US prepares to push for global capital rules

By Tom Braithwaite

Published: April 25 2010 17:24 | Last updated: April 25 2010 17:24

The US is preparing to pivot from domestic regulatory reform to a push for a tough new international capital regime after the weekend’s G20 and International Monetary Fund meetings glossed over differences between leading economies.

Tim Geithner, US Treasury secretary, met Mario Draghi, chairman of the Financial Stability Board, on Sunday to discuss the contours of a system that would decide the safety and profitability of banks for decades to come and could eclipse the arguments over bank taxes and regulation.

But the different positions of senior central bank and government officials from several countries expressed to the Financial Times on the sidelines of the G20 meetings in Washington suggested that a final international agreement remains a challenge.

The G20 communiqué on Friday said: “We recommitted to developing by end-2010 internationally agreed rules to improve both the quantity and quality of bank capital and to discourage excessive leverage.”

But participants said little time was spent on the issue and that officials were gearing up for a battle at the June meeting over the direction of the new standards, which would prevent banks from relying on short-term funding and disqualify some assets from counting towards core regulatory capital, the highest-quality loss-absorbing part of the capital structure.

The most important fault line runs between a bloc of countries that includes the US, the UK and Switzerland and one that includes Germany, France and Japan.

The first group is enthusiastically behind a substantial increase in capital ratios coupled with a more conservative assessment of what counts as capital, tough liquidity rules and a new simple leverage ratio.

The second group is more attached to the pre-eminence of the current risk-based approach and wants the leverage ratio to have a much less important role in governing banks’ balance sheets.

Officials in the US and Europe are now starting to discuss the quantity of an increase in ratios among themselves. Some want a dramatic increase in the minimum level of capital over risk-weighted assets – perhaps to as much as 25 per cent from 8 per cent today – to be on the table while others want a more modest revision of capital rules.

“In the US right now there’s an absolute paranoia about a future bail-out,” said Douglas Elliott, fellow at the Brookings Institution think-tank. “In Germany and France, where they haven’t had to do this to the same extent and there’s more of a feeling that the state should be involved in the banking system, they’re not as concerned. The more you’re comfortable with the public sector as the potential backstop, the less private capital you need.”

Initial proposals from the Basel committee that sets capital rules met a robust response from banks which complain – with the sympathy of some officials in France and Germany – that some proposals are too unsophisticated to take account of the real asset risk, and credit would become scarcer and more expensive as a result of a move towards tangible equity capital and an increase in capital ratios.

JPMorgan Chase, in a response to a request for consultation, said: “To maintain the same level of profitability, pricing on products would have to increase by 33 per cent.”

One participant at a US Federal Reserve meeting this month to discuss the new regime said “full and frank” did not do justice to the furious response from some industry delegates.

The reaction from capital hawks was that a blunt backstop might be better than an overreliance on the sophistication of risk models and regulators. They also said banks would be given plenty of time to adjust to the new system, perhaps several years, to minimise the immediate impact on credit provision.

Technocrats said they were stepping up the pace of their work, drawing up impact assessments for new regimes. But they were under contradictory pressures, not only over content but also timing, with countries including France recommending a slower, more deliberative approach while the US urges more speed.

For all the technical work, there is an increasing belief that governments and central banks will supersede the Basel officials in the next few months and engage in contentious meetings over the summer.