The Bank for International Settlements has announced:
a substantial strengthening of existing capital requirements and fully endorsed the agreements it reached on 26 July 2010.
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The Committee’s package of reforms will increase the minimum common equity requirement from 2% to 4.5%. In addition, banks will be required to hold a capital conservation buffer of 2.5% to withstand future periods of stress bringing the total common equity requirements to 7%.
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Under the agreements reached today, the minimum requirement for common equity, the highest form of loss absorbing capital, will be raised from the current 2% level, before the application of regulatory adjustments, to 4.5% after the application of stricter adjustments. This will be phased in by 1 January 2015. The Tier 1 capital requirement, which includes common equity and other qualifying financial instruments based on stricter criteria, will increase from 4% to 6% over the same period. (Annex 1 summarises the new capital requirements.)
The Group of Governors and Heads of Supervision also agreed that the capital conservation buffer above the regulatory minimum requirement be calibrated at 2.5% and be met with common equity, after the application of deductions. The purpose of the conservation buffer is to ensure that banks maintain a buffer of capital that can be used to absorb losses during periods of financial and economic stress. While banks are allowed to draw on the buffer during such periods of stress, the closer their regulatory capital ratios approach the minimum requirement, the greater the constraints on earnings distributions.
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A countercyclical buffer within a range of 0% – 2.5% of common equity or other fully loss absorbing capital will be implemented according to national circumstances. The purpose of the countercyclical buffer is to achieve the broader macroprudential goal of protecting the banking sector from periods of excess aggregate credit growth. For any given country, this buffer will only be in effect when there is excess credit growth that is resulting in a system wide build up of risk. The countercyclical buffer, when in effect, would be introduced as an extension of the conservation buffer range.
These capital requirements are supplemented by a non-risk-based leverage ratio that will serve as a backstop to the risk-based measures described above. In July, Governors and Heads of Supervision agreed to test a minimum Tier 1 leverage ratio of 3% during the parallel run period.
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Systemically important banks should have loss absorbing capacity beyond the standards announced today and work continues on this issue in the Financial Stability Board and relevant Basel Committee work streams. The Basel Committee and the FSB are developing a well integrated approach to systemically important financial institutions which could include combinations of capital surcharges, contingent capital and bail-in debt. In addition, work is continuing to strengthen resolution regimes.
By “strengthen resolution regimes”, they mean “let regulators pretend they’re bankruptcy judges and eviscerate creditor rights”, but never mind.
The Basel Committee also recently issued a consultative document Proposal to ensure the loss absorbency of regulatory capital at the point of non-viability. Governors and Heads of Supervision endorse the aim to strengthen the loss absorbency of non-common Tier 1 and Tier 2 capital instruments.
The numbers are summarized in the Annex.
US agencies have expressed support:
The U.S. federal banking agencies support the agreement reached at the September 12, 2010, meeting of the G-10 Governors and Heads of Supervision (GHOS).1 This action, in combination with the agreement reached at the July 26, 2010, meeting of GHOS, sets the stage for key regulatory changes to strengthen the capital and liquidity of internationally active banking organizations in the United States and around the world.
No comments from OSFI so far. Maybe they haven’t been told.
Yalman Onaran of Bloomberg reports:
Of the 24 U.S. banks represented on the KBW Bank Index, seven would fall under the new ratios based on calculations using the revised definitions of capital, Keefe, Bruyette & Woods analyst Frederick Cannon said in a Sept. 10 report. Bank of America Corp. and Citigroup Inc., the nation’s No. 1 and No. 3 lenders, would be among those, Cannon estimates. Bank of America would have to hold off paying dividends or buying back shares until the end of 2013, he said.
European banks are less capitalized than U.S. counterparts and may be required to raise more funds under the new Basel rules. Deutsche Bank AG, Germany’s biggest lender, said today it plans to sell at least 9.8 billion euros ($12.5 billion) of stock. Germany’s 10 biggest banks, including Frankfurt-based Deutsche Bank and Commerzbank AG, may need about 105 billion euros in fresh capital because of new regulations, the Association of German Banks estimated on Sept. 6.
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The committee has yet to agree on revised calculations of risk-weighted assets, which form the denominator of the capital ratios to be determined this weekend. The implementation details of a short-term liquidity ratio will also be decided by the time G-20 leaders meet, members say. A separate long-term liquidity rule will likely be left to next year.
The two liquidity rules would require banks to hold enough cash and easily cashable assets to meet short-term and long-term liabilities. The long-term requirement has been criticized the most by the banking industry, which claims it would force banks to sell $4 trillion of new debt.
The Basel committee has another meeting scheduled for Sept. 21-22 and said it may gather in October to finish its work.
I can’t help feeling that the emphasis on capital misses the point. Banks did not fail due to insufficient capital, although more is always helpful, obviously. The banks failed, or came close to failing, or were crippled in the panic because:
- They held concentrated portfolios, particularly of CDOs that, while having a face value of X, had exposure to mortgages of many times that amount since they were comprised of subordinated tranches of structured mortgages
- Interbank (and inter-near-bank in the case of AIG) exposures were not collateralized and the uncollateralized risk was weighted according to the credit rating of the sovereign of the counterparty’s regulator (i.e., when BMO buys RBC paper, that is risk-weighted as if it has bought Canada paper). Interbank exposures should be penalized by the rules, not encouraged!
I don’t have much time for commentary because this is PrefLetter weekend … but discussion of this will form a big part of future posts, never fear!