G20 delays policies to police too big to fail institutions; will monitor Basel III impact on trade finance

G20 delays policies to police too big to fail institutions; will monitor Basel III impact on trade finance

By Gareth Vaughan

Leaders from the Group of 20 (G20) countries meeting in Seoul have agreed to tackle the “moral hazard” of international financial institutions regarded as too big to fail raised by the Basel-based Financial Stability Board (FSB), but agreement on the actual measures to be taken to do this has been delayed for at least a year.

The G20 leaders also say they will monitor how banking regulation affects the supply of trade finance, a key enabler of global commerce, amid concerns the so-called Basel III reform proposals could push the cost of trade finance up and/or reduce its availability.

The Basel III rules, designed to prevent a repeat of the global financial crisis, require banks to hold capital against all off-balance sheet items including short-term letters of credit used for trade finance, which supports a major chunk of annual global merchandise trade. See the full G20 statement here.

John Scott, New Zealand general manager of credit reporting agency Dun & Bradstreet, told interest.co.nz last month that this "unintended consequence" of the Basel III process meant New Zealand exporters faced a potential five-fold increase in the cost of trade finance.

Following the G20's two day summit, the G20 leaders said they would support measures to increase the availability of trade finance in developing countries. They also agreed to evaluate the impact of regulatory regimes on trade finance. The G20 had been lobbied to make changes  to reduce the impact on trade finance by major international banks such as HSBC and Standard Chartered.

Meanwhile, Bloomberg reports that the world’s biggest banks won a reprieve of at least a year before they'll face extra measures forcing them to reduce risk. The FSB, incorporating G20 finance ministers, regulators and central bankers, said in Seoul moves to prevent the collapse of systemically important financial institutions (SIFIs) will be suggested by 2011 rather than the end of this year as the G20 had asked.

The FSB describes what it terms SIFIs as financial institutions whose disorderly failure because of their size, complexity and systematic interconnectedness, would cause significant disruption to the wider financial system and economic activity. Moves to tackle such entities at an international co-operative level follow the global financial crisis when a series of major financial entities, including insurer American International Group (AIG) and Citibank, were rescued from collapse in 2008 and 2009 with the help of billions of dollars of taxpayers’ money.

The FSB said it will identify the firms that should be subject to stricter rules by the middle of next year, Bloomberg reports, and finish studies by then on the additional “loss absorbency” the biggest banks will need. National regulators will then be able to select “from a menu of viable alternatives” depending on individual circumstances.

Capital surcharge

The options being considered include a capital surcharge for the systemically important banks, contingent capital and bail-in instruments, Bloomberg reports. It describes contingent capital as debt that automatically converts to stock under stressful conditions. Bail-in instruments require bondholders to take a pre-set loss when a lender collapses. And a capital surcharge would raise the equity-to-assets ratio that the largest banks must hold compared with smaller rivals.

In a letter to G20 leaders Mario Draghi, Bank of Italy Governor and chairman of the FSB, said too often, because the tools and capacity to co-ordinate resolution across borders were lacking, the threatened failure of SIFIs had been answered with taxpayer funded bailouts. Now, Draghi said, agreement had been reached for a policy framework, work processes and timelines to address the “systematic and moral hazard risks” associated with SIFIs.

And in their declaration at the end of the summit, the G20 leaders' said no firm should be too big or too complicated to fail and that taxpayers should not bear the costs of resolution.

The FSB calls for action in five areas:

- Improvements to resolution regimes to ensure that any financial institution issues can be resolved without disruptions to the financial system and without taxpayer support.

- A requirement that SIFIs, and especially global SIFIs, have additional loss absorption capacity before the Basel III standards to reflect the greater risks these institutions pose to the global financial system.

- More intensive supervisory oversight for financial institutions which may pose systematic risk.

- Stronger robustness standards for core financial infrastructure to reduce contagion risks from the failure of individual institutions.

- Peer review by an FSB Peer Review Council of the effectiveness and consistency of national policy measures for global SIFIs, starting by the end of 2012.

“Every country must have a supervisory system that is up to the task of ensuring that the new regulations are backed up by effective risk assessments and enforcement,’ Draghi said.

“Moreover, supervisors must have the powers to be able to detect problems proactively and intervene early to reduce the impact of potential stresses on individual firms and therefore on the financial system as a whole.”

A key lesson from the GFC, he said, was that financial and supervisory authorities and regulatory bodies need to act faster and more coherently to combat emerging stability threats.

“This will require ongoing collective diagnosis of evolving risks and regulatory weaknesses, strong co-ordination of regulatory and supervisory agendas, and political accountability for defining and implementing mitigating actions," said Draghi.

Meanwhile, he said the new bank capital and liquidity standards devised by the Basel Committee on Banking Supervision, dubbed Basel III, would reduce the likelihood and severity of future financial crises and establish a banking system better able to support economic growth. National implementation of the Basel III standards is expected to start on January 1, 2013 running until January 1, 2019.

'Gneral support' from RBNZ

Reserve Bank of New Zealand (RBNZ) Governor Alan Bollard says the central bank “generally supports” Basel III but intends to fully assess the potential impact of the various proposals on the local financial system before initiating any changes to the New Zealand bank supervisory framework.

Basel III sets out plans to enhance the quality of banks’ capital, boost the level of capital they hold, promote the build up of capital buffers to mitigate procyclicality, improve capital framework risk coverage, introduce a leverage ratio as a supplementary measure to the risk-based capital requirements and introduce global minimum liquidity standards.

The RBNZ covered its views on Basel III and the relevance to New Zealand in detail in last’s week’s Financial Stability Report.

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