Financial Regulatory Forum

Banks eye clock on tougher capital rules, may face pressure to act soon

By Reuters Staff
September 8, 2009

Governor of the Bank of Italy Mario Draghi, who also chairs the international Financial Stability Board, speaks during the International Organisation of Securities Commissions (IOSCO) annual meeting in Tel Aviv June 10, 2009. REUTERS/Gil Cohen Magen By Huw Jones and Steve Slater
LONDON, Sept 8 (Reuters) – Banks face pressure to raise billions of dollars in fresh equity to meet tough new capital rules and many European lenders may need to act soon to improve quality even though the proposals will not be fully felt for several years.

Finance ministers from the G20 countries on Saturday began formalising pledges their leaders made in April to raise bank capital and map out structures of bank pay packages so that lessons from the credit crunch are applied.  A day later, central bankers and regulators who oversee the Basel Committee on Banking Supervision outlined a second set of anticipated reforms to bank capital rules to turn G20 policy into tougher standards.

U.S. Treasury Secretary Timothy Geithner said on Saturday he wants the new capital rules agreed by the end of 2010 and in force two years later, but others were less specific.

“There’s nothing that’s come out that wasn’t conceptually in the pipeline and the timeline of introduction is better than it could have been,” said Exane BNP Paribas analyst Ian Gordon.

Timing will depend on how quickly economic recovery beds down so that lending to aid the economy is not hampered by a need to bolster capital.

“These changes are not going to happen overnight, so the banking sector will have plenty of time to adjust. (They)… will be phased in gradually,” Mario Draghi, chairman of the Financial Stability Board, a global regulatory body, said at Saturday’s G20 meeting.

The proposed changes to the Basel II bank capital framework will hurt the ability of banks to make money — but by exactly how much will remain unclear for about a year at least.

The Basel Committee already adopted a change in July to roughly double the amount of capital banks will have to set aside against their trading book activities, even tripling in the case of underpinning securitised products.

This takes effect from the end of 2010.

The big change in Sunday’s reforms is that at least half of core Tier 1 capital must be common equity and retained earnings, which can absorb losses rapidly. Banks will have to deduct items such as writedowns on goodwill from this top-quality bucket, which must then be topped up.

This will toughen up standards as many banks now make such deductions from lower quality capital known as hybrid debt, the bond-like capital that is less costly to replace.

“A greater focus on common equity within Tier 1 is already something the United States has done and Switzerland and the UK as well, but there are still plenty of markets in Europe where hybrids account for a large proportion of capital,” said Huw van Steenis, European banks analyst at Morgan Stanley.

Michael Wainwright, a partner at Eversheds lawfirm, added: “This could affect UK government stakes in UK banks, as well as holders of hybrid capital in banks elsewhere in Europe.”

It may force France and Germany to semi-nationalise more of their banks, Wainwright said.

LESS LEVERAGE
Banks already accept the need to raise capital levels and their key concern is not only timing but exact details of how all the reforms will mesh together.

The Basel Committee has not yet decided where to peg the overall level of minimum capital requirements, currently at 8 percent, though big banks are already well above this.

It will work on devising a leverage ratio to supplement its existing risk-based approach but details of how it would work won’t be published until year end. But it could see bank borrowings limited to 25 times their assets, analysts reckon.

Banks will also be required to build up an extra capital cushion in good times to draw down in bad times and a minimum global standard on how much minimum liquidity banks should hold.

“Regulators don’t want to lift the leverage ratios in the midst of the crisis because that will hinder lending restarting, but they don’t want to leave it forever,” Morgan Stanley’s van Steenis said.

“This is going to be very delicate. But the bottom line is more equity will be raised by European banks over time.”

Resurgent equity markets could prompt some lenders to
raise equity sooner rather than later, encouraged by strong appetite for $5 billion of UBS shares sold last month.

Big cross-border banks whose failure would destabilise the wider financial system may also face a surcharge.

An impact assessment will be done in early 2010 to gauge the effect of all planned changes to Basel II and aid “calibrations” of the new capital levels required.

So it won’t be until late 2010 that banks know how much more capital they will have to hold, a timeline that worries them.

“We agree capital requirements need to be raised but we would like to know what the total package will look like instead of having this piecemeal approach,” a European banking industry official said.

Basel II took a decade for supervisors to thrash out as countries like Germany fought to preserve the use of hybrid capital but there is political and industry momentum for speedier progress towards what will effectively be Basel III.

“If this isn’t all done in the next couple of years, I would be quite surprised,” said Graham Bishop, a former banker who advises the EU on financial services.

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