Oct. 26 (Bloomberg) -- European Central Bank governing council member Christian Noyer said banks need to keep up reforms and shore up their capital base, recommending restraint in dividend distributions and compensation.

Efforts to strengthen the regulation and capital of the global financial industry remains a priority and must be maintained even as banks report “impressive quarterly profits,” Noyer, 59, said in a speech in Singapore today.

“It is striking that these performances were achieved only a few months after some of those same institutions came very close to failure,” Noyer said. “This might give the impression that the financial sector has recovered its balance and that no further reforms are necessary. Nothing could be further from the truth.”

The credit-market meltdown that led to a financial crisis has caused more than $1.6 trillion in losses and writedowns worldwide. European Union finance chiefs earlier this month said stress tests on 22 major European cross-border banking groups showed they are sufficiently capitalized.

“One major risk in the period to come is the emergence of a ‘business-as-usual’ mentality,” Noyer said. “Once the immediate dangers have receded, the incentives to reform may become weaker and the opposition stronger. It is essential that we keep up the momentum.”

U.S. regulators this year closed more than 100 banks in a single year for the first time since 1992, signaling the financial crisis hasn’t abated for lenders struggling with mounting losses tied to commercial real estate. China’s banking regulator ordered stress tests for commercial banks on a quarterly basis to prevent possible future liquidity crises, the China Securities Journal reported Oct. 23.

Bank Profits

Lenders’ profits should be kept in the banking system and be used to finance the flow of credit, said Noyer, who is the governor of the Bank of France.

“In the immediate future, priority should be given to capital conservation,” Noyer said. “Most of the current banking profits are by-products of public policy and there is a good case for requesting that they should be kept inside the banking system and used to strengthen balance sheets and finance credit to the economy.”

Noyer said there shouldn’t be “black holes” in financial regulation and that all participants in the financial sector should be properly regulated and supervised.

“Our economies need more robust and better capitalized banks,” he said. “They need stronger and robust risk management and better governance in all parts of the financial industry. They need increased oversight and stronger supervision of systemically important institutions.”

‘Out of Line’

Wall Street bonuses for 2009 may jump 40 percent to $26 billion, a year after bad bets on subprime mortgages sent financial firms to the government for bailouts, according to estimates by compensation consultant Johnson Associates Inc.

“There are signs that parts of the financial industry have resumed risk-taking practices, reminiscent of those which led to the crisis,” he said. “This impression may be reinforced by compensation packages,” which may appear “out of line” with the underlying performance of the industry.

The Obama administration’s special master for executive compensation, Kenneth Feinberg, said last week he slashed pay at firms including Citigroup Inc., Bank of America Corp. and insurer American International Group Inc., all of which obtained “exceptional” aid from the Treasury’s $700 billion bailout. The cash salary reductions averaged 90 percent and total compensation was cut 50 percent.

Conserving capital “would require some restraint in dividend distribution and, or course, in the overall amount of variable compensation,” Noyer said. “In parallel, all possibilities to issue new equity should be exploited.”

Many downside risks to the world economy exist and adverse scenarios may still materialize, he said.

“Bank credit to the business sector is faltering, especially for small and medium-sized companies, and most of the negative effects of the economic downturn on balance sheets are still to come,” he said.

To contact the reporter on this story: Joyce Koh in Singapore at jkoh38@bloomberg.net; Shamim Adam in Singapore at sadam2@bloomberg.net

Last Updated: October 25, 2009 23:46 EDT