Regulators must grab chance to bin EU capital ruse

January 15, 2013

By George Hay

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Regulators must seize the chance to ditch one of euro zone banks’ more absurd regulatory wheezes. In the first half of 2013, the Basel Committee on Banking Supervision will publish a comprehensive study assessing how global banks risk-weight their assets. The rule-setter should use its platform to name and shame the national regulators and lenders that are still getting away with holding no capital against their euro zone sovereign debt.

Basel rules oblige banks to assign capital depending on how risky their sovereign assets are. Banks can choose Basel’s own clunky standardised risk-weighting template, which zero risk-weights sovereigns rated AA- or above. Or they can use their own models, which have to take into account independent ratings.

Euro zone banks, however, have a workaround. The Brussels interpretation of the Basel rules allows banks in euro-denominated states to zero risk-weight all sovereign debt, regardless of whether they use the template or their own models. This incentivises banks to stock up on government bonds, with the politically pleasing effect of keeping sovereign borrowing costs low. But it also means bank investors worry that lenders aren’t holding enough capital.

Supranational bodies like Basel Committee and the European Banking Authority clearly don’t like this. In October, Basel highlighted dodgy risk-weighting as one of the key ways Europe didn’t comply with its new Basel III rules. And the EBA’s 2011 stress test forced banks to assign proper risk-weights to their sovereign exposures.

The snag is that there is no clarity on who is dodging capital and who isn’t. Until March, 2014, when the European Central Bank starts to regulate the largest euro zone lenders, no central authority can force its policies upon national regulators currently tolerating the ruse. But acting proactively now might not be too bad: a few supervisors already require extra capital against sovereign risks, so that a proper risk-weighting might only shave 20 basis points off average core Tier 1 ratios, according to Barclays.

That’s why the Basel Committee must not pull its punches. Naming errant national regulators and banks would force them to address capital shortfalls. As investors become more confident that bank risk-weights are sound, funding costs will fall and share prices rise. Basel should jump on this golden opportunity.

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