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Biggest Banks Face Tougher Basel Rule on Risk Concentration

Bank of England Governor Mark Carney, who chairs the FSB, said this month that “further intense work” is needed on rules for too-big-to-fail banks. Photographer: Simon Dawson/Bloomberg
Bank of England Governor Mark Carney, who chairs the FSB, said this month that “further intense work” is needed on rules for too-big-to-fail banks. Photographer: Simon Dawson/Bloomberg

Banks identified as systemically important to the global economy face tighter rules on how much business they can do with each other as part of a push to limit the chance a single failure would drag down multiple lenders.

The Basel Committee on Banking Supervision published rules that from 2019 will cap one too-big-to-fail bank’s financial dealings with another at an amount no greater than 15 percent of its capital. The measures also refine an existing rule capping the amount of business that a bank can do with a single counterparty at no more than 25 percent of its capital.

Such limits “can directly contribute toward the reduction of system-wide contagion risk,” the Basel group said in a statement on its website. The tougher rules are needed to protect banks from “traumatic losses caused by the sudden default of an individual counterparty or group of connected counterparties.”

The Basel group’s overhaul of its so-called large-exposure rules are part of regulatory measures to address the risks posed by the largest banks. The Financial Stability Board has drawn up a list of 29 lenders including HSBC Holdings Plc, JPMorgan Chase and Co. and Barclays Plc that face higher capital requirements because of the risk their failure poses to the global economy.

Bank of England Governor Mark Carney, who chairs the FSB, said this month that “further intense work” is needed on rules for too-big-to-fail banks.

The Basel rule covers loans, some derivatives trades and securities-financing transactions. Exemptions to the measure will apply for intraday-interbank lending, and banks’ purchases of sovereign bonds.

Tighter Definition

Banks have opposed such rules in the past. Goldman Sachs Group Inc. said a concentration limit proposed by the Federal Reserve could cut U.S. economic growth by as much as 0.4 percentage point and eliminate as many as 300,000 jobs in a 2012 letter to the U.S. central bank.

The bank joined rivals including JPMorgan Chase & Co., Citigroup Inc. and Morgan Stanley in opposing the draft U.S. rule that would limit financial firms with at least $500 billion in assets from having credit risk to any other exceeding 10 percent of its regulatory capital plus excess loan-loss reserves. That limit is stricter than a 25 percent limit that’s applied more broadly to banks in the Dodd-Frank financial-overhaul law.

Today’s Basel measures retain a general 25 percent rule limiting banks’ risk concentration, while fleshing out how it should be applied, and toughening the standard by tightening the definition of capital.

‘Material Differences’

The update is needed to address “a considerable variation of practice” among different regulators, the Basel group said.

The committee’s assessment “revealed material differences in important aspects,” including definition of capital “and whether certain types of exposures were subject to more lenient treatments,” the group said.

“It’s another positive development for financial stability; however, Europe’s banking system remains still entangled in a web of cross-holdings,” said Alberto Gallo, head of European macro-credit research at Royal Bank of Scotland Group Plc in London. “According to European Central Bank data, over 50 percent of debt from European banks is in the hands of other banks and equity cross-holdings are also strong.”

Intraday-interbank lending won’t be covered by the rule “to avoid disturbing the payment and settlement processes,” the Basel group said.

Special Treatment

The committee is weighing whether special treatment is needed for “a limited range” of other types of interbank transactions to avoid “adverse consequences for the implementation of monetary policy.” It is also assessing what, if any, concentration risk limits should apply to banks’ dealings with clearinghouses.

Under the Basel measures published today, clearing activities with platforms that meet international standards would be exempt from the 25 percent limit.

The group said it will conclude these reviews by 2016.

“Concentration risk goes beyond exposure to a particular institution or group of institutions,” Richard Reid, a research fellow for finance and regulation at the University of Dundee in Scotland, said in an e-mail. “Matters such as sector exposures or geographical focus are largely unaddressed in these measures and from a stability perspective these may be of equal importance.”

Draft Proposals

The Basel committee brings together regulators from 27 nations, including the U.S., U.K. and China, to coordinate rules for banks.

The Basel plans go less far in some respects than draft proposals that the group published last year.

The group at that time suggested that the limit on financial dealings between two globally systemic banks could be set as low as 10 percent of capital, compared with 15 percent in the final rule.

The draft plans also included the possibility of using a tougher definition of capital than than applied in the final standard.

Other differences compared with those proposals include adjustments to recognize “particular features of some covered bonds,” the Basel group said.

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