wrote to their EU counterparts to argue against a more favourable capital treatment for banks’ software investment, saying: “Software treatment should not be hastily changed given that deduction as presently applied still reflects the likely absence of value of software in resolution and even more in liquidation”.

A European official said there was a “political logic” to granting the region's banks some capital relief on their software investments. The official said this would both avoid European lenders being put at a disadvantage compared to US banks that benefit from similarly favourable capital treatment and support them in competing with technology groups, many of which are encroaching into financial services.

After EU lawmakers insisted on the change, the EBA opted for a compromise whereby banks’ new software investments are offset against capital over three years. The EBA declined to comment further.

The European Commission did not respond to a request for comment.

Additional reporting by Michael Peel.