In desperate attempts to stave off another global financial crisis and restore public confidence, the Basel Committee on Banking Supervisionare is mulling over imposing a capital surcharge on the world’s largest banks if they grow bigger. The target banks are those that could threaten global economy if they collapse, Bloomberg reported on Thursday.
This will be in addition to the new set of minimum capital standards, known as Basel III, proposed by the regulatory officials of more than two dozen countries in 2010.
As most of the major large-cap banks seem to comfortably maintain the minimum capital norms mandated by the Basel Committee, they might not hesitate to take more extravagant risks in attempts to grow further. Also, the success of regulatory efforts in restoring financial stability worldwide has created a wrong impression that the government will save big institutions from failing whenever they face major financial trouble. As a result, it was required to force these banks to stock up additional capital reserves in order to confront financial turmoil, if they create any.
The Size of Surcharge
The Basel Committee is contemplating placing as much as a 3.5% capital surcharge on mega banks worldwide, if they grow further. However, this is expected to be the maximum percentage of surcharge. Initially, these banks will not have to bear the highest surcharge. Depending on the size of these banks, links to other lenders and the growth scenario, the surcharge would be increased.
The Swiss government was an early bird, proposing to increase the minimum common equity requirement to 10% from the Basel III mandate of 7% for UBS AG (UBS) and Credit Suisse Group (CS).
Any Timeline?
During November last year, G-20 nations instructed the Basel Committee to start framing additional measures for mega banks. But there is no concrete clue as to when the Basel Committee will enact the additional surcharge. The Committee will meet next week to decide which banks and the extent to which the surcharge would be imposed.
However, the Committee members may not reach a conclusion on the composition of surcharge, in their first meeting. It might take them time to decide whether the surcharge should comprise only common equity (ordinary shares and retained earnings) or if it should also include contingent capital instruments. So we cannot expect the structure of the surcharge to be finalized any time soon.
Are Countries Okay With This?
Following the circulation of the draft plans before next week’s meeting, some countries are pressing the Committee to be less strict with respect to the proposed requirements. Most likely, these countries are scared of losing their growth momentum as expansion of their systemically important banks would be obstructed significantly as a result of this surcharge. But, wouldn’t this supernormal growth of big banks increase the odds of collapse again? Hopefully, the Basel Committee will keep the recent nightmarish past in mind before entertaining requests for such flexibility from some countries.
Are U.S. Banks Steady?
According to the Basel III requirements, banks will have to maintain a minimum Tier 1 capital ratio as high as 12.0%. This will comprise a minimum buffer of 6.0%, a conservation buffer of 3.0% and an additional 3.0% anti-cyclical buffer. The anti-cyclical buffer will help increase the Tier 1 capital requirements to 12% during boom times.
Most of the major U.S. banks including JPMorgan Chase & Co. (JPM) and Citigroup (C) maintain Tier 1 capital ratios above the minimum level mandated by the Basel Committee. Furthermore, the latest stress test results and consequent approvals to hike dividend yields also reflect that these banks will be able to comfortably maintain up to 3.5% in extra reserves.
Safety, First to Last
A weak capital level is always a threat to worldwide economic well being. Needless to say, such capital restrictions would act as building blocks of the still unstable world economy, with fewer bank collapses and less involvement of taxpayers’ money for bailing out troubled financial institutions.
Regulators and bankers are bound to disagree over the extent of the positive impact from the new capital rules as there remains other lingering concerns, including a high unemployment rate, continuation of residential and commercial real estate loan defaults and liquidity challenges. However, many big banking names that run on lower capital ratios will be forced to maintain higher capital standards, reducing their risky ventures.
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