Big Banks May Escape Capital Surcharge as Global Talks Founder

Chairman of the Federal Deposit Insurance Corp. Sheila Bair
Chairman of the Federal Deposit Insurance Corp. Sheila Bair, seen here, was among those pushing hardest inside the Basel committee for harsher capital requirements, members said. Photographer: Andrew Harrer/Bloomberg

Leaders of the world’s largest economies, divided over how to curb risk-taking by their biggest banks, will likely fail to agree on a capital surcharge.

Instead, the Financial Stability Board, which is weighing measures to prevent such institutions from causing another economic crisis, will recommend a range of options without setting a level of extra capital to be imposed globally, said members of the group who declined to be identified because the discussions are private. The FSB will meet in Seoul next week.

The fissures running through the group are similar to those that split the Basel Committee on Banking Supervision when it considered tighter capital requirements for all banks this year. Germany, France and Japan are resisting a surcharge for big lenders, as are lobbyists for those firms, while the U.K., U.S. and Switzerland advocate the approach, members say. That camp agreed to soften some of the Basel capital rules with the understanding that more would be done to restrain the largest banks through the FSB.

“The remaining issues surrounding too-big-to-fail banks are tougher than what has been resolved, so that highlights the differences between these two camps even more,” said Richard Spillenkothen, a former member of the Basel committee who is now a director at Deloitte & Touche LLP in Washington. “The U.K., U.S. and Switzerland had to provide huge amounts of money to support their biggest troubled institutions, so they’re under pressure at home to prevent that from happening again.”

Cross-Border Resolution

Global leaders pushed to revise banking regulations after the collapse of Lehman Brothers Holdings Inc. in 2008 and the bailouts of banks that had become too big to fail. The Basel committee didn’t resolve the issue, leaving the FSB to come up with a solution. Now countries such as Switzerland are taking unilateral action, proposing higher capital requirements for their largest banks.

Increasing divisions among regulators may also prevent the FSB from coming up with a mechanism for winding down a failed bank with global operations, members say. The group will lay out a possible framework for how each nation’s mechanism should be structured and encourage countries with the largest global banks to sign bilateral agreements to share information and cooperate during the shutting down of financial firms.

Last month the Basel committee agreed to triple the highest-quality capital banks need to hold and narrowed the definition of what counts as such capital. The agreement among the 27 member countries was achieved after the U.S., U.K. and Switzerland accepted a compromise to extend the implementation time frame to about a decade for most of the new rules.

Seoul Meeting

The FSB recommendations, which will be made to leaders of the Group of 20 nations meeting in Seoul next month, will likely include a study by each country on whether systemically important financial institutions, or SIFIs as Basel and FSB members refer to them, would need supplementary capital, according to two members.

It will also encourage the consideration of contingent capital, debt that automatically converts to stock under stressful conditions, and so-called bail-in instruments, where bondholders would take a pre-set loss when the lender collapses.

The FSB was set up by the G-20 last year to oversee the work of groups setting international standards. It replaced the Financial Stability Forum, a think tank with no formal role that was created in 1999 after the Asian financial crisis.

Contingent Capital

France, Japan and Germany are opposing capital surcharges for big lenders because they say their banking systems are different from those in the U.S., U.K. and Switzerland, where the largest blow-ups occurred during the crisis, members say. U.S. regulators have been skeptical of contingent and bail-in capital as alternatives to straightforward surcharges, arguing that they’re untested mechanisms that might not fulfill their intended purposes during the next crisis.

“We can’t rely on them yet,” Sheila Bair, chairman of the Federal Deposit Insurance Corp., said in a telephone interview last week. “There’s not much of a market for them. Triggering them could end up destabilizing the bank and the markets. We just got rid of TruPS because they did not provide loss absorption in the crisis. We could end up with the same problem with these new instruments.”

Trust preferred securities, or TruPS, are bonds accepted by regulators as capital because the borrowers could postpone interest payments to bondholders during a crisis without penalty. Yet banks were hesitant to do so, concerned that they would look weak. Those that did defer payments faced a run by creditors. U.S. financial regulations passed this year and new Basel rules discontinue their use as capital.

Bair’s Role

Bair, 56, was among those pushing hardest inside the Basel committee for harsher capital requirements, members said. She’s not a member of the FSB, which brings together about two-thirds of the institutions represented at Basel, finance ministers from those countries and global organizations such as the International Monetary Fund. While the U.S. is represented by five regulators on the Basel committee, only the Federal Reserve and the Treasury attend FSB meetings.

The FDIC chairman’s absence from the FSB has softened the U.S. delegation’s resolve, according to members who belong to both groups. Daniel Tarullo, 57, the Fed board member who attends FSB meetings, has a different style from Bair, preferring one-on-one dialogue with other participants, these people say. Tarullo declined a request for an interview.

Bair was invited to an FSB meeting last month to describe her agency’s work on the resolution mechanism being set up in the U.S., according to two people in attendance. The FSB recommendations on national resolution procedures will reflect the FDIC’s model to a great extent, members said. Bair said she’s satisfied with the group’s work on the matter.

Winding Down SIFIs

National mechanisms, without an international infrastructure tying them together, won’t be effective in winding down SIFIs that operate in dozens of countries, some analysts say. There’s little political will globally for such a framework because it would have to lay out clearly the burden-sharing by governments in case of a bank failure, according to two FSB members.

“You can’t have a resolution mechanism without the cross- border element,” said Jeffrey Taft, a partner at law firm Mayer Brown LLP in Washington. “This has proven hard to do for a long time because countries want their local creditors to be protected. But capital is so global that what they think as local creditors are many times based in other countries.”

Such ring-fencing by local courts occurred after the Lehman Brothers bankruptcy, pitting creditors in the U.S. against those in the U.K. and other countries.

Swiss Rules

The resolution mechanism and capital surcharge debates are intertwined as governments seek ways to reduce the burden on their taxpayers from the collapse of interconnected financial firms, Taft said.

Switzerland, which had to pump more than $6 billion into the rescue of UBS AG during the crisis, is already moving to impose a capital surcharge on its two largest lenders. A government-appointed panel recommended earlier this month that UBS and Credit Suisse Group AG, both based in Zurich, hold common equity equal to at least 10 percent of its assets weighted by their risk. That’s 3 percentage points higher than the new Basel minimum standard.

The panel also proposed that the two banks hold additional capital, an amount equal to 9 percent of assets, which it could meet through the use of contingent capital instruments. The plan has to be endorsed by the government and approved by parliament.

‘More Stringent’

The U.S. and U.K. may soon follow suit, analysts and regulators say. The financial reform passed by the U.S. Congress in July stipulates “more stringent” standards for SIFIs, which many expect to translate into a capital surcharge. The Bank of England has talked about the need for additional charges for the largest banks.

Banks are concerned such unilateral moves by individual nations will create uneven competitive pressures for operating in different locations and hurt the economic recovery.

“Arbitrary constraints on large firms will undermine their effectiveness in a globalized world to play their full roles as catalysts and intermediaries for global investment, trade expansion and growth,” Josef Ackermann, CEO of Deutsche Bank AG, the biggest German lender, said last week.

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