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New Banking Rules Would Ease Shocks to System

If all goes well, the world will be a slightly safer place after top central bankers and bank regulators emerge Sunday from meetings in Basel, Switzerland. By agreeing on new rules designed to prevent financial crises, they will remove a source of uncertainty that has weighed on markets just as concerns about European sovereign debt rise again.

Columns and steps
Columns and steps

But the rules will also put further pressure on weaker banks, many of which will have to raise more capital, and mark another step in the triage of the banking world into healthy institutions and sick ones with few options other than to plead for more government aid — or go out of business.

The financial authorities from 27 countries, including Ben S. Bernanke, chairman of the U.S. Federal Reserve, and Jean-Claude Trichet, president of the European Central Bank, have been working for months on what new constraints the banking industry should face.

The fierce debate about the so-called Basel III rules has added an extra dose of tension to markets made nervous in recent weeks by the problems of Anglo Irish Bank in Ireland, and new questions about sovereign debt holdings.

In the long run, if the rules work the way they are supposed to, banks will be much more able to absorb violent market shocks and the world will be less susceptible to the kind off inancial crisis it has experienced the past three years.

“The system does not have the capacity for another round of bailouts, nor does the public have the tolerance for it,” said Nout Wellink, chairman of the Basel Committee on Banking Supervision, which drafted the proposed rules.

But the new regulations probably mean that banking will become a less profitable business. According to some dire predictions, economic growth could even suffer as banks curtail lending to build up bigger financial cushions.

“If the new rules come all banks will go to the capital markets looking for new money, but you would need a crystal ball to know if the markets will provide it,” said Carsten Gross, who follows regulatory issues for the Association of German Public Sector Banks, which has said its members might need to raise €50 billion, or $64 billion, and warned that economic growth could suffer as a result.

Even though the new rules would not go into full force for years, already there are signs that banks are lining up to ask investors for more capital.

Deutsche Bank plans to issue €9 billion in new shares to finance its acquisition of Postbank, a German consumer-oriented institution, Bloomberg News and The Financial Times reported, without citing their sources. Deutsche Bank declined to comment, but it has said previously that it will finance any acquisitions with new shares.

This past week, National Bank of Greece said it would raise €2.8 billion, and there is speculation that other institutions, like Commerzbank in Frankfurt, might also try to raise money soon.

Mr. Wellink’s panel is overseen by the so-called Group of Central Bank Governors and Heads of Supervision, under the chairmanship of Mr. Trichet of the E.C.B. Mr. Trichet’s group is expected to forge a pact on the new rules late Sunday, though talks could continue through Monday. Its recommendations will go to the G-20 nations in November, and only take effect after individual nations write them into law.

For all the loud complaining and doomsday predictions from some corners of the banking industry, many analysts say the new rules could be positive for most banks.

“So far regulators have been quite prudent in trying not to burden the banking sector too much,” said Marie Diron, an economist in London who advises Ernst & Young, the consulting firm. She noted that regulators were expected to phase in the new rules through 2018, giving banks plenty of time to adjust.

Dire forecasts of the economic effect are “the reaction of a group that is trying to defend its position and is under stress,” Ms. Diron said. “Most of them should be able to meet requirements without problems. The ones who will have problems are the ones who would have problems without Basel III.”

Most large European banks that need to raise new capital will be able to do so by holding on to earnings rather than paying dividends to shareholders, said Jon Peace, an analyst at Nomura Equity Research.

True, banks are not likely to rack up the kind of earnings they did before the crisis hit, he said. But they will still make respectable returns and be less risky. “We would see this as a positive catalyst,” Mr. Peace said of the Basel III rules.

Many bankers seem resigned to slightly more modest but steadier profits in the future, and some even sound like they welcome the prospect.

“For sure the returns on equity we were talking about a few years ago are not any more a reality,” Alessandro Profumo, chief executive of UniCredit, the Italian bank, said in Frankfurt this past week. “In my opinion there will be less volatility in the results.”

The central issue before the regulators in Basel is how much low-risk capital banks should be required to keep in reserve, and what qualifies as low-risk capital.

Under current rules, banks might hold so-called core Tier 1 capital, the most bulletproof category of reserves, equal to as little as 2 percent of their assets. Analysts at Morgan Stanley expect the regulators to raise the required amount to about 8 percent.

“Uncertainty" worse than "the measures.”

In addition, during boom times regulators could oblige banks to raise their reserves an additional 3 percent, to a total of about 11 percent, as protection against a sudden market collapse. According to other estimates, banks might even be required to set aside as much as 16 percent in boom times.

Much hinges on what banks will be allowed to count as core Tier 1 capital. Indications are that regulators will only allow equity — common shares in the institution — and earnings that banks retain rather than paying out to shareholders.

That narrow definition would be bad news for Germany’s public-sector Landesbanks, which have been vocal in opposing too-stringent requirements. Some of the Landesbanks have bolstered their reserves with government bailout money that might no longer qualify as core Tier 1 capital.

There is also fierce debate about another key number, the leverage ratio. Core Tier 1 is calculated as a percentage of risk-weighted assets, or assets adjusted according to how risky a bank’s portfolio is. U.S. government bonds are low-risk assets, for example, while car loans would be higher risk.

The minimum leverage ratio, probably 3 percent, would apply to all the money that banks have at risk. That basic requirement would serve as insurance against the possibility that banks try to game the rules for calculating risk-weighted assets. The leverage ratio would also offer protection against the chance that markets suddenly lose faith in an asset once considered low risk, as occurred with Greek government bonds.

Such a low minimum leverage ratio would be fiercely opposed by some in the banking industry as arbitrary. But, said Morgan Stanley in a report Friday, more certainty about the future shape of regulations might encourage some banks in the United States, Canada and Europe to start paying dividends again.

Said Ms. Diron at Ernst & Young, “I think the uncertainty is more damaging than the actual content of the measures.”