Basel to Curb Bank-Capital Boosts on Derivatives Writedowns

Global regulators are seeking to curb banks’ use of an accounting rule allowing lenders to boost their profits and capital by writing down the value of their own debt and derivatives when market prices fall.

The rule, known as debt or debit-valuation adjustment, says that banks can book financial gains when the value of their own bonds and derivatives falls, under the theory that a profit would be realized if the liabilities were repurchased at a discount.

Banks shouldn’t be able to count such gains toward their capital reserves, the Basel Committee on Banking Supervision said in a statement published on its website. The committee is seeking “full deduction” of debit-valuation adjustments from lenders’ core reserves, including that arising from derivatives.

Citigroup Inc. (C), JPMorgan Chase & Co. (JPM), and Morgan Stanley (MS) each booked more than $1.5 billion of gains from DVA in the third quarter as bank credit spreads widened. Morgan Stanley Chief Executive Officer James Gorman has described his firm’s $3.4 billion gain from the accounting rule as a “bizarre accounting anomaly.”

Global regulators agreed last year to more than triple the core capital that lenders must hold to guard against insolvency and also to force them to stockpile easily sellable assets to survive a short-term funding squeeze. They will be expected to have core capital equivalent to seven percent of their assets, weighted according to their riskiness, by 2019.

Under Basel rules, a bank’s core capital consists mainly of retained earnings and ordinary shares. The Basel committee will seek views on its decision until Feb. 17, it said.

Falling Bank Stocks

The Standard & Poor’s 500 Financials Index (S5FINL) has fallen 20 percent this year, led by Bank of America’s 61 percent plunge. Goldman Sachs, Morgan Stanley and Citigroup have all fallen at least 45 percent, while JPMorgan has dropped 24 percent.

The Basel committee is seeking to avoid “an increase in a bank’s capital when its own creditworthiness deteriorates, which would otherwise undermine the quality of capital and the protection it provides to depositors and senior creditors,” the group said.

Lenders including HSBC Holdings Plc (HSBA), Citigroup and BNP Paribas (BNP) SA have warned that plans by the Basel committee to impose additional capital surcharges on systemically important lenders could force them to cut loans to businesses and support to international trade.

To contact the reporter on this story: Jim Brunsden in Brussels at jbrunsden@bloomberg.net

To contact the editor responsible for this story: Anthony Aarons at aaarons@bloomberg.net

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