Bank capital

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Contents

Basel consultative document on capital requirements

Issued for comment by 16 April 2010

Overview of the Basel Committee’s reform programme and the market failures it addresses

  1. This consultative document presents the Basel Committee’s1 proposals to strengthen global capital and liquidity regulations with the goal of promoting a more resilient banking sector. The objective of the Basel Committee’s reform package is to improve the banking sector’s ability to absorb shocks arising from financial and economic stress, whatever the source, thus reducing the risk of spillover from the financial sector to the real economy.
  2. The proposals set out in this paper are a key element of the Committee’s comprehensive reform package to address the lessons of the crisis. Through its reform package, the Committee also aims to improve risk management and governance as well as strengthen banks’ transparency and disclosures.2 Moreover, the reform package includes the Committee’s efforts to strengthen the resolution of systemically significant cross-border banks.3 The Committee’s reforms are part of the global initiatives to strengthen the financial regulatory system that have been endorsed by the Financial Stability Board (FSB) and the G20 Leaders.
  3. A strong and resilient banking system is the foundation for sustainable economic growth, as banks are at the centre of the credit intermediation process between savers and investors. Moreover, banks provide critical services to consumers, small and medium-sized enterprises, large corporate firms and governments who rely on them to conduct their daily business, both at a domestic and international level.
  4. One of the main reasons the economic and financial crisis became so severe was that the banking sectors of many countries had built up excessive on- and off-balance sheet leverage. This was accompanied by a gradual erosion of the level and quality of the capital base. At the same time, many banks were holding insufficient liquidity buffers. The banking system therefore was not able to absorb the resulting systemic trading and credit losses nor could it cope with the reintermediation of large off-balance sheet exposures that had built up in the shadow banking system. The crisis was further amplified by a procyclical deleveraging process and by the interconnectedness of systemic institutions through an array of complex transactions. During the most severe episode of the crisis, the market lost confidence in the solvency and liquidity of many banking institutions. The weaknesses in the banking sector were transmitted to the rest of the financial system and the real economy, resulting in a massive contraction of liquidity and credit availability. Ultimately the public sector had to step in with unprecedented injections of liquidity, capital support and guarantees, exposing the taxpayer to large losses.
  5. The effect on banks, financial systems and economies at the epicentre of the crisis was immediate. However, the crisis also spread to a wider circle of countries around the globe. For these countries the transmission channels were less direct, resulting from a severe contraction in global liquidity, cross border credit availability and demand for exports. Given the scope and speed with which the current and previous crises have been transmitted around the globe, it is critical that all countries raise the resilience of their banking sectors to both internal and external shocks.
  6. To address the market failures revealed by the crisis, the Committee is introducing a number of fundamental reforms to the international regulatory framework. The reforms strengthen bank-level, or microprudential, regulation, which will help raise the resilience of individual banking institutions to periods of stress. The reforms also have a macroprudential focus, addressing system wide risks that can build up across the banking sector as well as the procyclical amplification of these risks over time. Clearly these two micro and macroprudential approaches to supervision are interrelated, as greater resilience at the individual bank level reduces the risk of system wide shocks.
  7. Building on the agreements reached at the 6 September 2009 meeting4 of the Basel Committee’s governing body5, the key elements of the proposals the Committee is issuing for consultation are the following:
    1. First, the quality, consistency, and transparency of the capital base will be raised. This will ensure that large, internationally active banks are in a better position to absorb losses on both a going concern and gone concern basis. For example, under the current Basel Committee standard, banks could hold as little as 2% common equity to risk-based assets, before the application of key regulatory adjustments.6
    2. Second, the risk coverage of the capital framework will be strengthened. In addition to the trading book and securitisation reforms announced in July 2009, the Committee is proposing to strengthen the capital requirements for counterparty credit risk exposures arising from derivatives, repos, and securities financing activities. These enhancements will strengthen the resilience of individual banking institutions and reduce the risk that shocks are transmitted from one institution to the next through the derivatives and financing channel. The strengthened counterparty capital requirements also will increase incentives to move OTC derivative exposures to central counterparties and exchanges.
    3. Third, the Committee will introduce a leverage ratio as a supplementary measure to the Basel II risk-based framework7 with a view to migrating to a Pillar 1 treatment based on appropriate review and calibration. This will help contain the build up of excessive leverage in the banking system, introduce additional safeguards against attempts to game the risk based requirements, and help address model risk. To ensure comparability, the details of the leverage ratio will be harmonised internationally, fully adjusting for any remaining differences in accounting. The ratio will be calibrated so that it serves as a credible supplementary measure to the riskbased requirements, taking into account the forthcoming changes to the Basel II framework.
    4. Fourth, the Committee is introducing a series of measures to promote the build up of capital buffers in good times that can be drawn upon in periods of stress. A countercyclical capital framework will contribute to a more stable banking system, which will help dampen, instead of amplify, economic and financial shocks. In addition, the Committee is promoting more forward looking provisioning based on expected losses, which captures actual losses more transparently and is also less procyclical than the current “incurred loss” provisioning model.
    5. Fifth, the Committee is introducing a global minimum liquidity standard for internationally active banks that includes a 30-day liquidity coverage ratio requirement underpinned by a longer-term structural liquidity ratio. The framework also includes a common set of monitoring metrics to assist supervisors in identifying and analysing liquidity risk trends at both the bank and system wide level. These standards and monitoring metrics complement the Committee’s Principles for Sound Liquidity Risk Management and Supervision issued in September 2008.
  8. The Committee also is reviewing the need for additional capital, liquidity or other supervisory measures to reduce the externalities created by systemically important institutions.
  9. Market pressure has already forced the banking system to raise the level and quality of the capital and liquidity base. The proposed changes will ensure that these gains are maintained over the long run, resulting in a banking sector that is less leveraged, less procyclical and more resilient to system wide stress.
  10. As announced in the 7 September 2009 press release, the Committee is initiating a comprehensive impact assessment of the capital and liquidity standards proposed in this consultative document. The impact assessment will be carried out in the first half of 2010. On the basis of this assessment, the Committee will then review the regulatory minimum level of capital in the second half of 2010, taking into account the reforms proposed in this document to arrive at an appropriately calibrated total level and quality of capital. The calibration will consider all the elements of the Committee’s reform package and will not be conducted on a piecemeal basis. The fully calibrated set of standards will be developed by the end of 2010 to be phased in as financial conditions improve and the economic recovery is assured, with the aim of implementation by end-2012.8 Within this context, the Committee also will consider appropriate transition and grandfathering arrangements. Taken together, these measures will promote a better balance between financial innovation, economic efficiency, and sustainable growth over the long run.
  11. The remainder of this section summarises the key reform proposals of this consultative document. Section II presents the detailed proposals. The reforms to global liquidity standards are presented in the accompanying document International framework for liquidity risk measurement, standards and monitoring, which is also being issued for consultation and impact assessment. The Committee welcomes comments on all aspects of these consultative documents by 16 April 2010. Comments should be submitted by email (baselcommittee@bis.org) or post (Secretariat of the Basel Committee on Banking Supervision, Bank for International Settlements, CH-4002 Basel, Switzerland). All comments will be published on the Bank for International Settlements’ website unless a commenter specifically requests anonymity.

BIS consultative paper on liquidity

Issued for comment by 16 April 2010

Throughout the global financial crisis which began in mid-2007, many banks struggled to maintain adequate liquidity. Unprecedented levels of liquidity support were required from central banks in order to sustain the financial system and even with such extensive support a number of banks failed, were forced into mergers or required resolution.

These circumstances and events were preceded by several years of ample liquidity in the financial system, during which liquidity risk and its management did not receive the same level of scrutiny and priority as other risk areas. The crisis illustrated how quickly and severely liquidity risks can crystallise and certain sources of funding can evaporate, compounding concerns related to the valuation of assets and capital adequacy.

2. A key characteristic of the financial crisis was the inaccurate and ineffective management of liquidity risk. In recognition of the need for banks to improve their liquidity risk management and control their liquidity risk exposures, the Basel Committee on Banking Supervision1 (“the Committee”) issued Principles for Sound Liquidity Risk Management and Supervision in September 2008. These sound principles provide consistent supervisory expectations on the key elements of a robust framework for liquidity risk management at banking organisations. Such elements include:

  • board and senior management oversight;
  • the establishment of policies and risk tolerance;
  • the use of liquidity risk management tools such as comprehensive cash flow forecasting, limits and liquidity scenario stress testing;
  • the development of robust and multifaceted contingency funding plans; and
  • the maintenance of a sufficient cushion of high quality liquid assets to meet contingent liquidity needs.

Possible 10-20 year transition to higher capital standards

"Has Christmas come early for the world’s banks, or are we witnessing a grasping of straws for anything resembling regulatory forbearance this Wednesday?

Banking shares in Japan and Europe are up this morning, and it’s all because of a single report from Japanese newspaper Nikkei. MarketWatch sums up the story:

The Nikkei business daily said in an unsourced report that the Swiss-based Basel Committee on Banking Supervision will stick to its plan to gradually introduce the new, stricter capital standards starting in 2012, but will establish a transition period of 10-20 years.

The proposed changes include raising the current 8% minimum capital ratio and focusing on a narrower definition of core capital, the report said

LOS ANGELES (MarketWatch) — New global capital-adequacy rules for large banks may be delayed by at least a decade during a “transition period,” according to a Japanese news report Wednesday. And it looks like this story now has legs – albeit of mismatched lengths.

From Reuters:

TOKYO/FRANKFURT (Reuters) – Global regulators will give banks a grace period before forcing them to implement stricter capital rules, three people said on Wednesday, easing concerns that lenders might need to issue massive amounts of shares in the near future.

Shares of major Japanese banks surged on the news, with Mizuho Financial Group and Sumitomo Mitsui Financial Group both gaining more than 14 percent.

European bank shares rose a more modest 1.3 percent on relief that banks would have more time to adjust to new rules being drafted by the Basel Committee on Banking Supervision, made up of central bankers and regulators from nearly 30 countries.

The committee is expected to publish proposals this week for stricter financial regulations in response to the credit crisis, and there had been fears that if banks had to implement the new rules quickly, they would have to raise substantial capital.

The three people with knowledge of the matter said the committee would stick to its plan to gradually implement changes starting in 2012, but will give banks a transition period to help them adjust to the rules.

Regulators do not plan to set a specific time frame for the transition period, said the people, who were not authorized to speak publicly on the matter. Japan’s Nikkei newspaper said it would be at least 10 years.

Investors, however, seem not to be too bothered by the discrepancy in details just yet.

Banks worldwide may get three years to comply

Banks worldwide will get as many as three years to comply with stricter capital requirements, European and Japanese government officials said.

A transition period for tighter capital rules probably won’t start until 2012 or 2013, according to the officials who declined to be identified because last week’s deliberations by the Basel Committee on Banking Supervision are private. Bank stocks in Asia and Europe rallied.

The delay gives banks longer to repair balance sheets weakened by $1.71 trillion of losses and writedowns during the credit crisis. The Group of 20 Nations agreed in April that banks should be required to hold more and better quality capital to reduce risks to the financial system.

“In the U.K. and some other places the local regulators have already started to impose higher capital requirements and higher liquidity buffers,” said Simon Willis, an analyst at NCB Stockbrokers Ltd. in London. “The issue this raises is whether effective coordinated cross-border regulation can be achieved.”

The Bloomberg Europe Banks and Financial Services Index, which tracks 64 financial companies, rose 2.3 percent at by 5:35 p.m. in Zurich. Alpha Bank AE was the biggest gainer, rising 6.9 percent, followed by Commerzbank AG, which rose 6.7 percent.

Tokyo Trading

The gain by bank shares “reflects the value inherent in postponing -- and possibly alleviating -- the belt-tightening that will result from implementing changes to the Basel Accord,” said Bob Penn, a partner specializing in financial services regulation at London-based law firm Allen & Overy LLP. Investors hope that giving banks more time will allow a better assessment of the new rules and lead to a more workable result, Penn said.

Bank shares in Tokyo had their biggest gain since May after the Nikkei newspaper reported that lenders will be given 10 to 20 years to comply with stricter capital rules. The Topix Banks Index of 84 lenders rallied 7 percent.

“Certainly this takes the pressure off the Japanese banks to raise capital,” said Ismael Pili, a Tokyo-based analyst at Macquarie Group Ltd. “It gives them ample time to build up capital organically through retained earnings.”

‘Bad News’

The head of France’s market regulator said any delay would be unwelcome.

“It is bad news,” said Jean-Pierre Jouyet, head of France’s Autorite des Marches Financiers. “We need to have the quickest convergence possible.”

The Basel Committee, which met in Basel, Switzerland, last week, coordinates banking supervision among 27 member countries and territories. Core capital should allow a bank to absorb losses and always be available, according to the committee, which published the capital requirements, known as the Basel II framework, in 2004.

Japan’s Financial Services Agency denied the Nikkei report that there is an agreement on the grace period. Bettina Eberhard, a Switzerland-based spokeswoman for the Basel committee, declined to comment.

“Next year and 2011 will be difficult years for many banks as is, so a delay would be helpful,” said Andreas Plaesier, a Hamburg-based banking analyst at M.M. Warburg.

National bank supervisors will spend next year assessing the effect of a new definition of what assets count toward bank capital, according to the Financial Stability Board’s coordination of global regulation. The Basel framework has measures for so-called core and Tier 1 capital.

Core capital includes shares and retained earnings. Tier 1 capital, a broader definition, includes hybrid capital instruments such as bonds that convert into equity when certain events occur. Tier 1 ratio is a measure of financial strength, which compares a bank’s capital to the exposure of its loans and other at-risk assets.

UK banks must add $47 billion in trade capital, FSA says

U.K. banks must find as much as 29 billion pounds ($47.3 billion) of additional capital by 2011 to put against their trading books under proposals published by Britain’s financial regulator.

Today’s proposals by the Financial Services Authority to strengthen balance sheets would also limit the amount banks and building societies can lend to any single borrower, and tighten rules on what counts as capital. The proposals come in response to changes to European Union rules covering bank capital, one of which is still being debated, the FSA said in a statement.

“The wide range of changes address some of the lessons learned from the financial crisis,” the FSA said. More capital will have to be put aside “to ensure that a firm’s assessment of the risks connected with its trading book better reflects the potential losses from adverse market movements in stressed conditions.”

Lawmakers and policy makers worldwide are grappling with how to overhaul regulation in the wake of the worst financial crisis for a generation. FSA Chairman Adair Turner said in a March report, which was largely endorsed by both the U.K. government and the Group of 20 Nations, that banks would have to put more capital aside and have tighter liquidity rules.

While Turner is against a legal split between banks that take customer deposits and those that trade on their own account, he has said making banks put more capital against risky trades will make certain investments economically unviable.

Proprietary Trading

He told lawmakers as early as February that banks would need to hold several times more capital in “revolutionary” changes to regulations that would lead to the downsizing of proprietary trading.

Proprietary trading is when a bank or financial institution trades securities and other financial instruments with its own money rather than for its customers.

The FSA said today that on average, firms will have to put aside 119 percent more capital against their trading books.

With the overall extra capital, including trading books, needed by banks standing at 33 billion pounds, annual ongoing costs from today’s proposals for firms could total 6 billion pounds, the London-based regulator said. The trading capital proposals would cost banks with “significant” trading books about 1.4 billion pounds a year, the FSA said.

Reducing Costs

“Affected firms may seek to reduce or change the composition of their trading-book assets, thus giving rise to a smaller increase in capital requirements, which would reduce the costs,” the regulator said.

The FSA said that its reforms will help prevent future crises and could boost the U.K. economy by 4 percent of gross domestic product, or 50 billion pounds. The agency’s consultation on the proposals ends in March 2010 with rules taking effect in January 2011.

“Our biggest issue relates to the implementation date, which we think is premature,” said Simon Hills, executive director at the British Bankers’ Association. “A 2012 implementation date would seem to be much more pragmatic and allow alignment with Basel and give banks time to adjust their capital and systems and controls accordingly.”

Basel, or the Basel Committee on Banking Supervision, sets minimum capital rules for banks worldwide.

Skin-in-the-Game

Banks also would only be able to invest in securitizations in which their originator had kept an economic interest of at least 5 percent, a so-called skin-in-the-game. They will have to also undertake significant research into the loans behind the securities before investing, or risk “heavy capital penalties,” the regulator said.

A lending cap would limit to 25 percent of overall lending capital the amount banks can loan to a single borrower, under the proposals.

There will be more stringent rules on what can be counted toward capital buffers, the FSA said. Hybrid capital, which has elements of both debt and equity, must be able to absorb losses for it to be counted as part of a bank’s tier 1 capital ratio, a key measure of banks’ strength. Core tier 1, a subset of that, is mainly shareholder equity.

Lloyds CoCos

Banks would have three “buckets” that would limit the amount of different types of hybrid capital they can hold within tier 1 to 15 percent, 35 percent and 50 percent respectively, the FSA said. The biggest bucket would be limited to hybrid capital that would convert to equity at an emergency trigger point.

Lloyds Banking Group Plc, in which the U.K. government owns a 43 percent stake, is bolstering its capital to avoid the U.K.’s Asset Protection Scheme, which would have increased the government’s stake to about 62 percent and cost the bank 15.6 billion pounds in fees. The bank is issuing $13 billion of enhanced capital notes, also known as contingent convertible securities, or CoCos, that become equity if the bank’s core tier 1 ratio drops below 5 percent.

The FSA said last month Lloyds’ CoCos could be treated as hybrid capital.

Basel proposes excluding deferred tax assets from Tier 1 ratios

On Thursday, FT Alphaville wrote of a potential regulatory crackdown on Deferred Tax Assets — tax carry forwards which can make up a proportion of banks’ Tier 1 capital.

DTAs make an especially poor form of capital, since they only apply if banks are making enough money. In times of losses they’re almost completely useless and are simply carried forward until a time when (hopefully) the bank is generating enough to use them.

And on Thursday the Basel committee on banking supervision sought to fix this incongruity, by proposing DTAs be excluded from Core Tier 1 as part of its efforts to strengthen and purify banks’ capital. Also, out were pension fund liabilities.

UBS bank analysts John-Paul Crutchley and Alastair Ryan have helpfully crunched some numbers on Friday morning, to show European banks’ DTA and pension exposure.

Bank capital abritrage

Did accounting help cause the financial crisis?

A minuet playing out now is showing that the answer is yes — but not in the way the banks want us to believe.

The issue is a couple of new accounting rules that are forcing banks to put back on their balance sheets some strange creations that bad accounting rules had allowed them to shunt aside in the past.

The banks have accepted the inevitability of that change. But they are asking the bank regulators to make the rules easier to live with by phasing them in. Otherwise, the banks say, they would need to raise more capital or cut back lending.

The Federal Deposit Insurance Corporation, one of the regulators, has indicated it would consider that request this week, and Sheila Bair, the F.D.I.C. chairwoman, has voiced some sympathy for the banks’ desire to delay the impact. But she added that those assets should have been on the balance sheets all along, and that banks should have been required to set aside capital in case their value plunged.

Robert Herz, the chairman of the Financial Accounting Standards Board, which wrote both the rules that were used to justify the off-balance sheet shenanigans and the new rules that bar them, thinks banks violated the old rules, in at least some cases. Perhaps so, but auditors signed off, which at a minimum indicates the rules were not well written.

The logic of the off-balance sheet treatment of such things as structured investment vehicles, or SIVs, which banks created in order to get assets off their books, was that the bank did not control them, and so did not have to show the SIV assets, and liabilities, on its own books.

That fiction evaporated early in the financial crisis. Some SIVs were among the first structures to fail, when they could not roll over loans to finance assets that had lost value. The banks chose to, or had to, rescue the SIVs. Maybe they did so to guard their reputations, or maybe they feared they would have been vulnerable to fraud allegations from those who lent to the leaking SIVs. In either case, it turned out there was a black hole that the regulatory rules had ignored in assessing how much capital the banks needed to hold.

There are other examples. Bank holding companies have been allowed to issue something called “trust preferred securities.” The beauty of those securities was that they were really debt that the holding companies could call capital. Having that “capital” meant the bank could take on more debt. A system that lets a bank borrow more money because it has already borrowed money — rather than because it has sold stock — is hardly a wise one.

All this was part of what financial engineers openly called “capital arbitrage,” in which they created securities and structures whose purpose was to let banks slide around the capital rules. Regulators seem to have responded by assuming that everything would be fine.

“Capital arbitrage has been an issue for years,” Ms. Bair told me this week. “Nobody wanted to take away the punch bowl.” She thinks a council of regulators, with an appointed chairman, could monitor the systemic risk created by rising risk levels in the banking system and take away the bowl the next time.

Of course, banks also engaged in regulatory arbitrage, by moving from one regulator to another to seek more lenient treatment. Their route to regulatory success — at least in terms of building an empire — was to spike the punch bowl.

The banks now want to stop FASB from forcing them to mark assets to market, or reveal their current market value. And they have some sympathy from bank regulators, which fear that marking to market can make banks look too healthy in good times and too unhealthy in bad times.

That appalls investors. “The purpose of financial reporting is to convey the results of the company,” said Sandra Peters, the director of financial reporting for the CFA Institute, an investor advocacy group. “It is not to assure the company stays around.”

Mr. Herz, the chairman of the accounting standards board that determines what are “generally accepted accounting principles,” or GAAP, this week proposed further “decoupling” of capital rules and accounting standards. He noted that in some cases the capital rules were already stricter than accounting rules, and said that if bank regulators want to base the capital rules on the original cost of assets, rather than market value, they should at least let investors also see the market value. “Handcuffing regulators to GAAP or distorting GAAP to always fit the needs of regulators is inconsistent with the different purposes of financial reporting and prudential regulation,” he said in a speech.

Ms. Bair sounded hesitant about that when I spoke to her, saying she was concerned that decoupling could lead FASB to stop listening to bank regulators, something Mr. Herz said would not happen.

She said she would like to see one accounting change that FASB is talking about, which would make it easier for banks to take reserves against loans in good times. “With better reserving methodology,” she said, capital and reserves would have been higher before the current crisis erupted, and banks safer.

The financial crisis showed that regulators should have required banks to hold much more capital than they did. Some regulators figured that out.

In Spain, some smaller banks are in trouble from real estate loans, but the big banks seem to have emerged in good shape. One reason is that Spanish regulators were not fooled by things like SIVs, and insisted that if any bank wanted to create one, it could, but would have to hold reserves anyway. Since there was no business reason — other than capital arbitrage — for a SIV, those banks shied away. Good regulation is not easy. A new paper by Amir E. Khandani and Andrew W. Lo of M.I.T., and Robert C. Merton of Harvard, estimates that repeated “cash-out” refinancings of mortgages led to more than $1 trillion in additional losses in this crisis.

It used to be that people who had owned homes for a longer time were less leveraged than recent purchasers, but the refinancing boom changed that. “A coordinated increase in leverage among homeowners during good times will lead to sharply higher correlations in defaults among those same homeowners in bad times,” they wrote.

But they added that it was hard to imagine any existing regulator acting against any of the causes of the refinancing boom — rising home prices, new mortgage products and low interest rates. Those developments allowed more people to buy homes, made Americans richer, and fueled both economic growth and consumer spending.

“Which politician or regulator would seek to interrupt such a virtuous circle?” they asked. “How could such a maverick accomplish the task?”

Their solution is to create a systemic risk regulator. But it is far from clear that such a regulator, had it been around the last time, would have had the wisdom to take away the punch bowl in time. If it had, it probably would have lacked the power.

Nonetheless, it is a good idea to try such a regulator, and to give the job to someone who is not conflicted by other responsibilities. Expecting any regulator to perform multiple tasks is asking for trouble when goals may conflict. The Fed’s pursuit of economic growth helped to create the refinancing boom that backfired.

That fact is why multiple regulators can make sense. The Securities and Exchange Commission, which supervises FASB, knows that investor protection is its job. Bank regulators have nothing against that, but it is not a primary goal. It is to be hoped that the bank regulators will adopt wise capital standards, but not at the expense of letting investors know what is going on.

Whalen sees need for bank restructurings, 1,000 could fail

Christopher Whalen, managing director of Institutional Risk Analytics, talks with Bloomberg's Deirdre Bolton and Erik Schatzker about the outlook for the U.S. banking industry. Whalen also discusses the risk of more bank failures and funding of the Federal Deposit Insurance Corp.

Taxpayer losses estimated at $155 billion

"Big banks are roaring back.

At crisis' edge last year, they are repaying billions of dollars dumped into their vaults to rescue them. Dividend checks are accumulating at the Treasury. Taxpayers won't recoup the full sum of the government's unprecedented infusion to the financial sector, but the returns are ahead of schedule.

With large bets on bonds, commodities and exotic financial products, big banks are reporting third-quarter profits.

Of the $250 billion that the government initially set aside to spend in direct assistance to banks, it has spent $205 billion and the Treasury is already taking steps to bring that program to an end. The ledger: Banks have paid back $71 billion of the infusions. They have also paid the Treasury nearly $7 billion in dividends.

If propping up much of the teetering financial markets was the goal of the government's $700 billion Wall Street rescue, then mission accomplished.

But there were other objectives for the Troubled Asset Relief Program, too: greater lending to consumers and businesses, mitigating foreclosures and helping banks shed toxic mortgage-backed assets.

On that, it's unfinished business.

A program announced with fanfare four weeks ago that would funnel money to small banks at low rates to increase small business lending is still being designed. Treasury officials are looking at plans that could cost taxpayers between $10 billion and $50 billion but are encountering reluctance from small banks.

"I'm told by banker associations and banks, 'Hey, this is good capital, we'd like to have it, but we don't want to be the only bank in town who takes your capital because the others will advertise against us,'" Herbert Allison Jr., the assistant Treasury secretary in charge of TARP, said in an interview. "There is a stigma and it's frustrating, frankly."

Meanwhile, TARP is set to expire Dec. 31. But with about $140 billion still uncommitted (even more, about $300 billion, unspent), the Obama administration is considering extending at least a portion of the huge fund until next October.

"We are winding it down and will close it as soon as we can," Treasury Secretary Timothy Geithner told a congressional committee. But he stiffly opposed any congressional effort to force the program to end. The struggle facing Treasury is how to continue TARP as insurance against further instability without having Congress use it as a source of new spending.

Officials are keeping a wary eye on smaller banks, which have been failing at the highest rate since 1992 due largely to losses from commercial real estate loans.

"The financial system is stable, but it is not normal and it could be derailed again, and you need to guard against that possibility," said economist Mark Zandi, head of Moody's Economy.com and a regular adviser to congressional Democrats.

Extending TARP as insurance for banks wouldn't be a popular move. Conservatives and liberals object to the direct assistance to big banks and insurance conglomerate American International Group. Republicans have called for the program to end and assigning the unused money to debt reduction. Some liberals want the money for jobs programs.

Overall, the bank infusions alone could end up costing taxpayers about $14 billion, according to estimates by Economy.com. While banks are paying money back, not all of them can be saved. Earlier this month, a San Francisco bank became the first bailed-out institution to fail. More could fall. And two weeks ago small business lender CIT Group, which received $2.3 billion in rescue funds, filed for bankruptcy protection with little hope of repaying taxpayers.

Add to that the money injected into the auto industry, AIG and a $50 billion mortgage assistance program, and Economy.com estimates taxpayers could be left with a bill totaling $155 billion.

For instance, General Motors announced it would pay back a $6.7 billion in U.S. government loans by 2011, four years ahead of schedule. But that still leaves more than $40 billion that the government lent to GM in exchange for a common equity stake. Moody's estimates taxpayers could recoup half of that.

The mortgage assistance program, off to a slow start, has now helped 650,000 homeowners with trial loan modifications, with average savings of $500 a month. The administration aims to help between 3 million and 4 million over three years, but that is $50 billion that won't get repaid directly to the Treasury.

The potential cost to taxpayers illustrates the dramatic change in TARP's purpose from the fall of 2008 when President George W. Bush proposed using the entire $700 billion to help banks get rid of toxic mortgage-backed assets. "We expect that much, if not all, of the tax dollars we invest will be paid back," Bush said on Sept. 24 of last year.

Administration critics say Geithner has not spelled out with clarity how the program will ultimately end.

"Suppose they didn't renew it; there would be shock," said Douglas Holtz-Eakin, a former director of the Congressional Budget Office and an economic adviser to Republican John McCain's 2008 presidential campaign. "There is an implicit expectation that they'll do something. But there is not a nicely framed expectation of how they will exit."

If stabilizing the financial sector was TARP's main goal, increasing lending was the other.

Treasury Department figures released this month show that outstanding loan balances by TARP recipients in September, the latest available data, were 3.8 percent lower than they were in February when the economy was at its worst. Lending by the largest banks that received TARP money declined for the eighth straight month in September.

Analysts and Treasury officials attribute the decline to decreased demand from borrowers and continuing skittishness by banks in the face of economic weakness. "TARP giveth, but unemployment taketh away," said Scott Talbott, chief lobbyist for the Financial Services Roundtable, which represents large banking institutions.

Lending volume has declined less than it did during the 1991-92 recession, even though this downturn was deeper. But Allison said there is still a widespread perception that banks could be lending more.

"That's what the business community is telling us uniformly," he said.

Given that, the administration has a dual message for banks that are regenerating their capital.

"We want to see them using their capital for lending as much as they reasonably can," Allison said. "We want to see banks that took TARP capital, especially the larger banks, paying it back when they are able to."

Australia

Australian banks fail new capital test

"Ratings agency Standard & Poor's has warned that nearly all the world's big banks - including Australia's major lenders - have insufficient funds to cover their lending exposures and risk a ratings downgrade unless they move to bolster their balance sheets over the next 18 months.

The warning follows the release of a tougher global measure of bank capital by Standard & Poor's, which has found that most large banks do not meet the minimum 8 per cent threshold under the credit ratings agency's new risk-adjusted capital ratio.

The findings appear to be out of step with claims by Australian banks that they are among the strongest in the world under the traditional measure of bank capital known as the tier 1 ratio.

Over the past year, Australian banks have raised more than $20 billion in new capital to strengthen their balance sheets. This has resulted in an increase in the average tier 1 ratio of the big four banks to 8.9 per cent from 7.8 per cent a year ago.

But critics warn that these measures of tier 1 can be misleading because they fail to distinguish between higher-risk and lower-risk forms of lending. As well, the tier 1 measure is not consistently calculated on an international level.

Australian banks argue that their capital ratios would increase by about 2 per cent on average if they were calculated under existing British rules.

Under the new measure, S&P gives a lower rating to hybrid capital because it behaves more like debt than equity. For Australian banks, hybrid securities can make up to a quarter of their total capital. Specific exposures including trading desks and private equity would require banks to significantly increase the level of capital.

S&P reviewed 45 banks around the world under its new risk-adjusted measure. No Australian banks were included in the handful that hit the minimum threshold to be considered safe.

Of three local lenders included in the review, ANZ scored the highest rating with 7.1 per cent. National Australia Bank was at 6.9 per cent and Commonwealth Bank at 6.3 per cent.

While Australian banks benefited from having a large exposure to low-risk residential mortgages, S&P said a narrow geographic and business base counted as a negative. It also noted that the capital raisings by the local banks had been used mainly to fund acquisitions or balance sheet growth.

Among the global banks considered most vulnerable are Mizuho Financial (2 per cent), Citigroup (2.1), UBS (2.2) and Sumitomo Mitsui (3.5). The global average came in at 6.7 per cent.

The results to date appear to confirm our view that capital is a rating weakness for a majority of banks in our sample, S&P said.

The ratings agency said it expected banks to continue strengthening their capital ratios over the next 18 months to comply with tougher regulatory standards. Failure to achieve this could put renewed pressure on ratings, it said.

The top-rated global bank is HSBC on 9.2 per cent, followed by Dexia on 9 per cent and ING on 8.9 per cent.

The review of capital strength comes as Australian banks face a crackdown on rules related to liquidity.

More bank capital under new APRA rules

Banks may be required to hold more capital on their balance sheets if the prudential regulator's proposed new rules covering complex trading activities and securitisations are introduced.

The Australian Prudential Regulation Authority (APRA) released a new discussion paper on Monday seeking industry comment on the proposed new rules for the banks' trading activities, securitisations and exposures to off-balance sheet vehicles.

APRA's move comes after it wrote to banks and other authorised deposit-taking institutions on Friday saying it will delay introducing new rules for liquidity by 12 months to move in step with changes introduced by the global prudential regulator, the Basel Committee on Banking Supervision (BCBS).

APRA on Monday proposed changes that would require banks to hold a higher level of capital because of the greater credit risk of complex trading activities, and apply higher risk weightings to exposure to resecuritisation to better reflect their inherent risk.

Resecuritisation exposures included instruments such as asset-backed commercial paper conduit arrangements, APRA said in its discussion paper.

APRA is also advocating increased credit conversion factors for short-term liquidity facilities provided to off-balance sheet conduits.

The latest discussion paper is a response to measures released in July 2009 by the BCBS, to strengthen regulatory capital and improve risk management practices by banks.

The liquidity changes aim to safeguard the financial system in line with proposed global standard to ensure local banks could withstand a mild bank run and continue to roll over maturing wholesale debt.

APRA proposes banks hold more capital and high-quality liquid assets, which it says will add five basis points to standard variable rates on home loans after the liquidity rules are finalised in 2011.

Local banks and analysts say the cost of complying with the proposed liquidity rules will result in banks passing on interest rate hikes to borrowers of between four and 35 basis points.

Separately, outgoing ANZ Banking Group chairman Charles Goode on Friday called for a global move to standard derivative contracts that could be traded on a well-capitalised clearing house.

That market had proven opaque regarding counter-party risk and "highly dangerous" to the stability of the financial system, he said.

References

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