Banks' equity arms in peril

New European rules could force banks to reduce their private equity investments or sell off the businesses altogether.

The proposals come from the Basel Committee, a group of central bankers from 10 industrialised countries. It believes that banks should increase the amount of money they have in their reserves to cover risks. Because private equity is considered relatively risky, under the proposals banks would have to set aside more capital.

Sources said this could put off some banks from getting involved in private equity deals. The European Commission has pledged to turn the recommendations into law. It is understood they could be in force before 2007, although many banks may want to sell off their private equity investments in advance.

The British Venture Capital Association (BVCA) is consulting its members to decide on a course of action to take on the "potentially damaging" rules. But reactions are likely to be mixed.

Some banks , such as Lloyds TSB, are believed to be firmly attached to their private equity divisions and will therefore dislike the increased restriction of the rules.

However, other banks are less committed to their private equity arms. HSBC, for example, is understood to be in the process of splitting off its division.

"Historically, private equity had a low capital allocation, but with Basel ... you are talking about a significant increase in capital," said John Mackie, chief executive of the BVCA.

"Private equity was attractive because the banks don't have to allocate lots of capital. Now, looking forward, if they want to do private equity, is it worth doing?"