G-20 Calls for Higher Bank Capital to Avert Financial Crisis

The Group of 20 countries said banks need “significantly higher” capital to avert another financial crisis, while granting member nations more flexibility to meet the new requirements.

Leaders meeting in Toronto yesterday said countries should adopt higher capital standards by the end of 2012, though banks can phase in capital increases during a transition period.

“This issue of balance is in there,” said Royal Bank of Canada Chief Executive Officer Gordon Nixon. “We need more capital, we need more leverage, but we also have to ensure that it is not to such an extent that it kills economic growth.”

Financial firms around the world have racked up $1.78 trillion in losses since the third quarter of 2007 and have since raised $1.5 trillion in new capital, according to Bloomberg data. U.S. firms account for $1.2 trillion in losses and $812 billion in fresh capital.

“The financial crisis has imposed huge costs,” the G-20 statement said. “This must not be allowed to happen again.”

Leaders said they will seek final agreement on capital rules at a summit in Seoul in November when the Basel Committee of Banking and Supervision, made up of international central bankers and other officials, will propose a road map.

Withstand Shock

The G-20 also reiterated its support for a leverage ratio to accompany the capital framework known as Basel III. The G-20 called for banks to increase common equity as a percentage of their so-called Tier 1 capital to allow them to withstand another shock “of a magnitude associated with the recent financial crisis” without significant government support, the statement said.

“The amount of capital will be significantly higher and the quality of capital will be significantly improved,” the final statement said.

G-20 nations will be allowed to phase in the increased capital to take into account each country’s “circumstances,” and is “consistent with sustained recovery and limits market disruption.”

“We should provide transition arrangements that enable movement to robust new standards without putting recovery at risk, rather than allow concerns over the transition to weaken the standards,” Financial Stability Board Chairman Mario Draghi said. The stability board was created last year to advise international banking regulators.

‘Ambitious’ Standard

The transition periods need to be internationally consistent, a U.S. official told Bloomberg News. The official said today’s agreement means banks may be held to the ambitious standard of being able to withstand a shock similar to the recent crisis.

As the new rules take effect, regional differences should be “narrowing over time as countries converge to the new global standard,” the statement said.

“What we’ve been trying to emphasize in these debates and discussions is the recognition that the banking industry was undercapitalized going into the crisis,” said Nixon, who leads Canada’s largest bank. “There’s no question that increased capital requirements are not only coming, they’re important, as are leverage limits.”

The G-20’s endorsement of transition periods could complicate efforts to move to international standards on capital levels, said Carsten Brzeski, an economist at ING Group in Brussels, in a telephone interview.

No G-20 Standard

“If we go back to national regulation, there is the risk that it’s going to be very chaotic. This is going to be tricky,” Brzeski said. “It’s a pity that we don’t have a G-20 strategy.”

Global leaders also supported the Basel committee’s work to consider the role of contingent capital to help banks shore up their finances. Under the contingent capital proposal backed by Canada, subordinated debt and preferred shares sold by lenders may be converted to capital in the event of a crisis.

The U.S. official said the idea of contingent capital for the biggest banks would need a lot of work to be feasible. The U.S. is open to considering the issue if it can be shown to be effective, the official said.

The Basel committee is racing against a December deadline set by G-20 nations, and banks faced with raising what UBS AG estimates may be $375 billion of fresh capital are appealing to nationalist sentiments to ease the pain.

Rewriting Rules

The current round of changes was spurred by G-20 leaders who urged the committee to improve the quantity and quality of bank capital, strengthen liquidity requirements and discourage excessive leverage.

U.S. President Barack Obama and Treasury Secretary Timothy F. Geithner urged their counterparts to join the push for higher capital requirements. This effort gained momentum after American lawmakers agreed last week on legislation to overhaul the U.S. financial system.

The G-20 didn’t support the implementation of a global bank tax policy, which has the backing of countries including France and Germany.

“We recognized that there are a range of policy approaches” to ensure the financial sector pays for any government bailouts, the statement said. “Some countries are pursuing a financial levy. Other countries are pursuing different approaches.”

French President Nicolas Sarkozy said the Group of 20 nations views a tax on banks to pay for bailout costs as a legitimate policy.

“The possibility to tax banks is recognized as legitimate by the G-20,” Sarkozy told reporters.