A collection of 500-euro ($551) banknotes (Photographer: Angel Navarrete/Bloomberg)

Europe Said to Threaten Revolt Over Bank Capital-Rule Revamp

(Bloomberg) -- Europeans told the world’s top banking regulator that they’ve had enough.

In two heated meetings in the past week, regulators from countries including Germany and Italy told the Basel Committee on Banking Supervision that proposed changes to how banks assess credit, market and operational risks must be scaled back and slowed down, according to two people with knowledge of the matter.

Some European officials went so far as to say they wouldn’t adopt the proposals on the table, according to the people, who asked not to be identified because the deliberations were private. If the European Union -- home to nearly half of the world’s most systemically important banks -- balks at implementing the Basel Committee’s rules, it could undermine the global regulator’s authority and contribute to fragmentation of the industry.

The Basel Committee is racing to finish work on the post-crisis capital framework known as Basel III by the end of the year, and it’s under instructions not to increase capital requirements significantly in the process. The debate in Basel pits bank regulators from Tokyo to Frankfurt against a U.S.-backed push for stiffer standards, which take effect when they’re implemented by national governments.

‘Negative Consequences’

The industry says the proposed revisions to risk-assessment rules and limits on banks’ use of their own models to make these calculations would send capital requirements spiraling. 

Credit Agricole Deputy Chief Executive Officer Xavier Musca said he’s confident supervisors won’t create “new problems” for the banking sector at a time when there’s a risk of another global economic slowdown. “We have repeated that we need to stop this process of increasing capital requirements and we have got a lot of responses from our supervisors telling us that their willingness is on the same line,” he said on Friday.

Key policy makers have heeded their message. German Finance Minister Wolfgang Schaeuble last week insisted that the Basel Committee not only keep any overall increase in capital requirements to a minimum, but also ensure the rules have no “particularly negative consequences for specific regions,” such as Europe.

Leverage Ratio

Shunsuke Shirakawa, vice commissioner for international affairs at Japan’s Financial Services Agency, said in June that the regulator needs to “make adjustments” to bring the new rules in on target. The Basel Committee’s members include Japan’s FSA, Germany’s Bundesbank and the U.S. Federal Reserve.

The main focus of the Basel Committee as it finishes up work on the capital framework is on how banks assess the riskiness of their assets for regulatory purposes. For about the past decade, lenders have been allowed to use sophisticated models as long as they have supervisory approval. 

In theory, this should give them an incentive to invest in less risky assets and to price assets in line with their risk. Yet supervisors’ practical experience and empirical research have fed suspicions that banks misuse it to understate risks and manage down their capital requirements. That triggered Basel’s reform plan, according to William Coen, secretary general of the Basel Committee.

Risk Weights

“If we wanted to increase capital, that would be far easier than what we’re doing at present,” Coen told reporters on Sept. 13. “We’re doing this work to reduce risk-weighted asset variability. And why are we doing that? To restore confidence in the risk-weighted capital ratios and to fully restore credibility to the capital adequacy framework.”

Large European banks may be more vulnerable than their global peers to those changes for a number of reasons. Bank loans to companies are overall much more relevant in Europe than in the U.S., where bonds dominate corporate borrowing. European banks keep mortgages on their books, while U.S. lenders offload them to government-sponsored entities such as Freddie Mac.

One of the most contentious issues is Basel’s proposal to put a floor under the amount by which banks can reduce capital employed for an asset when compared with a standardized approach set by regulators. That floor and the way it’s applied could significantly affect the resulting capital requirements.

Corporate Loans

Other disagreements include how the banks’ own models can be applied to certain areas of lending, such as large companies, other banks, or operational risks such as fines and rogue traders.

On top of structural factors that affect balance sheet composition, European banks use internal models more actively than their U.S. peers. Consequently, their risk-weighted capital ratios, the key regulatory gauge, are on average higher than those of their international peers, while risk-neutral measures like the leverage ratio are lower. Basel’s changes could put them in a weaker position.

Deutsche Bank AG’s assets weighted by risk were 22.3 percent of its total assets as of end June, for example, data compiled by Bloomberg show. For Societe Generale SA, that ratio was 24.3 percent, the data show.

European regulators told the Basel Committee that its sweeping new proposals, dubbed Basel IV by the industry, were impeding banks’ ability to finance the economy and even to pursue mergers and acquisitions, one of the people said.

Basel’s overall goal still has the support of policy makers. The committee’s oversight body, the Group of Governors and Heads of Supervision “endorsed the broad direction of the Committee’s reforms,” according to a statement after the Sept. 11 meeting. EU Commission President Jean-Claude Juncker said in a letter to EU leaders on Aug. 30 he supports the committee’s work.

Spokesmen for the Basel Committee and the Bundesbank declined to comment. The regulator’s next scheduled meeting is Nov. 28-29 in Santiago, Chile.