New global rules for banks

2010-09-13 07:05

Basel, Switzerland - Global financial regulators on Sunday agreed on new rules designed to strengthen bank finances and rein in excessive risk-taking to help prevent another crisis.

Banks will be forced to hold more and safer kinds of capital to offset the risks they take lending money and trading securities, which should make them more resistant to financial shocks such as those of the last several years.

European Central Bank president Jean-Claude Trichet, chairperson of the committee of central bankers and bank supervisors that worked on the new rules, called the agreement "a fundamental strengthening of global capital standards."

"Their contribution to long-term financial stability and growth will be substantial," Trichet said in a statement.

US officials including Federal Reserve chairperson Ben Bernanke in a joint statement called the new standards a "significant step forward in reducing the incidence and severity of future financial crises

Some banks have protested however that the new rules may hurt their profitability and cause them to reduce the lending that fuels economic growth, possibly dampening a global economic recovery.

Representatives of major central banks, including the ECB and the U.S. Federal Reserve, agreed to the deal at a meeting in Basel, Switzerland, on Sunday. The deal still has to be presented to leaders of the Group of 20 forum of rich and developing countries at a meeting in November and ratified by national governments before it comes into force.

The agreement, known as Basel III, is seen as a cornerstone of the global financial reforms proposed by governments following the credit crunch and subsequent economic downturn caused by risky banking practices.

Earlier this year the Brussels-based European Banking Federation warned that the new global rules forcing banks to put aside more capital could keep the eurozone economy in or close to recession through 2014.

The federation said its analysis of proposed new Basel III banking standards would limit eurozone banks' credit growth and profits, hurt the economy and prevent the creation of up to 5 million jobs in the 16 nations that use the euro.

Under the agreement, banks will have six years starting Jan. 1, 2013, to progressively increase their capital reserves. Under current rules banks have to hold back at least 4 percent of their balance sheet to cover their risks. Starting in 2013, this reserve - known as tier 1 capital -will have to rise to 4.5 percent, reaching 6 percent in 2019.

In addition, banks will be required to keep an emergency reserve known as a "conservation buffer" of 2.5%. In total, the amount of rock-solid reserves each bank is expected to have by the end of the decade will be 8.5% of its balance sheet.

Already one bank has cited the new rules as a reason for its plans to tap the market for billions of euros in new capital.

Earlier Sunday, Germany's biggest bank, Deutsche Bank AG, announced plans to raise at least $12.4bn in a capital increase.

The planned issue of 308.6 million new common shares is meant primarily to cover the consolidation of Postbank, "but will also support the existing capital base to accommodate regulatory changes and business growth," Deutsche Bank said. It did not elaborate.

New rules

Stung by the experience of having to bail out some ailing banks to avoid wider economic collapse, regulators also agreed a number of other measures to shore up the stability of financial institutions:

- Countries will be able to demand that banks build up a further reserve during good times amounting to up to 2.5% of their common equity. This "countercyclical buffer" is to help avoid excessive lending during periods of economic boom.

- Another measure aimed at preventing banks from overstretching themselves is the introduction of a leverage ratio of 3%. Leverage, or borrowing to invest elsewhere, boosts returns but can backfire catastrophically if an investment declines. Some European banks had objected to this, arguing that the measure unfairly penalizes small lenders with relatively safe credit portfolios.

- Regulators also agreed to continue working on additional safeguards for "systemically important banks" - those that could bring down entire economies if they collapse.

  • greg suddards - 2010-09-15 12:10

    The purpose of capital reserves is to impose a web between the value f assets (mostly loans and advances in the case of banks) so that the impact of poor lending decisions is not bourne directly by depositors (and in so doing impacting the money supply and an important aspect of wealth in an economy). Such a wedge or buffer, however is only as good as the integrity of the assets into which the capital is deployed. Banks must offer shareholders returnns which are competitive with those obtainable elsewhere in the capital market. The temptation will exist, therefore, for banks to ivest their share capital in increasingly risky assets in order to compensate for the reduction in gearing due to higher capital requirements. Consequently, it is uncertain whether the increased capital reserves will achieve their desired objective. Perhaps consideration ought to have been given to specifying the types of assets into which capital must be deployed.

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