Bank capital

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See also Basel 3, Basel Committee on Banking Supervision, capital adequacy and liquidity.


Basel sets 7% capital ratio

Central bank governors and senior regulators are set to ordain that banks must have a minimum core tier one capital ratio, including a new so-called "buffer" to protect against extreme economic conditions, of 7%, I can reveal.

This is considerably lower than was wanted by the "hawks", the US, UK and Switzerland. They wanted a core tier one capital ratio of 8 to 9% including buffer, which is what British banks currently have to maintain. In fact most British banks currently have a core tier one ratio of around 10%.

But the new 7% minimum has been agreed in the face of stiff resistance from a number of countries, led by Germany, many of whose banks typically have much lower stocks of core capital in the form of equity and retained earnings - and will have great difficulty meeting the new standard.

This new international minimum was negotiated by regulatory and central banking officials in a meeting of the Basel Committee on Banking Supervision earlier this week. It is expected to be approved by the governors and senior regulators when they meet in Basle on Sunday.

It will then be ratified in a final, supposedly irrevocable way by the heads of the G20 governments, at their summit in November.

The 7% minimum represents a dramatic increase on the current minimum of 2%. That 2% minimum is widely seen as far too low: banks' low levels of capital relative to their assets was a major contributor to the severity of the 2008 banking crisis, as investors lost confidence in their ability to survive losses.

As they approached collapse, the capital ratios of Northern Rock and Royal Bank of Scotland fell to dangerously low levels - which is why Northern Rock was nationalised and RBS was semi-nationalised.

The point of capital is to absorb losses when loans and investments turn bad.

Although this new 7% minimum ratio of core capital (in the form of equity and retained earnings) to assets (loans and investments) as measured on a risk-weighted basis represents a significant increase, some will argue that the ratio is still too low.

One reason for this is that the absolute minimum capital ratio, without buffer, will be around 4%, or double the previous minimum.

Under the new system, if a bank's capital ratio falls below 7% or would fall below 7% when the bank is tested for financial stresses, the bank will be forced by regulators to raise new capital. And if the ratio falls below 4%, the bank will be put into "resolution" - which means that it will be taken over by regulators and wound up.

It means that banks' core capital ratios must always be above 7% in normal economic and financial conditions. But regulators would tolerate those ratios falling below 7% for short periods during economic downturns.

A senior regulator has told me that many of the biggest banks - those "too-big-to-fail" banks whose collapse would cause ruptures to the financial system - will in practice be forced to hold more than the 7% minimum.

"There will be some kind of add-on for systemically important banks," he said. So the likes of Barclays, JP Morgan, Royal Bank of Scotland, UBS and so on will in practice have to maintain core capital ratios greater than 7%.

The major concern of banks about the imposition of the higher capital ratios is that it will constrain their ability to lend in the transition period, as they build up stocks of capital - and that could undermine the global economic recovery.

The point is that there are two ways for banks to raise capital ratios: they can persuade investors to buy new shares; or they can shrink their balance sheets relative to their existing stock of capital by lending and investing less.

Because of the threat to economic growth of rapid implementation of the new capital ratios, the regulators and central bank governors are expected to give banks several years to meet the new standards.

Basel Committee softens bank capital rules, sets leverage cap

The Basel Committee on Banking Supervision softened some of its proposed capital and liquidity rules while introducing new restrictions on how much lenders can borrow in order to rein in their risk-taking.

The panel agreed yesterday to allow certain assets, including minority stakes in other financial firms, to count as capital, according to a statement. The committee set a leverage ratio to apply to banks globally for the first time, which could become binding by 2018, pending further adjustments to the method of calculating banks’ assets.

“Even after all the compromises, the banks aren’t off the hook from tighter capital and liquidity rules,” said Frederick Cannon, chief equity strategist at New York-based Keefe, Bruyette & Woods.

France and Germany have led efforts to weaken rules proposed by the committee in December, concerned that their banks and economies won’t be able to bear the burden of tougher capital requirements until a recovery takes hold, according to bankers, regulators and lobbyists involved in the talks. The U.S., Switzerland and the U.K. have resisted those efforts. The announcement reflects the give and take between the two sides, said Barbara Matthews, managing director of BCM International Regulatory Analytics LLC in Washington.

German Concerns

Germany hasn’t signed yesterday’s preliminary agreement, said Sabine Reimer, a spokeswoman for BaFin, the country’s financial regulator.

“One country still has concerns and has reserved its position until the decisions on calibration and phase-in arrangements are finalized in September,” the committee said in a footnote to its statement.

Sumitomo Mitsui Financial Group Inc., Japan’s second- largest bank by market value, led banks higher in Tokyo after the committee agreed to allow some deferred tax assets to be counted as capital. The nation’s banks and regulators had fought against excluding deferred tax assets.

“The Basel Committee’s easing of restrictions gives investors a reason to take another look at Japanese banks, which have been cheap recently,” said Mitsushige Akino, who oversees about $450 million in assets in Tokyo at Ichiyoshi Investment Management Co.

Sumitomo Mitsui rose 2.8 percent to 2,587 yen at the 3 p.m. close of trading in Tokyo. Mitsubishi UFJ Financial Group Inc., the country’s largest bank, gained 2.5 percent and Mizuho Financial Group Inc. climbed 2.2 percent.

‘Making Concessions’

“They’re definitely making concessions on the definition of capital and the liquidity ratios,” said BCM International’s Matthews, who used to lobby the committee on behalf of banks. “Those were necessary to convince the Germans to accept the leverage ratio. But even though we see a lot of concessions, there are also limits to the concessions. So this isn’t fully caving in.”

The Basel committee, which represents central banks and regulators in 27 nations and sets capital standards for banks worldwide, was asked by Group of 20 leaders to draft rules after the worst financial crisis in 70 years.

Yesterday’s agreements were announced after a meeting of the group of governors and heads of supervision, which oversees the committee’s work. While the committee narrowed differences when it met two weeks ago in Basel, it left most of the final decisions to its board, members said.

The board said some of its proposals might not be completed by the end of this year, the deadline set by the G-20. Liquidity requirements for how much cash and cashable securities banks need to hold against their longer-term liabilities and counter- cyclical buffers, which would raise minimum capital requirements in times of faster economic growth, have to be worked on longer, the board said.

Lobby Efforts

European banks lobbied against the proposed exclusion of minority interests that banks hold in other financial institutions. Japan fought the hardest against the elimination of deferred tax assets, past losses that lenders use to offset tax charges in future years. The U.S. has opposed removing mortgage-servicing rights, contracts to collect payments, which are unique to U.S. banks.

The compromise announced yesterday would allow a bank to count part of a stake it owns in another financial firm in relation to the risk the capital is supposed to cover at the entity in which it invested. Deferred tax assets and mortgage- servicing rights would be included in capital up to a limit. The total for all three could not exceed 15 percent of a lender’s common equity.

While the capital ratios allow banks to assign weights to assets based on their risks, the new leverage figure considers all assets without a risk assessment. The committee initially set it at 3 percent -- meaning a bank’s total assets cannot be more than 33 times its Tier 1 capital, which includes securities that could help a lender cover unexpected losses.

Level Playing Field

The new rule also defines how assets are tallied, so as to level the playing field between different accounting standards and bring off-balance-sheet items into the calculation. The ratio will be tested from 2013 until 2017, and banks would be required to start publishing their individual leverage figures starting in 2015.

Bankers including Deutsche Bank AG Chief Executive Officer Josef Ackermann and HSBC Holdings Plc Chairman Stephen Green have said that the new rules may force banks to reduce lending, potentially limiting economic growth.

While yesterday’s announcement resolved several issues, many areas of contention, such as the actual minimum capital ratios that will be set, remain outstanding, said KBW’s Cannon.

“The definition of capital had to be finalized before the numbers can be put on, but there are still many moving parts,” said Cannon, whose research firm specializes in financial companies. The committee is planning to present a final package of reforms to the G-20 leaders meeting in Seoul in November.

Risk-Weighted Assets

Banks currently need to hold capital equal to a minimum of 8 percent of risk-weighted assets. Half of that must be Tier 1, and half of the Tier 1 needs to be common stock. Both Tier 1 and common-equity ratios will be increased, Cannon and other analysts expect. The Basel committee is also revising how the risk weighting will be done.

Like the leverage ratio, the liquidity rules are new to the Basel standards. The liquidity coverage ratio sets the amount of cash that needs to be held by a lender against any payment coming due within a month, while the net stable funding ratio considers liabilities up to 12 months.

The committee announced several modifications to the definition of liquid assets and of how to measure the safety of different types of funding. Government deposits will now be considered the same as corporate cash put in a bank, instead of treated as other banks’ money as originally proposed. Bank deposits are seen as less stable.

The changes should please banks, said Cannon.

“They compromised more on the short-term ratio than we were expecting,” he said.

Stress tests pass 90+% of Euro banks

Seven of 91 European Union banks subject to stress tests failed with a combined capital shortfall of 3.5 billion euros ($4.5 billion), stirring concern the evaluations weren’t strict enough.

Hypo Real Estate Holding AG, Agricultural Bank of Greece SA and five Spanish savings banks have insufficient reserves to maintain a Tier 1 capital ratio of at least 6 percent in the event of a recession and sovereign-debt crisis, lenders and regulators said today.

The banks are in “close contact” with national authorities over the results and the need for more capital, said the Committee of European Banking Supervisors, which coordinated the tests. Governments are seeking to reassure investors about the health of financial institutions after the debt crisis pummeled the bonds of Greece, Spain and Portugal.

“It would have aided credibility if there had been a higher number of fails and a higher amount of capital raised,” said Jon Peace, a London-based analyst at Nomura International Plc. “People will be surprised that it is as small as that.”

The evaluations took into account potential losses only on government bonds the banks trade, rather than those they are holding to maturity, according to CEBS. That means the tests ignored the majority of banks’ holdings of sovereign debt, analysts said.

Test Criteria

“The long awaited stress tests do not seem to have been that stressful after all,” said Gary Jenkins, an analyst at Evolution Securities Ltd., in a note. “The most controversial area surrounds the treatment of the banks’ sovereign debt holdings.”

Regulators tested portfolios of sovereign five-year bonds, assuming a loss of 23.1 percent on Greek debt, 12.3 percent on Spanish bonds, 14 percent on Portuguese bonds and 4.7 percent on German state debt, according to CEBS.

The tests also assessed the impact of a four-step credit rating downgrade on securitized debt products, a 20 percent slump in European equities in both 2010 and 2011 and 50 other macroeconomic parameters, including a drop in the EU’s gross domestic product over two years, CEBS said.

In Germany, Hypo Real Estate, a property lender that was taken over by the state, was the only bank to fail among the 14 that were tested, the Bundesbank and the nation’s financial regulator, BaFin, said in a joint statement today.

Spanish Banks

Agricultural Bank of Greece, which is 77 percent owned by the Greek state, reported a shortfall of 242.6 million euros and said it would proceed with a share capital increase to strengthen capital.

Spain, with 27 tested banks, makes up the biggest portion of the exams. The savings banks that failed were: CajaSur; a merger group led by Caixa Catalunya; a group led by Caixa Sabadell; Caja Duero-Caja Espana, and Banca Civica. Spain’s largest bank, Banco Santander SA, passed with a Tier 1 capital ratio of 10 percent under the most stringent scenario.

BNP Paribas, Societe Generale SA, Credit Agricole SA and BPCE SA, France’s four largest banks, each have enough capital to outlast an economic slump and a sovereign debt crisis, the Bank of France said. In Britain, HSBC Holdings Plc, Barclays Plc, Lloyds Banking Group Plc, and Royal Bank of Scotland Group Plc passed the tests, the Financial Services Authority said today.

The evaluations, which came two years after the U.S. subprime mortgage crisis roiled global financial markets, covers 65 percent of the EU banking industry

Many trust preferred securities will cease to qualify for Tier 1 capital

Trust preferred securities have long played a controversial role as a component of tier 1 regulatory capital for depository institutions and their holding companies.1

During the financial regulatory reform debate in the United States Congress, there was discussion of the appropriateness of trust preferred securities as a limited component of tier 1 capital in the aftermath of the credit crisis.2 Trust preferred securities are a popular form of regulatory capital, having steadily grown in both number of issuers and in outstanding amount since first permitted as qualifying tier 1 capital. As of December 31, 2008, there were approximately 1400 bank holding companies (BHCs) that had issued over $148 billion of trust preferred securities (compared with 110 BHCs with $31 billion of trust preferred securities in 1999).3

The so-called "Collins Amendment" was proposed in the United States Senate to eliminate trust preferred securities as tier 1 regulatory capital for depository institution holding companies and nonbank financial companies that are supervised by the Federal Reserve Board. However, this provision was subsequently modified in the Conference Committee on the reform legislation to apply only to depository institution holding companies that (i) have more than $15 billion of total consolidated assets as of December 31, 2009 or (ii) were not mutual holding companies on May 19, 2010.4 This provision is currently included as Section 171 of the Dodd-Frank Act, which is printed in the June 29, 2010, Conference Report on H.R. 4173 (Conference Report).5

Affected depository institution holding companies have a three-year phase-out period, beginning January 1, 2013, to replace the related trust preferred securities (see Section 171(b)(4)(B) of the Dodd-Frank Act) with qualifying tier 1 regulatory capital. Similarly, most US bank holding company subsidiaries of foreign banking organizations that have issued trust preferred securities would have a five-year transition period.

Notably, for trust preferred securities that were issued on or after May 19, 2010, there is no phase-out period and the disqualification would become effective on May 19, 2010.6

Accordingly, depository institution holding companies that had more than $15 billion in total consolidated assets on December 31, 2009, will no longer be able to include trust preferred securities as tier 1 regulatory capital, and would be obliged to replace their outstanding pre-May 19, 2010, trust preferred securities with qualifying tier 1 regulatory capital during the phase-out period. Depository institution holding companies with less than $15 billion in total assets could continue to count their pre-May 19, 2010, trust preferred securities as tier 1 regulatory capital, but could not issue new capital-qualifying trust preferred securities.

Notably, qualifying "small bank holding companies," as defined by existing Federal Reserve Board supervisory policy statements (in general, bank holding companies with consolidated assets of less than $500 million),7 would be exempt from Section 171 of the Dodd-Frank Act and could continue to issue capital-qualifying trust preferred securities.

Of course, governing instruments for existing trust preferred securities will dictate which related trust preferred securities can be called and when.

Affected sponsors of trust preferred securities should carefully review the governing instruments for the requirements of a call and, in cases where the no-call period may not yet have fully run, carefully review the definition of "Capital Treatment Event" (or similar term) used for trust preferred securities. This is because there are different definitions used in the capital markets and the differences may be material to which specific issue of trust preferred securities is callable for adverse changes in regulatory capital treatment and when.

Treasury Secretary says legislation doesn't set bank capital

"... Treasury Secretary Timothy Geithner told Congress Tuesday that the system needs "clear rules" that impose "unambiguous limits" on financial firms.

But Geithner's desire is undercut by the bill under consideration in the Senate. The legislation, proposed by Senate Banking Committee Chairman Christopher Dodd, doesn't specify clear rules or unambiguous limits. Specifically, it doesn't set firm rules on how much cash firms are required to keep on hand; the amount of capital they need in order to back up their loans and other assets; or limits on leverage.

Rather, it leaves those issues up to regulators at the Federal Reserve.

"We cannot design a system that relies on the wisdom of regulators to act preemptively with perfect foresight," Geithner told the House Financial Services Committee. "To come in and preemptively diffuse pockets of risk and leverage in the system. You can't build a system that... requires that level of preemptive exercise of perfect foresight. It is not possible."

Later, Geithner told Rep. Ed Royce (R-Calif.): "The only way I'm aware of to design a more stable system is to use capital requirements... to set and enforce constraints in leverage on institutions that could pose catastrophic risks to the financial system."

The debate over setting firm rules versus giving regulators more authority and discretion is an important one: regulators and policymakers now argue that financial regulators didn't have the necessary authority to effectively police large, interconnected Wall Street firms like Goldman Sachs and Bear Stearns, for example, or to orderly wind down failing firms like Lehman Brothers and AIG. Had they been armed with those powers back then, things might have turned out different, say the Obama administration and its backers.

Others dismiss that argument by claiming that regulators had the authority back then -- they just chose not to use it. The U.S. Securities and Exchange Commission, for example, had full oversight over Lehman Brothers yet chose not to exercise it, according to Congressional testimony delivered Tuesday by the examiner in the Lehman Brothers bankruptcy, Anton R. Valukas. The Fed had full access to Lehman's books for months before it failed, yet steadfastly stood by while the firm descended into bankruptcy.

n AIG's case, the Office of Thrift Supervision had full regulatory authority over the firm's derivatives dealings. Yet that agency, too, chose not to exercise its full powers. The problem with the crisis and the regulatory failings that preceded it wasn't a lack of regulation or a lack of regulatory authority, critics say -- it was the refusal to use it.

Yet beginning on page 91 of the 1,408-page bill, the language in Dodd's bill is clear: The Fed's Board of Governors "shall" establish rules that "are more stringent" on systemically-important firms when it comes to capital requirements, leverage limits and liquidity requirements (the three things highlighted above).

But when it comes to specifics or how stringent those rules will be, that is entirely up to the Fed. Even the oversight council that's supposed to watch over the system doesn't have full authority to crack down on Wall Street. Rather, it "may" institute rules on capital, leverage and liquidity. It also "may" not.

To Geithner, that appears to be enough.

"In the bill that Senator Dodd has proposed in the Senate, he takes an approach which does impose actual limits and would require the Federal Reserve, if passed, to design regulations that would apply those limits," Geithner said. "So, it includes your broad grant of authority but accompanies that with an explicit requirement that clear limits be put in place," he told Rep. Paul Kanjorski (D-PA).

The bill doesn't specify the kind of limits that will be put in place. it just promises to be "more stringent."

In a January speech, Federal Reserve Chairman Ben Bernanke said that regulators -- including those at the Fed -- were to blame for the housing bubble and subsequent financial crisis.

"The crisis revealed not only weaknesses in regulators' oversight of financial institutions, but also, more fundamentally, important gaps in the architecture of financial regulation around the world," Bernanke said in January.

But regulators always run the risk of being shoddy, especially when it comes to policing financial firms.

"It is the habit of regulatory agencies to get captured by the industries that they are meant to be regulating," said Raj Date, chairman and executive director of the Cambridge Winter Center, a non-profit, non-partisan think tank focused on U.S. financial institutions. This happens most often with the bank regulators, Date said.

That's why, Date argues, the financial system needs "more bright lines" in legislation regarding what banks can and cannot do, and how much cash and capital they're required to have, for example.

In an interview with the Huffington Post, Federal Reserve Bank of Kansas City President Thomas M. Hoenig said he prefers for these rules to be set in law, rather than having it be left to regulators. So does former Fed chairman Paul Volcker, who told HuffPost that there's too much pressure on regulators and that they'd be too scared to act.

In an April 14 letter to Senate leadership, three dozen top economists, Wall Street veterans and former federal regulators called for specific minimum capital levels for banks to be enacted into law.

Dodd-Frank requirements for bank capital

Title I of the Act, designated the "Financial Stability Act of 2010" (the "Financial Stability Act") creates the Financial Stability Oversight Council (the "Council") and gives broad authority to the appropriate federal banking agencies to mandate minimum leverage capital requirements and risk-based capital requirements for insured depository institutions, depository institution holding companies and nonbank financial companies supervised by the Board of Governors of the Federal Reserve System (the "Board").

Title VI of the Act, designated the "Bank and Savings Association Holding Company and Depository Institution Regulatory Improvements Act of 2010" (the "Improvements Act"), mandates stronger capitalization for all insured depository institutions, depository institution holding companies and any company that controls an insured depository institution, and provides that any company in control of an insured depository institution be accountable for the financial strength of that entity.

Financial Stability Act

The Financial Stability Act implements increased oversight of the capital requirements applicable to insured depository institutions, depository institution holding companies and nonbank financial companies supervised by the Board. The Council has been tasked with identifying risks to the financial stability of the United States that could arise from the material financial distress or failure, or ongoing activities, of large, interconnected bank holding companies or nonbank financial companies. The Financial Stability Act gives the Council broad authority to make recommendations to the Board regarding heightened prudential standards for, among other things, risk-based capital, leverage capital and contingent capital.

Minimum Leverage and Risk-Based Capital Requirements

The Financial Stability Act mandates that each federal banking agency set appropriate minimum leverage capital and risk-based capital levels, on a consolidated basis, for insured depository institutions, depository institution holding companies and nonbank financial companies supervised by the Board. It also mandates that the Board establish prudential standards for nonbank financial companies supervised by the Board and bank holding companies with total assets of $50 billion or greater that, subject to certain exceptions, include risk-based capital requirements and leverage limits.

In addition, the Financial Stability Act sets the floor for both leverage and risk-based capital requirements based on the minimum capital requirements established by the appropriate federal banking agencies under section 38 of the Federal Deposit Insurance Act. Subject to the recommendations of the Council, each federal banking agency must develop capital requirements applicable to insured depository institutions, depository institution holding companies and nonbank financial companies supervised by the Board that address, at a minimum, risks arising from

  1. significant volumes of activity in derivatives, securitized products purchased and sold, financial guarantees purchased and sold, securities borrowing and lending, and repurchase agreements and reverse purchase agreements;
  2. concentrations in assets for which the values presented in financial reports are based on models rather than historical cost or prices deriving from deep and liquid two-way markets; and
  3. concentrations in market share for any activity that would substantially disrupt financial markets if the institution is forced to unexpectedly cease the activity.

In developing these capital requirements, each federal banking agency is required to take into consideration the risks posed by the activities of each institution on not only the institution itself but also to public and private stakeholders in the event of adverse performance, disruption or failure of the institution.

The minimum leverage and risk-based capital requirements discussed above will be applicable as follows:

  • Debt or equity instruments issued on or after May 19, 2010, by insured depository institution holding companies or nonbank financial companies supervised by the Board will be deemed to have become subject to the requirements as of May 19, 2010;
  • For debt or equity instruments issued before May 19, 2010, by depository institution holding companies or nonbank financial companies supervised by the Board, any regulatory capital deductions imposed by the requirements will be phased-in over a period of three years commencing on January 1, 2013, provided that capital deductions that would be required for other institutions will not be required for depository institution holding companies with total consolidated assets of less than $15 billion as of December 31, 2009, or organizations that were mutual holding companies as of May 19, 2010; and
  • Depository institution holding companies that were not supervised by the Board as of May 19, 2010, will (other than as described in (i) and (ii) above) become subject to the requirements on July 21, 2015; and certain foreign bank holding company subsidiaries of foreign banking organizations will (other than as described in (i) above) become subject to the requirements on July 21, 2015.

Investments in financial subsidiaries that insured depository institutions are required to deduct from regulatory capital pursuant to the Federal Deposit Insurance Act do not have to be deducted from regulatory capital by depository institution holding companies or nonbank financial companies supervised by the Board, unless required by the Board or the primary regulatory agency in the case of nonbank financial companies supervised by the Board.

The minimum leverage and risk-based capital requirements imposed by the Financial Stability Act will not be applicable to:

  • Debt or equity instruments issued to the United States or any agency or instrumentality thereof pursuant to the Emergency Economic Stabilization Act of 2008, and prior to October 4, 2010;
  • Any federal home loan bank; or
  • Any small bank holding company that is subject to the Small Bank Holding Company Policy Statement of the Board of Governors, as in effect on May 19, 2010.
Off-Balance-Sheet Activities

Each bank holding company with $50 billion or greater in total consolidated assets and each nonbank financial company supervised by the Board must include off-balance-sheet activities1 in its computation of capital for purposes of meeting its applicable capital requirements.

Contingent Capital Requirement

The Council is required to conduct a study, and submit a report to Congress no later than July 21, 2012, relating to the feasibility, benefits, costs and structure of a contingent capital requirement for nonbank financial companies supervised by the Board and large, interconnected bank holding companies. Subsequent to submitting the Council's report to Congress, the Board is authorized to issue regulations, and the Council is authorized to make recommendations to the Board, to require any of the aforementioned entities to maintain a minimum amount of contingent capital that is convertible to equity in times of financial stress.

Stress Tests

The Board, in coordination with the appropriate primary financial regulatory agencies and the Federal Insurance Office, is required to conduct annual analyses that evaluate whether nonbank financial companies supervised by the Board and bank holding companies with total consolidated assets equal to or greater than $50 billion have the capital, on a consolidated basis, necessary to absorb losses as a result of adverse economic conditions.

In addition, each nonbank financial company supervised by the Board and bank holding company with $50 billion or more in total consolidated assets will be required to conduct semiannual stress tests. Any other financial company that has total consolidated assets of more than $10 billion and is regulated by a primary federal financial regulatory agency will be required to conduct annual stress tests, in accordance with regulations to be prescribed by its primary financial regulatory agency in coordination with the Board and the Federal Insurance Office.

Hybrid Capital Study

The Financial Stability Act requires that the Comptroller General, in consultation with the Board, the Comptroller of the Currency and the Federal Deposit Insurance Corporation, conduct a study to determine whether hybrid capital instruments, such as trust preferred securities, should be included as a component of Tier 1 capital for banking institutions and bank holding companies when determining their compliance with minimum capital requirements. The study is also to examine the differences between the components of capital permitted for insured depository institutions versus those permitted for companies that control insured depository institutions. A report on the findings from this study is due by January 21, 2012.

Currently, the U.S. Federal Reserve allows bank holding companies to count trust preferred securities as Tier 1 capital. Under this structure, the trust's common securities are held by the bank holding company. The trust preferred securities are issued to investors for cash. The trust then lends this cash to the bank holding company, taking in return a long-term, junior subordinated note. The junior subordinated note typically provides for interest deferral of at least five years. Trust preferred securities permit the bank holding company to deduct interest on the subordinated note in an amount equal to distributions on the trust preferred securities, resulting in tax deductible equity.

Improvements Act

The Improvements Act is intended to ensure that all insured depository institutions, depository institution holding companies and nonbank financial companies supervised by the Board are financially stable, and places responsibility on their controlling entities.

The Improvements Act amends both the Bank Holding Company Act and the Home Owners' Loan Act to require that bank holding companies and savings and loan holding companies that wish to expand the financial services of their bank subsidiaries are well capitalized and well managed. Previously, only the subsidiary banks were required to be well capitalized and well managed.

In addition, the Improvements Act imposes a heightened standard of review regarding the capitalization of a bank resulting from a merger or acquisition. Previously, the reviewing agency required the resulting bank to be adequately capitalized and adequately managed, but the standard has been increased to require that a well capitalized and well managed bank will result from the merger or acquisition. The effect of this heightened standard is that insured depository institutions, depository institution holding companies and nonbank financial companies supervised by the Board will now be required to maintain capital levels that exceed the current minimum capital levels set by the appropriate federal agencies to effectuate a merger or acquisition.

In an attempt to mitigate the financial stress on financial institutions caused by an economic downturn, the Improvements Act requires the applicable federal regulatory agencies to adjust the minimum capital requirements for insured depository institutions, bank holding companies and savings and loan holding companies, so that they are countercyclical, requiring less capital during periods of economic contraction and more capital during periods of economic expansion.

Perhaps one of the most significant changes to the regulation of capital requirements under the Improvements Act is that bank holding companies, savings and loan holding companies and any other companies that directly or indirectly control an insured depository institution will now be held accountable for the financial stability of their subsidiaries.

The Improvements Act requires that the applicable federal banking agencies require bank holding companies and savings and loan holding companies to serve as a source of financial strength for their subsidiaries that are depository institutions. If an insured depository institution is not the subsidiary of a bank holding company or a savings and loan holding company, the appropriate federal banking agency for the insured depository institution must require any entity that directly or indirectly controls the insured depository institution to serve as a source of financial strength for the depository institution.

The phrase "source of financial strength" is defined to mean the ability of a company that directly or indirectly owns or controls an insured depository institution to provide financial assistance to such insured depository institution in the event of the financial distress of the insured depository institution. The appropriate federal banking agencies are required to implement rules to this effect no later than July 21, 2012.

G20 gives banks a break on new capital rules

World leaders agreed to a flexible timetable for banks to adopt toughened capital rules, according to a draft G20 communique that offered concessions to a still-fragile financial sector.

The Group of 20 emerging and advanced economies plan to finalize an overhaul of bank capital and liquidity rules by November this year, and were aiming to have banks implement them by the end of 2012.

Banks have pushed back and said tough requirements to rebuild their capital reserves when economies are still emerging from recession would limit their ability to lend and slow the recovery. Clearly taking note of that, the G20 draft said countries would have options over how fast to introduce new capital rules, and whether to adopt a bank tax to fund future rescues.

The new capital rules, outlined in a draft communique obtained by Reuters on Saturday, are a crucial plank of the G20's vow to rein in banks and prevent another global financial crisis. But G20 leaders meeting in Toronto this weekend fear the recovery remains fragile and are wary of forcing tough new rules on banks too fast.

"Phase-in arrangements will reflect different national starting points and circumstances," the draft communique said, Countries will phase in the new requirements "over a timeframe that is consistent with sustained recovery and limits market disruption."

Finance officials meeting last month in South Korea had conceded they could not agree to stick to the 2012 deadline.

Banks argue that a regulatory crackdown on banks could cut 3 percent off economic growth over the next five years in the United States, the euro zone and Japan. The sector has called for more clarity on the intended reforms.

The G20 leaders provided some guidance, signaling they will give banks more wiggle room than previously expected for building up their core Tier 1 capital levels, the most important backstop against losses and something European and Japanese bankers wanted.


"The banks will obviously try to get a better deal than regulators are likely to be willing to give them," said Paul Masson, a professor at the Rotman School of Management, University of Toronto. "Lobbying and negotiations will continue, perhaps beyond the November deadline."

Masson said the G20 flexibility made sense given the uncertain outlook, leaving some countries and banks in worse shape than others.

G20 finance ministers had signaled some flexibility when they met in Busan, South Korea this month, but the leaders explicitly endorsed the idea in the Toronto communique.

In a sign the crisis-forged G20 unity has frayed, the G20 draft bluntly killed further debate on another contentious issue, a global bank tax: "Some countries are pursuing a financial levy. Other countries are pursuing different approaches."

Regulation across the world is taking different paths too. Washington passed a sweeping overhaul of financial legislation on the eve of the G20, while Britain, France and Germany have vowed to go ahead with a levy of their own. But Canada and others say their banks stayed afloat during the crisis due to prudent practices and should not be punished with a tax.

"We have unfortunately no common position in the G20 neither on a bank levy nor on a financial-transaction-tax," said German Chancellor Angela Merkel.

Bank of Canada Governor Mark Carney mused that if countries get the core capital reforms right, there would be no need for a tax.

Daniel Schwanen, an analyst with the Center for International Governance Innovation, agreed.

"More countries will see that they will not need to follow the European lead of a bank tax because they might say this (capital requirement) is sufficient," he said.

G20 delay on Basel III bank curbs

Hopes of the early implementation of tough anti-speculation curbs on banks were dashed today after finance ministers from the G20 group of developed and developing nations admitted that new capital regulations would be phased in over time.

Amid signs that ferocious lobbying from the global finance industry had exposed splits between leading members of the G20, ministers and officials said it was now unlikely that the changes to the Basel banking rules would start to bite before the original 2012 deadline.

Britain, the United States and Canada bowed to pressure from Germany, France and Japan, which have argued that forcing banks to hold more capital to guard against a future financial meltdown would starve companies and individuals of finance and risk plunging the global economy into a double-dip recession.

"Implementation is a variable. Some would like a shorter period, some would like a longer period. I think that can be worked out over time," Canada's finance minister Jim Flaherty told reporters at a meeting of G20 finance ministers and central bank governors in South Korea. "There can be a compromise on that."

Under the Basel I and Basel II accords, banks were obliged to hold a set amount of capital to guard against losses in the event that investments went sour. Since the onset of the financial crisis in August 2007, governments have been trying to agree a Basel III agreement that would increase the size of the financial cushion and force banks to hold more capital during boom periods.

Negotiations were fast-tracked amid concerns that the current Basel rules are pro-cyclical – allowing banks to ramp up in boom periods and thus helping to inflate asset-price bubbles. The original plan was for the talks to be completed by the end of 2010 and the new rules to come into force by the end of 2012.

George Osborne, the chancellor of the exchequer, insisted today that he wanted the Basel III talks to end on time this year, but aides said Britain was prepared to be flexible about the timing of the implementation of the new regulations provided there was no attempt to dilute the accord.

"One of the things I'll be pressing for is that the agreements that were reached last year on capital leverage and liquidity are now concluded. We want to end the uncertainty," Osborne said in Busan.

Basel III would scrap so-called hybrid capital, which is a mixture of debt and equity used by many Continental European banks, in favour of pure equity or retained earnings. Banks have argued that the changes to the capital rules could lead to huge funding gaps, with knock-on effects on economic growth.

Osborne made it clear that Britain would strongly oppose the use of hybrid capital in Basel III, which he sees as a way of watering down the proposals.

With the crisis in the eurozone adding to pressure on banks, France and Germany have been pushing for a window of up to 10 years before the Basel III rules are fully effective. The ECB has said that Europe's banks will need to renew €800bn in equity that matures by the end of 2012.

Tim Geithner, the US treasury secretary has made it clear that Washington is prepared to be flexible about the timing of new capital rules. "It is perfectly reasonable to use transition periods to make it easier for countries to adjust to what we believe should be substantially a more demanding, more ambitious set of constraints on leverage," Geithner said.

"That's a responsible policy and I'm perfectly comfortable negotiating using a reasonable transition period to help people be more comfortable they can live with those new standards."

Flaherty stressed the need to continue working on the tougher definition of bank capital so that G20 leaders can see progress when they hold a summit in Canada later this month.

"If we get some more work accomplished here this weekend, then I would expect the leaders in Toronto would be able to express with assurance that we're going in the right direction, that we're on time ... to have the agreement in place by the end of the year."

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 ( 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.

US and Euro banks have lost $1.2T on toxic assets since 2007

Top U.S. and European banks have lost more than $1.2 trillion on toxic assets and bad loans since the start of 2007.

U.S. banks are forecast to lose about $885 billion and Europe's banks are seen losing nearly $1.3 trillion in the 2007-10 period, according to International Monetary Fund forecasts in May. Roughly two-thirds of the losses are expected to come from loans and the rest from securities.

Below is a list of estimated losses (in billions of dollars at prevailing exchange rates):

BANK                          2007     2008     2009    2010   TOTALS
Citigroup (C.N)               29.1     63.4     30.7     7.3   $130.5
Bank of America (BAC.N)       12.1     29.2     35.5    10.8    $87.6
Wachovia Corp*                 4.0     73.4                     $77.4
HSBC (HSBA.L)                 19.3     30.3     26.4            $76.0
Lloyds (LLOY.L)&               6.8     28.9     36.1            $71.8
Merrill Lynch**               25.1     38.6                     $63.7
Royal Bank Scotland (RBS.L)    7.0     23.5     21.3     4.0    $55.8
UBS (UBSN.VX)                          50.6      1.8     0.1    $52.5
JPMorgan Chase (JPM.N)         4.5     10.2     29.5     7.9    $52.1
Fannie Mae (FNM.N)             4.7     26.9     15.4            $47.0
Freddie Mac (FRE.N)            5.2     24.4     12.8            $42.4
Washington Mutual***           5.1     36.7                     $41.8
Barclays (BARC.L)              7.0     16.5     12.7     2.3    $38.5
Wells Fargo (WFC.N)            3.5      8.7     18.2     5.3    $35.7
Santander (SAN.MC)             4.8      8.3     13.2     3.2    $29.5
Lehman Brothers****           12.5     14.0                     $26.5
BNP Paribas+ (BNPP.PA)         2.4      8.0     11.4     1.7    $23.5
Morgan Stanley (MS.N)         10.3     10.1      2.4            $22.8
Commerzbank/Dresdner (CBKG.DE) 3.9     13.3      4.5            $22.3
UniCredit (CRDI.MI)            3.5      5.1     11.3     2.3    $22.2
Deutsche Bank (DBKGn.DE)       4.0     11.2      4.9     0.4    $20.5
BBVA (BBVA.MC)                 2.7      4.2      7.7     1.5    $16.1
Credit Suisse (CSGN.VX)        3.5     11.9      0.5     0.1    $16.0
C.Agricole+ (CAGR.PA)          2.7      4.4      6.3     1.4    $14.8
IKB &&                                                          $14.7
Societe Gen+ (SOGN.PA)         1.3      3.7      7.9     1.5    $14.4
National City*****                                              $14.0
Intesa Sanpaolo (ISP.MI)       1.6      4.5      4.9     0.9    $11.9
ING (ING.AS)                            7.1      2.4     0.9    $10.4
Bayern LB                      1.1      8.0                      $9.1
Goldman Sachs (GS.N)           1.7      4.9      1.9             $8.5
Natixis+ (CNAT.PA)             2.0      2.5      2.0     0.1     $6.6
Canadian Imp Bk Commerce                                         $6.5
Standard Chartered (STAN.L)    0.8      1.8      2.0             $4.6
Erste Bank (ERST.VI)           0.8      2.5      1.3             $4.6
Bear Stearns******             3.0      0.6                      $3.6
Fortis                                                           $3.1
WestLB                                                           $3.0
Rabobank                       0.8      1.7                      $2.5

TOTAL                                                        $1,204.9

(Sources: Reuters/annual reports/company filings) Estimates based on writedowns and losses from subprime securities, mortgages, CDOs, derivatives and SIVs, and losses on bad loans, or non-performing loans. The definition of a bad loan is complex and can vary between countries and often includes a provision for future loan losses.

*      Acquired by Wells Fargo at the end of 2008.
**     Acquired by Bank of America on Jan 1, 2009.
***    Assets acquired by JPMorgan in Sept. 2008.
****   Filed for bankruptcy in Sept. 2008.
*****  Bought by PNC Financial Services Group in Dec. 2008.
****** Bought by JPMorgan in March 2008.
&      Includes HBOS, taken over by Lloyds in Jan. 2009.
&&     Bought by Lone Star in Aug. 2008 after state-led bailouts.
+      France bank estimates based on 'cost of risk'.

Global banks may need $1.5 trillion in capital, study says

Global banks may have a capital deficit of more than $1.5 trillion by the end of next year and some may require state support, according to a study by Independent Credit View, a Swiss rating company.

Allied Irish Banks Plc, Commerzbank AG, Bank of Ireland Plc and Royal Bank of Scotland Group Plc may have the biggest capital deficits by the end of 2011 among the 58 banks examined in the study, Christian Fischer, a partner and banking analyst at Independent Credit View, told journalists in Zurich today.

“Without state aid or debt restructuring these banks will hardly be able to raise capital,” Fischer said, forecasting “massive dilution for existing shareholders.”

The study compared estimated capital needs for the end of 2011 with capital ratios reported at the end of last year. The analysts took into account the banks’ earnings estimates for this year and next, forecasts for loan and provisions growth as well as an increase in the tangible common equity ratio to 10 percent from the average of 9 percent at the end of December.

Dublin-based Allied Irish and Bank of Ireland may need to raise capital equal to 681 percent and 536 percent of their current market values, respectively, Fischer said. The two Irish banks also got the lowest credit ratings in the study from Independent Credit View, of BB- and B+, respectively.

“We do have a substantial amount of capital that our financial regulator here in Ireland has requested us to raise,” Alan Kelly, a spokesman for Allied Irish, said by phone. “A substantial portion of that, that yet can’t be determined because we’re only in process, will be raised through the disposal of assets.”

Capital Raisings

Ireland’s financial regulator, Matthew Elderfield, who took over in January, has told Allied Irish and Bank of Ireland to raise about 10 billion euros ($12.2 billion) by the end of the year to meet new capital requirements and create a buffer against losses as loans turn bad.

“The financial regulator has determined how much capital Bank of Ireland needs and we’re currently in the process of finalizing the raising of an amount in excess of that,” spokeswoman Anne Mathews said by phone. “The findings in this report are clearly out of date.”

Bank of Ireland is selling new shares as part of a plan to raise 2.9 billion euros, while Allied Irish has said it will sell stakes in banks in Poland and the U.S. as it tries to raise about 7.4 billion euros.

Independent Credit View’s study doesn’t take into account the bank’s transfer of loans to the National Asset Management Agency, Bank of Ireland said.

Commerzbank, RBS

Commerzbank of Frankfurt may see a capital deficit equal to 611 percent of its market value, while for Edinburgh-based RBS that ratio may be 359 percent, according to the study. Commerzbank is also among the banks that may have the biggest potential for rating downgrades, along with Barclays Plc, Banco Santander SA and Italian lenders, Fischer said.

Spokespeople for RBS and London-based Barclays declined to comment. Commerzbank declined to comment.

A spokesman for Madrid-based Santander, who asked not to be identified in line with company policy, said the study’s conclusion about potential rating downgrades is “mistaken.” Santander is “one of the best capitalized banks in the world with a very low risk profile and that has continued to generate profit and pay dividends through the financial crisis,” he said.

Zurich-based Independent Credit View was formed in 2003. In an August 2007 study, the company warned about higher risks on the balance sheets of German Landesbanks, U.K., Icelandic and Spanish lenders than perceived by other rating companies at the time, Fischer said.

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.


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.

Bank of England study on reduced capital and lending

"... How is it then possible to identify and attribute lending changes to bank capital? We draw on three methods.

First we take advantage of historic data on banks’ balance sheets from 1990 to 2004 to investigate shocks to different portfolio components. Along with the time dimension, we use cross-bank differences in a panel of UK banks to extract the important comovements among capital, loans, securities and liabilities. This approach, is known as a panel vector autoregression specification. We find that innovations in a bank’s capital in the sample period, other things equal, were coupled with a loan response that lasted up to three years and the effect was especially strong among small banks.

Our second method uses indicators of regulatory capital pressure from confidential supervisory returns. We use this information to test whether banks responded differently to capital innovations depending on how close they were to their minimum capital requirements set by the regulator during the sample period. Banks approaching their regulatory minimum were found to cut lending. But they also responded to an increase in capital by lending more. A further result is that banks were less compelled to raise their deposit interest rate to attract funds when they received positive capital shocks starting from a constrained position.

Our third method is the least vulnerable to the problem that the lending response may be contaminated by demand conditions or by factors driving both demand and supply. We identify a possible exogenous shock to bank capital, in the form of a shock originating in a different geographical region. Because many UK banks take deposits from and lend to non-residents, we take advantage of data on write-offs on loans to non-residents. These write-offs will tend to reduce bank’s capital (relative to the counterfactual), and are independent of a bank’s lending to UK residents. For example, the East Asian crisis led to an increase in non-resident write-offs but was not associated with a rise in write-offs on resident loans. We find some evidence that a shock to non-resident write-offs caused a significant and sustained fall in UK lending. We also isolate the movements in bank capital coming from non-resident write-offs and find a significant positively correlated effect on UK resident lending (controlling for resident write-offs, liquidity and other measures). The effect was strongest on private non-financial corporation (PNFC) loans, and in contrast, lower bank capital had a positive effect on household loans. This indicates that – in this pre-crisis period – banks substituted away from risky PNFC loans into potentially less risky loans when capital was short.

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.

Bank equity is not expensive

Rock Center for Corporate Governance at Stanford University Working Paper No. 86, Stanford Graduate School of Business Research Paper No. 2063


There is a pervasive sense in discussions of bank capital regulation that “equity is expensive” and that equity requirements, while beneficial, also are costly for the system. Bankers and others warn that high equity requirements would restrict the provision of credit and would impede economic growth. We examine such assertions and the arguments often made to support them. We find that these arguments either are fallacious or irrelevant, or else are unsupported by empirical experience or by adequate theory. For example, methods used in studies of capital regulation often take as given the required return of return on equity, ignoring the fact that this return contains a risk premium that must go down if banks have more equity. Moreover, in many discussions of capital regulation no distinction is made between costs borne privately by banks and those borne by the public. For example, it is incorrect to assume that if bank taxes increase, this translates to a social cost.

Our analysis leads us to conclude that, starting from current capital requirements, the social benefits associated with significantly increased equity requirements are large, while the social costs, if any, are small. Quite simply, bank equity is not expensive from a social perspective, and high leverage is not required in order for banks to perform all their socially valuable functions, including lending, taking deposits and issuing money-like securities. Adding equity to absorb variation in the value of the banks’ assets also does not adversely affect the portfolio holdings of final investors.

Public policies that, through taxes and implicit guarantees, subsidize debt financing and indirectly penalize equity are distortive. If any bank activities require subsidies, subsidies should be given in ways that do not encourage leverage. We urge regulators to set significantly higher equity requirements and to use such requirements as a powerful, effective, and flexible tool with which to maintain the health and stability of the financial system on an ongoing basis. Regulators should also help banks achieve these higher equity levels quickly and efficiently by limiting equity payouts and potentially mandating equity issuance by all regulated institutions for a period of time. Eliminating banks’ discretion to recapitalize would remove potential negative inferences about the health of a particular bank that might otherwise be associated with these actions.

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.

US taxpayer losses on banks 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 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 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 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."


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.


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