BIS Says Banks Need More Capital to Withstand Shocks (Update1)

Feb. 9 (Bloomberg) -- Capital requirements on banks aren’t sufficient to ensure financial stability and lenders should hold enough liquid assets to survive a temporary loss of access to funding, the head of the Bank for International Settlements said.

The capacity and incentives to take risks have “clearly overwhelmed” any improvements in risk management, Jaime Caruana wrote in a paper he delivered to a gathering of central bankers in Sydney today. Financial companies alone can’t keep underlying risks in check and will need help from regulators to prevent any system-wide threat, he said.

Regulators worldwide have been wrestling with plans to increase supervision of banks following the global financial crisis, in which credit markets shut down and policy makers were forced to bail out lenders. The Basel Committee on Banking Supervision proposed changes in December that would improve the quality and quantity of capital as well as bolster easily sellable assets that lenders should hold to meet short-term liquidity needs.

“Capital and liquidity buffers need to be built up in good times so that they can be drawn down in bad times,” Caruana said. “Banks should hold a sufficient stock of high-quality liquid assets to be able to survive a month-long loss of access to funding markets.”

Reforms to global financial regulations shouldn’t suppress market forces, Andrew Crocket, president of JPMorgan Chase International, told the Sydney meeting today.

‘Market Failure’

“What has been demonstrated by recent events is not that the market should be abandoned as an organizing principle for economic relations, but that the scope for market failure is wider than previously supposed,” Crockett said. “Reforms therefore need to deal with these sources of market failure, not to attempt to suppress market forces.”

The Basel Committee, which sets minimum standards for banks in 27 countries and territories, proposed in December that banks should keep assets that are simple to value and wouldn’t have to be sold at fire-sale discounts during times of stress.

Lenders should also increase the amount of equity and retained earnings they hold to help them cope with losses better, the Basel Committee said last year. Banks’ core capital should exclude stock with preferential dividend rights to reduce risks to the financial system, it said in a report.

‘Speed Limits’

“Capital requirements are the speed limits of banking,” Caruana said today. “Capital requirements should draw on deep pockets that can absorb losses. An idea worth exploring is whether those pockets might be usefully deepened by debt that is convertible to equity when times are bad.”

Reserve Bank of Australia Governor Glenn Stevens told the same gathering in Sydney today that there remains “considerable debate” about the role of monetary policy in responding to risks to financial stability.

The “potential instability of a well-developed boom means that for policy makers the least-harm policy is to make sure that their settings are not inadvertently fueling the build- up,” Stevens wrote in a paper he co-authored and delivered to today’s event.

While financial booms and busts are inherent in a market- based economic system, such instability shouldn’t be allowed to “burn itself out” as it will come with unacceptable costs, Caruana said.

“The answer is not to repress financial markets,” he said. “It is to recognize that markets need rules, constraints and careful monitoring so that failures are less frequent and less costly.”

Banking supervisors need to strengthen the so-called resolution regime mechanisms to ensure the failure of any important financial institution will be managed internationally, Caruana said.

“The Basel Committee has recommended that supervisors provide capital or other prudential incentives for banks to simplify group structures that are too complex to permit orderly and cost-effective resolution,” he said.

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