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New Capital Rules Will Weigh On Banking Industry Profits

A year after the collapse of Lehman Brothers, one thing is clear: banks' ability to generate healthy profits will be challenged, as regulators impose tighter rules on them.

But the measures, which include raising capital and capping bonuses, are not likely to be introduced for months, maybe years, and even now regulators aren't in complete agreement over what they should be.

US regulators want banks to raise more capital to help discourage a repeat of the speculation that so damaged financial markets in 2008-2009. But some say that quality, not necessarily quantity, of capital is important.

"There is a need in the world banking system for more capital," Rep. Paul Kanjorski, chairman of the House Capital Markets Subcommittee, told CNBC during a visit to London to discuss reforming the global banking system.

Differences in philosophy, not only between the two sides of the Atlantic Ocean but also among European countries, means a complete overhaul of the banking system will be difficult to achieve.

The Crisis: 1 Year Later - A CNBC Special Report - See Complete Coverage
The Crisis: 1 Year Later - A CNBC Special Report - See Complete Coverage

On September 6, central bankers and regulators in the Basel Committee on Banking Supervision revealed a set of changes to the rules that strengthen the quality of capital, introduce a cap on the amount of debt a bank can incur and impose minimum standards to fund liquidity.

Capital, the Key Issue

The measures announced, however, do not go far enough or bring fresh proposals to the table, according to some analysts.

"We have not seen too many new things yet," Antonio Ramirez, KBW European banks analyst told CNBC.com. "They said the same thing as two months ago."

Europe wants to keep the capital ratio at eight percent of risk-weighed assets, while also improving its quality by stipulating that the predominant form of Tier-1 capital must be common shares and retained earnings.

So far, European banks have used a mixture of debt and equity, known as hybrid capital, which many analysts say is not as safe as common shares--as the recent crisis illustrated.

Regulators in the U.S., where Tier 1 capital is more directly tied to common shares, insist on raising the capital ratio.

"In the short term the most important step needed is to insist that banks increase their equity capital to a multiple of their current level," Andrew Smithers, author of "Wall Street Revalued," told CNBC.com.

Smithers says the International Monetary Fund's recent financial stability report show banks cannot build up capital by simply retaining profits and therefore need to tap shareholders for huge new issues of equity.

"Governments will have to insist on this, as banks will resist. In fact stock markets may not be able to supply the required equity unless governments are prepared to underwrite the issues," he said.

Threat to Recovery

Banks will not expand their balance sheets and credit will remain in short supply until such additions to equity are raised, according to Smithers.

This Day 1 Year Ago - A CNBC Special Report - See Complete Coverage
This Day 1 Year Ago - A CNBC Special Report - See Complete Coverage

"This will probably inhibit recovery unless central banks greatly extend quantitative easing and this is undesirable because of the rational fears and other problems that it will raise for the future," he said.

Another important step would be creating a central clearing house for derivatives, which would be beneficial for banks, as well, Ramirez said. "In theory, that should reduce the risk, that would increase transparency," he added.

Some banks are kicking back at the threat of harsher regulation. They have been so vilified that many people forget they weren't the only actors in a debt debacle, say some analysts.

"We had an environment where risk was being taken without people recognizing that it was taken," said Mark Tinker of Axa Framlington Gemini. "The job of the regulator is to spot where the leverage is. The banks didn't blow up the economy."

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