Lehman two years on: banks cheer Basel accord

But there are fears over some countries ignoring the rules. James Moore reports

Banking shares across Europe sprang to life yesterday as investors took heart from the agreement by banking watchdogs on how much capital banks will have to hold. The agreement reached in the Swiss City of Basel might require banks to hold double the minimum amount of capital before the financial crisis. But it still gives them until 2015 to sort themselves out and – given that the stronger banking groups are already there – there were hopes that some capital might start flowing back into shareholders pockets, not least because many banks have started to turn fat profits again.

Nic Clarke, analyst at Charles Stanley, said: "What is clear is that UK banks with core tier one (capital) ratios of over 9 per cent are all well above the minimum levels already.

"Therefore, although we don't think that this will lead to significant amounts of capital being returned to shareholders it does put them in a relatively strong position compared to their international competitors. It is also positive for the sector because it is a key issue largely dealt with which lessens regulatory risk."

The industry rather concurs and is relatively upbeat. If there is a trouble, it may come, as ever, if countries seek competitive advantage for their banks by not implementing the rules at the cost of the world's financial stability. The US, for example, had not implemented Basel II prior to the financial crisis. Now, two years on from the seizure of the financial system after Lehman's collapse, we are at Basel III.

Irving Henry, director, prudential policy, at the British Bankers Association, said this could become a real danger. "That is the big concern of ours, and not just when it comes to the issue of competitiveness but also for the stability of the financial system as a whole. Inevitably, if it is not implemented then business will drift towards jurisdictions that are less stringent. That might benefit them in the short term but it won't do any favours for anyone long term."

Mr Henry is also concerned that the UK, in the form of the Financial Services Authority, could start "gold plating" the requirements by imposing tougher rules. UK standards are already higher than those agreed at Basel, although to be fair, Switzerland's banks may also find themselves in this position after Finma, the main financial regulator, and the Swiss National Bank indicated they may impose tougher rules to prevent the failure of a major bank dragging down the economy. Tough break for UBS and Credit Suisse then.

Mr Henry called on the FSA not to follow suit "now things are calming down" with all the UK banks currently holding capital in excess of the 4.5 per cent of "at risk assets" together with a 2.5 per cent "buffer" required by the Basel supervisors. He, and the bigger banks, are also nervous about the ill-defined additional requirement for "systemically significant" banks to hold a further buffer in "good times", which in theory affects all of the UK players and which will very much be under the control of national regulators.

Lord Turner, the chairman of the FSA did not have much to say on that, limiting himself to a brief statement hailing the Basel deal as "a major tightening of global capital standards" that "will play a significant role in creating a more resilient global banking system." He also said the transition timescale would "ensure that banking systems can play their role in supporting economic recovery". By lending.

But Ray Barrell, director of Macroeconomics at the National Institute for Economic and Social Research, said the measures should only be seen as "a first step". He said that the most important step ahead was for "greater product regulation in financial markets". "Reducing complexity and off-balance sheet activity are essential if crises are to be avoided. More capital alone is not enough," he added.

What the Basel deal means in English

Q: What's the basic requirement?.

Answer: Banks will have to hold 4.5 per cent of "core tier one" capital when compared with their "risk weighted assets", more than double the 2 per cent they currently have to hold, plus an additional 2.5 per cent "buffer" to cover them in the event of a crisis. If they have to eat into this, they will be prevented from paying dividends or buying back shares. UK banks already have to hold 8 per cent.

Q: What about the really big banks, those that are "too big to fail"?

Answer: They may face an additional "contra cyclical" requirement to hold a further "buffer" during the good times, when there is a build-up of debt in the global economy. This could be as much as 2.5 per cent, although the details have yet to be finalised and there will be further discussions. National regulators will likely be given a certain amount of leeway in how this works.

Q: How long have they got to get all this extra capital on their books? Will it affect lending?

Answer: The rules will start to be phased in from 1 January 2013 and take full effect on 1 January 2015. The first "conservation" buffer will be phased in from 2016 and be in full effect on 1 January 2019. The "contra cyclical requirement" for big banks hasn't been agreed. So banks should be able to support the recovery by lending, although those that can move quickly to comply probably will, hence Deutsche Bank's €9.8bn (£8.2bn) rights issue.

Question: What is "Core" Tier 1?

Answer: Effectively it is capital that banks can call on if they are hit with big losses. But the definition is being tightened up to exclude, for example, tax credits or "minority interests" in subsidiaries, although this too is being phased in between 2014-2018.