British banks warn over EU capital rules

The British Bankers' Association warned yesterday that UK banks could face a serious competitive disadvantage against banks outside the European Union because European law requires banks in member states to set aside more capital than non-EU banks as a backstop for potential financial disasters.

"It's an international trade issue that could disadvantage the EU and London," said Peter Vipond, assistant director of the British Bankers' Association.

The law at the heart of the problem is known as the Capital Adequacy Directive (CAD), which prevents EU banks taking advantage of incoming international standards set by banking supervisors in Basle, Switzerland. The standards, which will take effect later this year, require banks to put aside less of their capital as a kind of insurance policy.

The Basle supervisors have allowed banks to use more sophisticated methods - known as Value at Risk (VAR) - to calculate the amount of capital they need to cover risks.

EU banks cannot adopt the international standards until they become incorporated into the CAD. But, because of the slow pace of business in the European Parliament, British bankers fear they could be disadvantaged for at least two years - the time they believe it will take for the amendments to be made to the CAD.

Taking London as an example, this means that a branch of an American bank, which is subject to US regulation, will need less capital to conduct its business than a British rival.

This makes it cheaper for the American bank to trade, giving it a competitive advantage. However, it also means that a subsidiary of an American bank - in contrast to the branch, regulated by the Bank of England - will be required to set aside more capital to meet EU rules.

"This creates a problem of regulatory arbitrage where trades could be booked depending on where the capital charge is cheapest," said Mr Vipond. A subsidiary could benefit from European rules, giving freedom to trade throughout Europe while at the same time allowing it to benefit from the lower capital rules.