Basel Committee Issues New Bank Capital Rules

by Ulrika Lomas, LawAndTax-News.com, Brussels

15 September 2010

The Basel Committee on Banking Supervision has announced a revision of minimum bank capital requirements that, as could have been expected, are a compromise between a substantial strengthening of the existing requirements while also granting a long transition period for the weaker banks, particularly in Europe.

The Committee, which provides a forum for regular cooperation on banking supervisory matters and whose Secretariat is based at the Bank for International Settlements in Basel, Switzerland, has produced a package of reforms that will increase the minimum requirement for common equity, the highest form of loss-absorbing capital, from 2% to 4.5% after the application of stricter adjustments. This will be phased in from January 1, 2013 to January 1, 2015.

The Tier 1 capital requirement, which includes common equity and other qualifying financial instruments based on stricter criteria, will increase from 4% to 6% over the same period.

Furthermore, banks will be required to hold a capital conservation buffer of 2.5% to withstand future periods of stress bringing the total common equity requirements to 7%. The buffer requirement will be phased in from January 1, 2016 to January 1, 2019. National authorities have the discretion to impose shorter transition periods and, it is said, should do so where appropriate.

Banks that already meet the minimum ratio requirement during the transition period but remain below the 7% common equity target (minimum plus conservation buffer) should maintain prudent earnings retention policies with a view to meeting the conservation buffer as soon as reasonably possible.

The purpose of the conservation buffer is to ensure that banks maintain a buffer of capital that can be used to absorb losses during periods of financial and economic stress. This framework, it is believed, will address the collective action problem that has prevented some banks from curtailing distributions, such as discretionary bonuses and high dividends, even in the face of deteriorating capital positions.

In addition, a counter-cyclical buffer of up to 2.5% of common equity will be implemented, according to national circumstances. For any given country, this buffer will only be in effect when there is excess credit growth that is resulting in a system wide build up of risk. The counter-cyclical buffer, when in effect, would be introduced as an extension of the conservation buffer range.

The measures are also designed to reinforce the stronger definition of capital agreed by the Committee in July, the phase-in requirements for leverage ratios and the higher capital requirements for trading, derivative and securitization activities to be introduced from 2011.

Jean-Claude Trichet, President of the European Central Bank and chairman of the Committee’s oversight body, said that "the agreements reached today are a fundamental strengthening of global capital standards." He added that "their contribution to long-term financial stability and growth will be substantial. The transition arrangements will enable banks to meet the new standards while supporting the economic recovery."

Nout Wellink, Chairman of the Committee and President of the Netherlands Bank, added that "the combination of a much stronger definition of capital, higher minimum requirements and the introduction of new capital buffers will ensure that banks are better able to withstand periods of economic and financial stress, therefore supporting economic growth."

The Committee said that, while banks have already undertaken substantial efforts to raise their capital levels, its studies show that, as of the end of 2009, large banks will need, in the aggregate, a significant amount of additional capital to meet these new requirements. Smaller banks, which are particularly important for lending to the SME sector, for the most part already meet these higher standards.

The new measures have met with a reasonably favourable global reaction, possibly also with some relief that they were not more stringent. For example, apart from in Japan, where there was still confidence that banks would meet the requirements over the transition period, banks in Asia Pacific were relaxed about the ratios proposed, given that their overall balance sheets did not show the same high leverage in the financial crisis as those in Europe and the US.

The major banks in the US have, in fact, been generally recapitalized over the past 18 months, and are also largely unaffected. However, while there was a welcome in parts of Europe to the long transition period for compliance, the lower-capitalized European banks may be required to issue share capital. Deutsche Bank’s recent announcement of a share issue of around EUR9bn (USD11.5bn) could only be the first of such capital raisings.

It is known that some European countries are concerned at the effect of the new rules on the ability of their banks to continue to lend, and support the nascent economic recovery. But the measures do seem to recognize difficulties in particular countries; for example, the allowance that existing public sector capital injections will be grandfathered until January 1, 2018, will go a long way to allay short-term concerns over the German landesbanks.

The new regulations will now be presented to the G-20 leaders summit in Seoul in November and, if accepted, member countries should translate the rules into national laws and regulations before January 1, 2013.

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