Banks Get New Restraints

by Mercator Advisory Group 0

The Basel Committee On Banking Supervision issued its new rules for bank capital, which are intended to guard against the type of credit market freeze that occurred during the financial crisis of 2008-2009.

Regulators agreed to require banks to hold a specific level of a basic type of capital known as “common equity.” Common equity is considered the most effective type of capital because it is used to directly absorb losses. Officials agreed large, internationally active banks will have to hold levels of common equity equal to at least 7% of their assets, much higher than the roughly 2% international standard or 4% standard for large U.S. banks.

Banks will be allowed to phase in these new standards over a period of years, so they will have more time to comply. By 2015, banks will have to begin building a 2.5% “buffer” of capital that must be fully in place by Jan. 1, 2019.

If banks fall below the buffer, regulators could force them to hold onto more of their earnings to augment their capital, which means the companies will have less money on hand to pay dividends or offer large compensation packages. Some analysts believe the new standards could essentially force banks to shrink their loan portfolios or shed other assets in order to improve their capital positions.

Rules will be phased in over 8 years, so as to avoid putting added constraints on weak economic markets. Some fear that this will cause exactly these undesired effects, limiting banks’ ability to lend.

If banks fall below the buffer, regulators could force them to hold onto more of their earnings to augment their capital, which means the companies will have less money on hand to pay dividends or offer large compensation packages. Some analysts believe the new standards could essentially force banks to shrink their loan portfolios or shed other assets in order to improve their capital positions.

Left undecided is whether and how much additional “systemically important” (i.e. too big to fail) banks will be required to carry.

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