Basel Committee Nears Agreement on Capital Definition

Jean-Claude Trichet, president of the European Central Bank
Jean-Claude Trichet, president of the European Central Bank, pauses during a news conference at the bank's headquarters. Photographer: Hannelore Foerster/Bloomberg

The Basel Committee on Banking Supervision, nearing agreement on how to redefine capital and when to impose borrowing caps on banks worldwide, has left a final decision to its governing board, which meets next week.

The committee, a body of regulators and central bankers from 27 countries that sets capital standards, narrowed differences about how to count minority stakes in other financial institutions, deferred tax assets and mortgage- servicing rights, according to people with knowledge of the discussions that took place in Basel, Switzerland, last week.

It plans to present to its governing board two or three choices on how much of each of these items should be deducted from a bank’s capital, the people said. The board, which is made up of central bank governors and heads of supervisory agencies, will also decide on a time frame for making the leverage ratio binding on banks, they said.

“Before the committee makes big decisions, they’d like to run it through the board,” said Barbara Matthews, who used to lobby the committee on behalf of banks and now follows it as managing director of BCM International Regulatory Analytics LLC in Washington. “These issues are so contentious that it’s not surprising the board is summoned at this point. Something concrete will come out of the meeting next week.”

German Credit

Germany is trying to make sure that the revised rules don’t suffocate its regional savings and cooperative banks, which are at the heart of lending to small businesses, said the country’s deputy finance minister, Steffen Kampeter. Tightening the definition of capital could force these banks to raise capital, which may hurt the availability of credit in Germany, Kampeter said in an interview in New York today.

“We’re studying to see how Basel III might impact these banks,” Kampeter said. “If we destroy these two pillars of our financial system, we’ll destroy economic growth. That’s our concern.”

France and Germany have led efforts to soften the rules proposed by the committee in December, concerned that their banks and economies won’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. The U.S., Switzerland and the U.K. have resisted those efforts.

The proposals to be presented to the board when it convenes on July 26 will reflect these pressures, giving some concessions to banks, the people said. The differences have prevented the committee from agreeing on some issues, such as capital ratios. The board won’t be settling those next week, members said.

Overlapping Membership

In theory, the board includes central bankers and heads of regulatory agencies, while deputies or division heads often attend quarterly Basel committee meetings. In practice, the memberships of the two groups sometimes overlap.

Two U.S. representatives, Sheila Bair, chairman of the Federal Deposit Insurance Corp., and John Dugan, comptroller of the currency, attended the committee sessions last week and plan to be present at the board meeting next week, spokesmen for the two agencies said.

Federal Reserve Chairman Ben S. Bernanke and Bank of England Governor Mervyn King, who weren’t in Basel for the committee meeting last week, plan to be there next week, according to spokesmen for the central banks. European Central Bank President Jean-Claude Trichet chairs the board.

Minority Interests

The Basel committee, asked by Group of 20 leaders to draft rules after the worst financial crisis in 70 years, proposed excluding certain assets when calculating the most important category of bank capital, the cushion that’s supposed to protect against sudden losses.

European banks have lobbied against the proposed exclusion of minority interests that banks hold in other financial institutions. Japan has 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. has opposed removing mortgage-servicing rights, contracts to collect payments, which are unique to U.S. banks.

The committee will let the board choose among varying degrees of exclusion, softening its initial stance, according to three people with knowledge of the talks. The board might also decide to leave the deferred-tax-asset exclusion intact, while giving banks five years or more to comply, they said.

‘Similar Standards’

“Initially, Basel wasn’t about identical standards, but about similar standards,” said V. Gerard Comizio, a former Treasury Department lawyer who is now a senior partner at Paul, Hastings, Janofsky & Walker LLP in Washington. “But as it has gained credibility and acceptance worldwide, it has become more specific and is demanding more compliance. That makes it tougher to reach consensus.”

The committee also asked the board to decide when to require that banks cap their leverage by setting a ratio of assets to capital, according to committee members.

While current Basel rules allow banks to assign weights to assets based on their risks, the leverage ratio would look at all assets without a risk assessment.

Progress on the issue has come a long way since it was advocated by the FDIC’s Bair at a committee meeting in Merida, Mexico, in 2006. U.S. banks already face such a cap under national laws, and Bair’s proposal to expand the concept globally was met with almost unanimous opposition at the time.

Last week in Basel, committee Chairman Nout Wellink, who is also president of the Dutch central bank, reminded members of Bair’s speech in Merida, acknowledging the change of attitude toward a leverage ratio since then, according to one of the participants.

Leverage Ratio

As envisioned in the December proposal, the leverage ratio initially will be used to provide guidance to national regulators in their assessments of banks’ soundness. Only later would it become a requirement.

The committee plans to announce its rules by the time G-20 leaders gather in Seoul in November.

Wellink last week said the group was “fully on track” to finish its work by then. Final versions of some rules, including liquidity requirements for how much cash and cashable securities banks need to hold against their longer-term liabilities, may not be agreed upon before then, four committee members have said. Issues that can’t be resolved by the Basel committee may be settled by the G-20 leaders in November, members say.

The committee also issued a new proposal last week that would help regulators determine the need for and the size of a buffer above the minimum capital requirement. The formula, based on how much credit is extended in a country in relation to its gross domestic product, builds on the concept of a counter-cyclical capital buffer introduced in December.

Under the plan, banks would be forced to cut dividends if their capital falls below that level as a way of keeping them from lowering capital in good times.

The banks have until Sept. 10 to submit responses to the buffer proposal. While the committee aims to include the final version of the rule in its November package, debate might drag on until next year, some members said.