Central bankers and regulators adopted “new standards” for the global financial industry in a step to prevent a repeat of the worst economic crisis since the Great Depression.
The panel that oversees the Basel Committee on Banking Supervision, meeting after the Group of 20 nations sought to extend their reach into banks’ pay and profits, yesterday agreed lenders should raise the quality of their capital by including more stock. Financial firms also will have to introduce a leverage ratio and devise ways to boost reserves when the economy is robust.
The drive to revamp regulation comes after excessive risk- taking by the world’s banks led to $1.61 trillion in losses and writedowns, taxpayer-funded bailouts and a global recession. Meeting less than three weeks before a Pittsburgh summit of their leaders, G-20 finance chiefs on Sept. 5 united on a plan to have banks rein in compensation and hold more capital.
“The agreements reached today among 27 major countries of the world are essential as they set the new standards for banking regulation and supervision,” European Central Bank President Jean-Claude Trichet, who leads the oversight panel, said in a statement released yesterday by the Basel, Switzerland-based Bank for International Settlements, the bank for central banks.
The Basel statement builds on G-20 efforts started after the collapse of the U.S. housing market and the bankruptcy of Lehman Brothers Holdings Inc. a year ago. Finance ministers and central bankers from the G-20 concluded talks in London Sept. 5 proposing the “clawback” of cash awards and tying banker compensation to long-term performance. Banks will also have to raise the amount and quality of the assets they keep in reserve and curb leverage, they said.
Under the standard devised in Basel, banks will need to raise the quality of their so-called Tier 1 capital base, which measures a bank’s ability to absorb sudden losses, the group said. The majority of such reserves should be common shares and retained earnings and the holdings will be fully disclosed, it said.
Financial companies also will be required to introduce a leverage ratio, which gauges a bank’s share of equity to assets, in addition to rules they are already must meet under the Basel II banking code. The new ratio will be adopted internationally.
The Basel group, keen to avoid banks again taking on too much risk even in economic expansions, said a framework would be introduced to ensure minimum capital buffers exist for when slumps occur. Such a requirement will limit a bank’s distribution of capital through dividends.
Federal Deposit Insurance Corp. Chairman Sheila Bair last week said existing bank capital requirements don’t consider the stage of the economic cycle in which banks operate. Writing in the Bank of France’s “Financial Stability Review,” Bair said regulators should adopt counter-cyclical capital policies.
“Financial institutions could be required to limit dividends in profitable times to build capital above regulatory minimums, or build some type of regulatory capital buffer to cover estimated through-the-cycle credit losses,” Bair wrote in the article.
The Basel committee will issue proposals by the end of this year then will assess the rules before calibrating them by 2011, the statement said. The new standards will be phased in to ensure they don’t impede the economic recovery, the group said.
“These measures will result over time in higher capital and liquidity requirements and less leverage in the banking system,” said Nout Wellink, the head of the Dutch Central Bank and chairman of the Basel committee.
To smooth the transition to the new rules, the committee said regulators should push banks to boost capital by conserving earnings, limiting excessive dividend payments, buybacks and compensation. Pay and bonuses should be tied to prudent risk taking and banks’ long-term performance, it said.
Banks will have to move “expeditiously” to improve their capital bases, but with an eye on ensuring the world’s financial system and economy is not undermined, the statement said.