Regulators say banks face duller, expensive future

Regulators say banks face duller, expensive future

Basel, Switzerland: Banks will be duller in future as they creak under heavier capital requirements but risks should be clearer to investors and supervisors, global regulators and central bankers said.

The International Organisation of Securities Commissions is meeting to review steps to make the financial system safer by applying lessons from the worst crisis in 70 years.

Monitoring system-wide risks and heavy bank capital and liquidity requirements are core lessons but there are still tough talks ahead to forge a consensus on details of new rules.

“As a consequence of stronger liquidity and capital requirements banks of the future may seem more boring, with lower return on equity but less risky and frankly, probably socially much more useful," Philipp Hildebrand, designated chairman of the Swiss National Bank, told the IOSCO meeting.

The Swiss have led in toughening up capital requirements on its two biggest banks, Credit Suisse and UBS, requiring them to have Tier 1 capital ratios of 16 percent, double the level of globally-agreed rules set by the Basel Committee on Banking Supervision.

The Basel II rules are being toughened up with draft revisions due in December. The actual capital and liquidity figures will be set by the end of 2010 and take effect by the end of 2012 or when economic recovery is assured.

Banks say if capital and liquidity requirements become too heavy too soon, lending to aid recovery will be harder.

“The layering effect of all this could be quite significant which is why there will be the mother of all impact assessments next year," a regulatory source said.

The Basel revisions will include a new leverage ratio to cap how much a bank can extend itself, a new definition of capital to improve its quality, and a new liquidity ratio.

There is debate over which assets to include in a global leverage ratio -- set at 5 percent in the United States -- with some countries wanting to exclude on balance sheet assets like cash and government securities.

There is a concern that excluding cash and government bonds would send a “perverse" message, encouraging banks to cut their holdings to a minimum.

“But there is consensus emerging to include off balance sheet items but there is also a need for simplicity in a ratio," the source said. Such a leverage would be similar to Canada’s.

“I think it is a big step forward that the Basel Committee is improving the quality of its ratios. Most importantly, it will be introducing a new unweighted leverage ratio, a backstop ratio of 4 percent, which is much more closely aligned with the regular accountancy rules," Hans Hoogervorst, chairman of the Dutch markets regulator AFM told the IOSCO conference.

“At least this ratio will make the overall leveraging of a bank continuously visible to the market and the regulators," Hoogervorst said.

Under Basel II, half of the 8 percent minimum overall capital requirements must be Tier 1 or higher quality capital.

Part of Tier 1 must be retained earnings or common equity and the new rules will say this should be the predominant form but no exact figure is expected.

A view is also emerging that government capital injections such as coupons should not be subject to the new tighter capital quality rules as in some cases it would not qualify.

Regulators hope that by the time the new rules take effect, most banks will have paid back government capital and substituted it with better quality capital.

The Basel Committee will also propose a simple liquidity ratio of highly liquid assets to liabilities so bans can withstand sudden shocks for a few weeks at least.

The new liquidity framework is set to be substantial and separate from Basel II, in effect a new global Liquidity I regime, as one official dubbed it.

It is expected to be similar to a liquidity regime adopted this week by Britain which requires banks to build minimum liquidity buffers of only cash or government bonds.

So far, there is no timing on when the new liquidity regime will be introduced.

The Basel Committee has already adopted rules to increase capital requirements on trading books and although figures have yet to be fixed, it will force banks with trading desks to set aside two to three times the amount of capital.

Some regulators privately hope this magnitude of increase will force banks to reconsider whether to continue trading risky products that turned toxic in the credit crunch.