Thursday, April 17, 2008

Banks face closer scrutiny

(FT) The world’s top banking regulators moved to tighten the screw on the industry on Wednesday with new rules aimed at preventing a repeat of the crisis that has rocked the financial system.

The proposals from the Basel Committee on Banking Supervision, which sets global standards for banking regulation, underline the determination to press ahead with specific measures quickly in the aftermath of the credit turmoil, which has exposed glaring weaknesses in the global regulatory structure. “There is huge political pressure to be seen to do something – there has to be action,” said one senior US policymaker.

The proposals were published only days after the Financial Stability Forum – the body charged with co-ordinating the response to the credit crisis – set out a detailed blueprint to strengthen the global system.

The Basel committee’s plans, which will be implemented by national regulators, will require banks to set aside more capital against complex structured products and off-balance sheet vehicles – two of the main sources of stress in recent months.

The proposed changes are likely to add to the pressure on banks to boost their reserves, making them less profitable but also less risky. “We expect banks will want to raise capital sooner rather than later at the risk of being at the back of the queue, even if the rules will not be implemented straight away,” analysts at Royal Bank of Scotland wrote in a note.

However, the Basel committee acknowledged that pushing through the changes too quickly could add to problems for banks scrambling to strengthen their reserves and reduce lending.

The move comes as accounting standard-setters are considering proposals to improve transparency in banks’ accounts by requiring lenders to disclose their off-balance sheet interests in an unusually strict form.

In an interview with the Financial Times, Sir David Tweedie, chairman of the International Accounting Standards Board, suggested that accounts could be changed to force banks to provide detailed listings of each vehicle – even those where they have no official legal ties.

The Basel committee’s plans represent an effort to build on the Basel II framework, which was formally adopted by many of the world’s banks in January after almost a decade of preparations.

“Supervisors cannot predict the next crisis, but they can carry forward the lessons from recent events to promote a more resilient banking system that can weather shocks,” said Nout Wellink, chairman of the Basel committee.

The turmoil, which has led to billions of dollars of losses at large banks and triggered the failure of several smaller lenders, has prompted some politicians and policymakers to call for Basel II to be replaced.

But observers said it made more sense to tackle Basel II’s shortcomings while maintaining its foundations. “It would be completely wrong to rethink the framework,” said Patricia Jackson, head of the prudential advisory practice at Ernst & Young. “If the framework had been in place before the crisis we would have had a stronger system.”

The changes are likely to limit the complex techniques banks use in an effort to transfer risks.

Separately, some officials at the IMF are floating the idea of limiting the entities that can deal with credit default swaps while Gary Stern, president of the Minneapolis Federal Reserve, has argued that supervisors should be given authority to stop institutions outside the safety net from building up positions that create systemic interconnectedness.

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