G20 to roll out tougher bank rules to bring order

The Group of 20 is expected to endorse new capital requirements for the world’s banks this week, even as banking groups assert that they will undercut bank profits, hurt lending and eliminate jobs.

The endorsement in Seoul, South Korea, will be the signal for countries to start incorporating the so-called Basel III rules into their own laws, which should then gradually reveal who was right.

Bankers contend the rules will raise the cost of credit and devastate the securitisation market, which is crucial to lending. They are also alarmed at efforts by some countries to enhance the new rules and speed up adoption. Behind the scenes, banking groups are lobbying G20 leaders to call on nations to stick to the agreed plan.

The central bankers and national bank regulators who wrote the rules say that fears of enormous economic damage are overblown. On the contrary, they argue, there will be substantial economic benefits from a system less prone to the kind of financial collapse and near depression the world has just experienced.

Jean-Claude Trichet, the president of the European Central Bank, cautioned on Monday that there was still a lot of fine-tuning to be done on the rules, which would continue after the G20 meeting. “It’s a work in progress,” he said in Basel.

“But,” he added, “what has been done until now is very important and is an important contribution to global resilience of the financial system.”

At its heart, the debate reflects a fundamental disagreement between regulators and bankers about what the business model for the banking industry should be.

To the regulators, a less profitable but more stable banking system would be a good thing. Bankers see the rules as hobbling their ability to provide financial products that drive innovation and growth.

“At stake is the global economic recovery and much-needed job creation,” Josef Ackermann, the chief executive of Deutsche Bank, said in Beijing last week. Ackermann is also chairman of the Institute of International Finance, an industry group based in Washington that has warned of millions of lost jobs if the rules are put in place too quickly.

The centerpiece of the new rules dictates how much capital banks must hold. Starting in 2019, banks must hold risk-free capital worth at least 7 per cent of their assets, which will be calculated according to a bank’s level of risk.

Previously, banks could hold as little as 2 per cent of this so-called common equity.
In boom times, when there is a risk of credit bubbles, banks could be required to increase their capital to as much as 9.5 per cent of risk-weighted assets. Regulators are still working on rules that could require large or highly interconnected institutions, with the potential to sow distress throughout the financial system, to hold even more in reserve.

Deadline

In a concession to banks, the Basel committee agreed to phase the new requirements in gradually during the next eight years. Charles H Dallara, the managing director of the Institute of International Finance, said that the banking group could live with the capital requirements if there was sufficient time for banks to adjust.

But he expressed concern that some zealous national regulators were adding their own, stricter rules to the Basel standards. Already Switzerland has ‘gold-plated’ the Basel III rules, imposing stricter standards for its two big institutions, UBS and Credit Suisse.
“The effect has been to substantially undermine” agreements reached this year, Dallara said in an interview during a visit to Frankfurt. Banks could be required to bolster their reserves while they were still struggling to recover from the recession and financial crisis, he added.

“If banks are forced to raise capital in a short period of time or sell assets, there could be deleterious economic effects,” Dallara said.

He and other bankers also complained that investors had already begun using the Basel rules as a benchmark to rate bank shares.

Indeed, after Commerzbank reported its quarterly earnings on Monday, analysts at Barclays Capital issued a report saying that the institution in Frankfurt faced a 10 billion euro, or $14 billion, shortfall in common equity, which they called ‘a tough fix’.

A study by the Atlantic Council, a nonpartisan group, argued that some divergence in the way the rules were applied from country to country was acceptable. “Regulatory differences even have some benefits, in allowing a competition among ideas,” the council said in a study last month that was prepared with input from representatives of the financial industry.

There is broad agreement that the rules will increase the cost of credit, though studies disagree on how much. Some economists argue that credit was already too cheap during much of the last decade because banks enjoyed de facto insurance policies from taxpayers. The implied public guarantee encouraged too much risk-taking, they say.
“The cost of financing will increase,” said Harald A Benink, professor of banking and finance at Tilburg University in the Netherlands. “But what this means is shifting risks borne by taxpayers back to professional investors. That is a positive thing.”

Proponents, including the Obama administration, point out that the banks that got into the most trouble during the financial crisis were often those that did not have enough capital to absorb unexpected losses. Examples include European institutions like Hypo Real Estate in Germany and Royal Bank of Scotland.