Banks told to increase capital reserves

Regulators agree new rules in effort to prevent another financial crisis.

Banking regulators from the world’s major economies agreed yesterday (12 September) to substantially increase the capital reserves that banks must hold to protect themselves against risk.

The agreement ticks off one of the main agenda items of the G20 group of developed and emerging economies to overhaul bank regulation in the wake of the financial crisis.

It is intended to prevent any repeat of the taxpayer bailouts of banks that were needed during the crisis. The bailouts were necessary because banks were insufficiently capitalised to withstand a sudden, sharp financial downturn.

“The agreements reached today are a fundamental strengthening of global capital standards,” Jean-Claude Trichet, the president of the European Central Bank, said. Trichet chairs the regulatory group that agreed the new rules.

Regulators agreed to increase the tier-one (core) capital that banks must hold from 4% of the value of their assets to 6%. They also agreed that, within the overhauled tier-one total, banks should have to hold common equity (ie, funds raised through rights issues, retained earnings and other highly loss-absorbant forms of capital) equivalent to 4.5% of their assets, compared to 2% under current rules.

The rules require that assets are valued according to the level of risk they pose, with the riskiest assets being given the highest weighting.

The capital increases will be phased in between 1 January 2013 and 1 January 2015. The definition of common equity will be gradually tightened between 2014 and 2018. The overall definition of tier-one capital will tighten over a ten-year period beginning on 1 January 2013.

Regulators also agreed that, in addition to these minimum requirements, banks should build capital buffers consisting of common equity, as an extra precautionary measure. They want banks to begin building these buffers in 2016, and for them to reach 2.5% of banks’ risk-weighted assets by 2019. Although the buffers will not be compulsory, banks that do not have them will not be allowed to pay dividends to stockholders.

The timetable for introducing the increased capital requirements marks a defeat for Germany, which had sought a ten-year implementation period. German regulators were concerned that forcing banks to raise more capital in the current climate could stifle their lending to businesses, and so damage economic recovery.

However, Axel Weber, the president of the German Bundesbank, said that banks would have sufficient time to meet the new requirements. He said also that “the special nature of German financial institutions” had been taken into account – a reference to the relatively gradual tightening of the definition of tier-one capital.

The agreement was reached by the governing body of the Basel Committee on Banking Supervision, which brings together regulators from 27 countries including nine EU member states. It will be presented to leaders of the G20 countries for approval at a summit on 11-12 November.

Markets opened higher this morning on news of the agreement, which has ended weeks of uncertainty over what form the new rules would take.

The Basel committee agreed earlier this year on other reforms to capital requirements. These include the introduction of a leverage ratio that will limit banks’ ability to fund investments through debt, and liquidity ratios, which will require banks to hold a certain proportion of their funds in the form of cash, or assets that can be easily converted into cash. The liquidity ratios would protect banks from insolvency if there was a sudden rush by depositors or clients to withdraw their money, or if there was a short-term collapse in the inter-bank lending market. These agreements will also go to the G20 for approval.

The European Commission will present draft legislation in spring next year to implement the agreements in the EU.