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EU Faces Basel Bank Capital Scrutiny as Regulators Police Rules

European Union bank-capital rules, already criticized by global regulators, face another international probe just months after they start to take effect next year.

The Basel Committee on Banking Supervision will review how well the EU has applied its standards, Wayne Byres, the group’s secretary general, said in an interview. An earlier investigation, based on a draft version of the EU plans, pointed to loopholes and triggered a rebuttal from Michel Barnier, the bloc’s financial services chief.

The EU emerged bruised from last year’s process that cast doubt on its claims to be fully in line with a global pact to beef up banks’ defenses to avoid a repeat of the 2008 financial crisis. While the Basel group has also indicated that the U.S. will face a follow-up review, the chances that the EU will be judged non-compliant are much higher, said Karen Shaw Petrou, managing partner of Washington-based research firm Federal Financial Analytics Inc.

“The EU will fare far less well under Basel scrutiny because of the tremendous flexibility afforded banks” in measuring their capital requirements, Petrou said by e-mail.

The EU is set to phase in its version of the Basel accord starting in January, and the rules will fully apply as of 2019. Basel III requires banks to hold capital equivalent to at least 7 percent of their risk weighted assets, while also meeting an indebtedness limit and liquidity requirements.

Basel Scorecard

In last year’s scorecard, published in October, the committee concluded that the EU’s proposals lacked detail on what can count as core capital and also said lenders were given too much scope to label government debt as risk free, and so escape holding capital against it.

The future impact of Basel rules on EU lenders was underscored by data published by the European Banking Authority in March. It said EU banks would have needed an extra 112.4 billion euros ($149 billion) in their core reserves to meet the Basel bank capital rules had the standards been enforced in mid-2012.

“The reviews usually take a good six months, so I would not expect it to be completed and published before the middle of 2014,” Byres said. Regulators will follow “essentially the same process” as in last year’s exercise, with the EU first doing a self-assessment, and then a team of non-European supervisors carrying out their own reviews, he said.

‘Corrosive Forces’

The reviews are carried out by teams of regulators, who make on-site visits to government agencies and gather data from banks. Stefan Ingves, the Basel committee’s chairman, has said that the process is needed to tackle “the corrosive forces of short memories and supervisory complacency.”

The Basel committee, which brings together regulators from 27 nations including the U.S., U.K. and China, has said that it will carry out peer reviews into how all its members adopt Basel III, in order to flag potential divergencies from the international plans.

Of the reviews completed so far, the committee has found Japan, Singapore and Switzerland’s measures to be in general compliance with the Basel standards.

“In all jurisdictions, you can find lots of areas where particular words aren’t identical,” Byres said. “What’s relevant is actually whether the words make any difference in practice. That is, how material the differences are, in the sense of whether they can lead to materially different capital outcomes.”

The review of the EU can start once the EBA completes work on some technical standards needed to flesh out the bloc’s rules, he said.

Dodd-Frank

The Basel committee’s concerns last year about the U.S. centered on provisions in its Dodd-Frank law banning the use of credit ratings to determine capital needs. Its warnings for the EU were more varied.

The U.S. approach will probably be accepted by the Basel committee “as part of overall global efforts to limit reliance on credit ratings,” Petrou said.

While the Basel committee has no legal power to enforce adherence to its rules, a non-compliance decision may harm the EU’s standing with other regulators, Nicolas Veron, fellow at the Brussels-based Bruegel research group, said in a telephone interview. “In these global bodies, compliance is influence,” he said.

Sharp Contract

The EU measures were published last month, after a deal on the final version of the law was hammered out by EU Parliament lawmakers and governments in more than eight months of talks.

“My expectation is that the review will draw a sharp contrast between the EU on the one hand, and the rest of the systemically important jurisdictions including the U.S. on the other,” Veron said. “The Europeans haven’t put forward any compelling arguments” to defend their approach.

Barnier said last year’s Basel review exercise wasn’t “supported by rigorous evidence and a well-defined methodology,” There is a “lack of consistency” in how different jurisdictions have been reviewed, Barnier said at the time.

The former French government minister has insisted that the EU’s legislation respects Basel III’s level of ambition while making essential tweaks to adjust for local circumstances.

A spokesman for the European Commission didn’t have immediate comment on next year’s exam.

The rules “respect the balance and level of ambition of Basel III,” the EU authority said in a statement this month on its website. The fact the bloc is applying the rules to all 8,300 of its banks, not just the internationally active lenders targeted by the Basel committee, along with the need to respect existing “laws or arrangements,” necessitated some adjustments, it said.

The Basel group “can admonish, but it can’t sanction,” Petrou said. “The real discipline comes from whether other nations accept EU rules, with the U.S. so far standing firm against doing so for foreign banks doing business here.”

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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