Thursday, May 7, 2009

Tougher capital rules on risky bank products

Posted in the Financial Times by Nikki Tait:

Banks will have to set aside more capital to cover risky products after European lawmakers approved a package of measures to toughen capital rules and prevent a repeat of the current financial crisis.

The bank capital rules will force institutions to retain at least 5 per cent of the securitised products that they originate and sell to give them a direct interest in assessing the products’ riskiness.

They are the latest in a series of regulatory steps taken by EU authorities as they address weaknesses in the financial system that have been exposed by the recent market turmoil.

Lawmakers have already passed legislation to regulate credit rating agencies, for example, and pushed for centralised clearing of credit default swaps. More proposals – including controversial hedge fund regulations – are in the pipeline.

The European parliament’s backing for the new banking rules, which also tighten definitions of core capital and limit the amount of short-term exposure banks can have to one another, was overwhelming – 454 votes to 106.

Originally, the European Commission considered setting a higher retention level for securitised products – prompting an outcry from the financial industry – and in the legislation’s later stages left-leaning lawmakers again tried to push for a higher figure.

But others agreed that this could slow the recovery in lending activity. “Proposals for an increase to 10 per cent or more retention would have inhibited restoration of lending and so would have ended up hurting all borrowers,” said Sharon Bowles, a British Liberal Democrat MEP.

Rick Watson, managing director of the European Securities Forum, which is affiliated to the Securities Industry and Financial Markets Association, said he believed the industry would be relieved the issue had been resolved. “The market needs stability,” he said.

Privately, banks say they can live with the 5 per cent retention requirement.

The rules also require colleges of supervisors to be established for cross-border financial institutions, so facilitating co-operation between national authorities, and tighter caps on banks’ largest exposures, including loans to each other. They also call for the Commission to bring forward legislative proposals to make the market in derivatives that are not traded through exchanges more transparent, and to establish centralised clearing to make these instruments less risky.

National governments will have until October next year to implement the legislation – which has already been agreed with the Commission and member states – at domestic level and the new regime will come into force from the end of 2010.

The legislation’s approval comes a day after the International Organisation of Securities Commissions, which draws together all the main national securities regulators, suggested that originators retain a long-term economic exposure to their securitised products.

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