Banks Must Hold Capital for Sovereign Risk, EU Lawmaker Says

Banks should be forced to hold reserves to guard against possible losses on sovereign debt, according to a lawmaker overseeing Europe’s implementation of Basel capital rules.

The region’s fiscal crisis, which has involved bailouts of Greece, Portugal and Ireland has shown that a zero capital requirement for sovereign debt “no longer corresponds with economic reality,” said Othmar Karas, an Austrian member of the European Parliament, in a draft report published on the EU assembly’s website.

His demand echoes international calls to toughen rules that allow lenders to apply zero risk-weightings to government bonds issued in a bank’s home currency when calculating capital ratios. Lenders don’t need to hold any capital against possible losses on the securities, even after the cost of insuring government bonds against default rose to a record last year.

The European approach “is not in line with the spirit” of global measures endorsed by the Basel Committee on Banking Supervision, Herve Hannoun, deputy general manager of the Bank for International Settlements, said in October. The U.S. “situation regarding the treatment of sovereign risk is also unsatisfactory,” he said. The BIS is the Basel committee’s parent institution.

Banker-Pay Curbs

Karas is in charge of drafting the parliament’s opinion on last year’s proposals by the European Commission to implement the Basel capital and liquidity measures in the EU. The lawmaker’s office in Brussels didn’t respond to a call seeking comment on the plan.

The EU should also consider an “absolute cap” on the difference between top salaries and average pay at lenders, Karas said. Bank pay policies must be “aligned with the long term interest of an institution.”

The EU set rules on banker pay as part of a previous overhaul of the region’s capital rules that was adopted in 2010.

The commission, the EU’s executive arm, didn’t propose to scrap the zero risk weighting for government bonds.

The regulator should set out options for scrapping the zero weighting “as soon as possible, while taking into account potentially destabilizing effects” of making such proposals “during periods of market stress,” Karas said in his report.

The parliament and the region’s governments must agree on the final shape of the law to implement Basel rules in the EU before it can take effect.

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