Global regulators are drawing up tougher capital adequacy standards, but German banks do not like what they are seeing. Writer Michael Imeson

What is it?

Bankers in Germany are putting up fierce, but probably futile, opposition to plans by G-20 leaders and global regulators to tighten up capital requirements. Banks fear that strong international standards forcing them to hold more and higher quality capital will reduce their ability to lend, and therefore damage the German economy.

Who dreamed it up?

The driving forces are the G-20 leaders, the Financial Stability Board (FSB) and the Basel Committee on Banking Supervision. In September, the G-20 reached agreement in seven key areas, one of which was "to advance tough new financial market regulations". These will include "rules to improve both the quantity and quality of bank capital and to discourage excessive leverage". They are being developed by the Basel Committee, with implementation due by the end of 2012.

What are the main provisions?

The Basel Committee has published the proposed rules. One aims to "raise the quality, consistency and transparency of the Tier 1 capital base", the predominant form of which "must be common shares and retained earnings".

A second measure will "introduce a leverage ratio as a supplementary measure to the Basel II risk-based framework". When lending, banks will not be able to exceed this ratio, which will be calculated as Tier 1 capital divided by assets, so £100m ($158.2m) of capital divided by assets of £2bn would create a ratio of 1:20 (or 5%). The maximum ratio allowed is expected to be about 25 for AAA rated banks and lower for others.

A third step will be to introduce a framework for countercyclical capital buffers above the minimum requirement, which will include capital conservation measures such as constraints on capital distributions.

The Zentraler Kreditausschuss (ZKA), the joint committee operated by the five central associations of the German banking industry, is dismayed. It wrote to German finance minister Peer Steinbrück in September urging him to influence the G-20 "against the adoption of the proposed measures".

What's in the small print?

Higher capital requirements for risks in banks' trading books will be introduced, in some cases at least doubling by the end of 2010.

What does the industry say?

The ZKA has three gripes. A tighter definition of Tier 1 capital would be too limiting and "would have a dramatic effect on German banks"; very few banks would be able to comply with a doubling of the minimum capital requirements; and a leverage ratio, given its lack of risk sensitivity, "would fly in the face of the risk-based approach of Basel II". The ZKA accuses the Basel Committee of being too influenced by Anglo-Saxon countries, pointing out that "Anglo-Saxon corporate structures and methods of funding differ sharply from those in continental European countries, particularly Germany".

How much will it cost?

With a stricter definition of Tier 1 capital, every unit of capital no longer available will reduce a bank's scope for lending by at least 12.5 times the amount of that unit, therefore reducing its revenues and profits.

What do the regulators say?

The G-20, FSB and the Basel Committee are intent on implementing the new rules. Nout Wellink, chairman of the Basel Committee, claims that they "will result, over time, in higher capital and liquidity requirements and less leverage in the banking system, less procyclicality [and] greater banking sector resilience to stress".

The law of unintended consequences

Tighter capital requirements will limit German banks' ability to lend, which will stifle economic growth.

Could we live without it?

Yes. Banks will only succeed in keeping the effects of the financial crisis on the real economy to an absolute minimum "if they are not massively restricted in their ability to lend by new regulatory capital requirements", says the ZFA. "The proposals under discussion are consequently more than counterproductive."

 

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