Europe's Capital Rules Miss the Mark: The Ticker

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By Jonathan Weil

European bank stocks fell today on the news that policy makers are considering whether to make the region's lenders hold greater amounts of regulatory capital. One big caveat: Regulatory capital should not be confused with the actual amount of capital banks have in real life.

The European Banking Authority last week discussed a possible 9 percent capital threshold for banks at a meeting of its supervisory board in London, Bloomberg News reported. Banks would need to have "core Tier 1 capital" equivalent to 9 percent of their so-called risk-weighted assets.

As I wrote in my column today, the French-Belgian lender Dexia SA reported having a 12.1 percent core Tier 1 capital ratio as of Dec. 31, the date the banking authority used for its latest stress tests. So, Dexia would have had no trouble meeting a 9 percent minimum. Even under the EBA stress test's "adverse scenario," Dexia's core Tier 1 figure fell only to 10.4 percent, well above the 5 percent minimum needed to pass.

Dexia's tangible common equity ratio, meanwhile, was 1.18 percent, meaning it had barely any hard capital to absorb future losses. Dexia took a government bailout last weekend.

Dexia was able to show such high regulatory capital because it was allowed to exclude the bulk of its assets from the denominator in the equation, while also excluding billions of dollars of pent-up losses from the ratio's numerator. Those included losses on such things as soured Greek government bonds.

Arguing over whether the correct amount of a fake number should be 7 percent or 9 percent -- or whatever -- is not a useful exercise. It's a diversion. The regulators know this. If they wanted Europe's banks to hold more real capital, they would tell them to. It's becoming increasingly obvious that they don't.

(Jonathan Weil is a Bloomberg View columnist.)

-0- Oct/13/2011 19:14 GMT