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Banks Laud Basel Compromise on Capital Rules as Stocks Surge

Photographer: Daniel Acker/Bloomberg

Institute of International Finance managing director Charles Dallara. Close

Institute of International Finance managing director Charles Dallara.

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Photographer: Daniel Acker/Bloomberg

Institute of International Finance managing director Charles Dallara.

Banks worldwide applauded changes to proposed capital and liquidity standards that relaxed aspects of the rules and gave lenders as much as eight years to comply.

Lobbying groups in Europe and the U.S. praised the changes announced July 26 by the Basel Committee on Banking Supervision as steps in the right direction, while firms including Deutsche Bank AG and UBS AG welcomed the softening of rules proposed by the committee in December. European and Japanese bank stocks surged.

“To a large extent, the committee has taken into account the concerns of the industry,” said Charles Dallara, managing director of the Washington-based Institute of International Finance, which represents more than 375 companies around the world. “It’s too early to reach a firm conclusion because they still haven’t finalized many issues, but the announcement included a series of important clarifications.”

The Basel committee agreed to continue allowing some assets, including banks’ minority stakes in other financial firms, to count in part as capital, reversing its initial stance to ban their use all together. It also expanded the definition of what counts as liquid assets and gave banks until 2018 to comply with a new leverage ratio designed to rein in risk- taking. A long-term liquidity ratio that analysts estimated would have forced banks to sell more than $4 trillion of debt also won’t be imposed for eight years.

‘Generally Positive’

“Most of the concessions that have been made would be generally positive for us,” said John Cryan, chief financial officer of Zurich-based UBS, in a conference call with analysts yesterday after the bank announced second-quarter earnings exceeding analysts’ estimates.

That view was echoed by Stefan Krause, CFO of Frankfurt- based Deutsche Bank, Germany’s largest lender.

“We welcome the changes announced,” Krause said in a conference call. “And obviously there are some further changes we hope we still get where we have some different view.”

French banks and UBS are among the biggest beneficiaries of the changes, Credit Suisse Group AG analysts said in a note. Credit Agricole SA now has enough time to replenish capital through earnings retention to meet tougher liquidity and capital requirements, Morgan Stanley analysts said.

“Whilst we have been assuming delay and dilute in our base case, this confirmation helps provide a more helpful backdrop for European banks, which were in our view most challenged by the opening bid by Basel,” Morgan Stanley’s Huw van Steenis said in a report.

Bank Stocks Higher

European bank stocks rose for a second day, with Portugal’s Banco Espirito Santo and Dankse Bank A/S leading the Bloomberg Europe Banks and Financial Services Index higher today. The 54- member index was up 1.2 percent at 122.53 at 10:15 a.m. in London. The benchmark jumped 4.5 percent yesterday, the biggest gain since European leaders crafted a 750 billion-euro ($973 billion) rescue package on May 10.

“A substantial Basel u-turn greatly reduces future capital and funding needs,” London-based analysts at Evolution Securities Ltd. including Arturo De Frias Marques wrote in a report today. “This could be the turning point for many fund managers to finally consider rebuilding their banks positions.”

U.S. bank stocks hardly budged. The KBW Bank Index rose 0.4 percent to 49.39 in New York yesterday. U.S. banks have been forced by their regulators to raise capital since the 2008 credit crisis brought many to the brink of collapse and wouldn’t be impacted as much as European lenders.

Bank Lobbying

The Basel committee, which represents central banks and regulators in 27 nations and sets capital standards for banks worldwide, was asked by Group of 20 leaders to draft rules after the worst financial crisis in 70 years.

France and Germany led efforts to weaken regulations proposed by the committee last year, concerned that their banks and economies wouldn’t be able to bear the burden of tougher capital requirements until a recovery takes hold, according to bankers, regulators and lobbyists involved in the talks.

European banks lobbied against the proposed exclusion of minority interests that banks hold in other financial institutions. Japan fought the hardest against the elimination of deferred-tax assets, past losses that lenders use to offset tax charges in future years. The U.S. opposed removing mortgage- servicing rights, contracts to collect payments, which are unique to U.S. banks.

‘Need for Pragmatism’

The compromise, announced after a meeting of the group of governors and heads of supervision that oversees the committee’s work, would allow a bank to count part of a stake it owns in another financial firm in relation to the risk the capital is supposed to cover at the entity in which it invested. Deferred- tax assets and mortgage-servicing rights would be included in capital up to a limit. The total for all three could not exceed 15 percent of a lender’s common equity.

“All the virtuous effects sought by regulators and governments seem to be working out,” said Pierre Flabbee, a Paris-based analyst at Kepler Capital Markets. Basel’s softened proposals are “the acknowledgment of the need for pragmatism compared to an ideal rule.”

Germany was a lone holdout, even after softening the rules. The definitions of capital and the leverage ratio are still not satisfactory, the German central bank said.

“Even after all the compromises, the banks aren’t off the hook from tighter capital and liquidity rules,” said Frederick Cannon, chief equity strategist at New York-based Keefe, Bruyette & Woods.

‘Still in Play’

While the announcement resolved several issues, many areas of contention, such as the actual minimum capital ratios that will be set, remain outstanding. The committee is planning to present a final package of reforms to the G-20 leaders meeting in Seoul in November.

Banks currently need to hold capital equal to a minimum of 8 percent of risk-weighted assets. Half of that must be Tier 1, and half of the Tier 1 needs to be common stock. Both Tier 1 and common-equity ratios will be increased, and the committee is revising how the risk weighting will be done.

“We’re still waiting for the numbers on capital,” said Mary Frances Monroe, a vice president of the American Bankers Association, a lobbying group based in Washington. “It’s still in play.”

‘Right Direction’

The changes are “definitely in the right direction,” Monroe said. The British Bankers’ Association, the British counterpart to Monroe’s group, said the nation’s banks “welcomed” the Basel announcement. “The committee has taken on board industry’s concerns about the capital proposals,” the BBA said in a statement.

The Basel committee said some of its proposals might not be completed by the end of this year, the deadline set by the G-20. Liquidity requirements for how much cash and easily cashable securities banks need to hold against their longer-term liabilities will take more time to work out, the board said. The same applies to counter-cyclical buffers, which would raise minimum capital requirements in times of faster economic growth.

While the capital ratios allow banks to assign weights to assets based on their risks, the new leverage figure considers all assets without a risk assessment. The committee initially set it at 3 percent -- meaning a bank’s total assets cannot be more than 33 times its Tier 1 capital, which includes securities that could help a lender cover unexpected losses.

Economic Growth

The new rule also defines how assets are tallied, so as to level the playing field between different accounting standards and bring off-balance-sheet items into the calculation. The ratio will be tested from 2013 until 2017, and banks would be required to start publishing their individual leverage figures in 2015.

Bankers including Deutsche Bank Chief Executive Officer Josef Ackermann and HSBC Holdings Plc Chairman Stephen Green have said that the new rules may force banks to reduce lending, potentially limiting economic growth

“The Basel committee is being very sensible in giving a sufficiently long transition period so as not to derail any economic recovery,” Charles Goodhart, a former Bank of England policy maker and professor at the London School of Economics, said in an interview.

Liquidity Rules

Like the leverage ratio, the liquidity rules are new to the Basel standards. The liquidity coverage ratio sets the amount of cash that needs to be held by a lender against any payment coming due within a month, while the net stable funding ratio considers liabilities up to 12 months.

The committee announced several modifications to the definition of liquid assets and of how to measure the safety of different types of funding. Government deposits will now be considered as stable as corporate cash put in a bank, instead of being treated like money from other banks as originally proposed. Bank deposits are seen as less secure.

The changes should please banks, said KBW’s Cannon.

“They compromised more on the short-term ratio than we were expecting,” Cannon said.

To contact the reporter on this story: Yalman Onaran in New York at yonaran@bloomberg.net.

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