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How Europe Banks Can Avoid Tougher Capital Rules

Banks in the European Union could evade part of the tighter Basel III capital requirements under draft legislation implementing the new globally agreed standards across the 27-member bloc.

BCBS chairman Nout Wellink talks with BCBS secretary general Stefan Walter
Jung Yeon-Je | AFP | Getty Images
BCBS chairman Nout Wellink talks with BCBS secretary general Stefan Walter

The 500-plus page draft, which has not been officially released, could allow EU banks to count more of the capital in their insurance subsidiaries than the global rules call for. It will also allow some banks to continue issuing hybrid capital – preference shares and other debt-like instruments – for longer than expected. The biggest French financial companies, including Société Générale and BNP Paribas, and the UK’s Lloyds Banking Group have insurance arms. They would benefit disproportionately from the exception.

The Basel Committee on Banking Supervision agreed last year to tighten the definition of capital and require all banks to maintain core tier one capital equal to 7 percent of their assets, adjusted for risk. But it is up to national regulators and the European Commission to implement the rules.

A regulator involved in the Basel process said that if the two exceptions stand “it would be a violation of the global agreement” and would undermine the international effort to make banks safer.

The Basel III compromise limits the use of insurance capital to 10 percent of each bank’s total capital stock. It forces banks to gradually reduce their reliance on hybrids, which largely proved useless in absorbing losses during the financial crisis. It prohibits them from counting any hybrids issued after the Basel III standards were announced in 2010.

The EU draft amendments to its “capital requirements directive” would allow financial conglomerates to use another method of calculating their capital. Several people who have seen the draft said it could effectively gut the 10 percent limit on use of insurance holdings.

“You could drive a coach and horses through that exception,” said one of them.

However, EU officials said they believe the Basel III standards would not be breached because of the strict way in which the conglomerate provisions would be policed.

The EU legislation covers a broader scope than the Basel III guidelines, applying to investment firms, the insurance sector and across sectors, as well as to banks.

The EU plans to toughen rules for conglomerates.

The draft says that banks could count hybrids issued right up until the Commission formally unveils the amendments, which is likely to be July. That would benefit EU banks that have continued to issue hybrids in defiance of the planned phase-out. EU insiders said the later date is due to concerns about making rules retroactive.

Global bankers and regulators are on high alert for cheating on implementation of the Basel standards. US regulators infuriated European counterparts by refusing to implement the Basel II round for many years.


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