ANALYSIS:FINANCE MINISTERS from the G20 worked out a far-reaching agreement to insulate global banking against systemic shock at the weekend.
Now the governments that signed up to the deal must start the hard work of hammering out the detail. For all that appears to have been agreed, the G20 communiqué left much unsaid and there is scope for much negotiation.
Details of reforms to bankers’ bonus payments are to be presented to the G20 heads of government at their Pittsburgh summit on September 28th. It is clear that the banking industries of some member states will find the new framework much harder to swallow than others – a fact that US Treasury secretary Tim Geithner acknowledged on Saturday.
“Some parts of this are harder for some countries than for others,” he said.
Analysts point to two elements of the agreement that are likely to be contentious. The first is the requirement to hold more and higher-quality capital. The second is the setting of an overall leverage ratio, which will take into account off-balance-sheet activities, in order to limit the amount of borrowing conducted by institutions outside the formal banking regime.
The first element is likely to force some banks to raise more equity capital, while all the measures taken together could mean that returns on equity capital will be lower than they have been in the past. The second element may alter the way banks borrow in the capital markets.
“The need for regulatory reform and higher capital requirements is a no-brainer. But we’re not convinced the market has internalised the full implications, not least for growth,” said Hans Lorenzen, a credit analyst at Citi. “Further reductions in bank leverage and controls on shadow banking will have a significant impact on credit creation and the risk premia required to generate targeted returns on capital.”
Mr Lorenzen, citing International Monetary Fund data as at the end of 2008, noted that the ratio of tangible common equity to assets of European banks was 2.5 per cent, versus 3.7 per cent in the US.
For some European banks, hybrid instruments make up a significant portion of regulatory capital and, when new rules are finalised, they are likely to need to replace that with share capital.
Bankers are expressing concern about the new rules. Angela Knight, chief executive of the British Bankers’ Association, said that banks were already under pressure to lend more. “You can’t hold two times the amount of capital you already do and lend it at the same time,” she said.
The communiqué makes a tacit recognition of that point, saying new standards on capital are intended to take effect “once recovery is assured”.
For the French, the document represents a significant concession from the US; it has agreed to sign on to the Basel regulatory framework, which it refused to do up until now.
Bernd Brabänder, managing director for economic affairs at the Association of German Banks, said the wording of the communiqué on capital requirements seemed open to interpretation.
“We will have risk-based requirements, and at the end of the day we will have a lot more capital in the system, which is a good thing. But the bit about leverage ratios really makes me a bit nervous,” he said.
Mr Brabänder added that absolute leverage ratios should be used as a “trigger for supervisors to target a bank for closer inspection, not as a hard leverage ratio, US-style”.
A spokeswoman for the German finance ministry said the government had achieved its goals at the G20 finance ministers' meeting in the area of bonuses and exit strategy. But she refused to comment on capital requirements until the completion of Basel committee talks. – (Copyright the Financial Times Limited2009)
