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The Group of Governors and Heads of Supervision agreed over the weekend to force certain banks to hold between 1% to 2.5% in extra capital depending on their size, riskiness and complexity. But left unclear, among other things, was exactly which institutions will face that charge
June 27
WASHINGTON — U.S. banks aren't the only ones angry over a proposed surcharge on the world's riskiest financial institutions.
In comment letters to the Basel Committee on Banking Supervision, foreign institutions raised a host of issues that go beyond the traditional arguments made by U.S. banks that such a surcharge would inevitably curb lending and damage the economy.
Like American institutions, foreign banks make the case that the proposed surcharge — which would force banks to hold between 1% to 2.5% in extra common equity capital — goes too far. They also object to how regulators will determine which 28 institutions will be considered "globally systemically significant financial institutions," or G-SIBs, which are subject to the charge.
Overall, they argued that with so many other issues still in flux — including the ongoing European debt crisis, new Basel III standards and various other national reform rules yet to be implemented - the full impact of the surcharge is unpredictable.
"It is difficult to understand how the Basel Committee comes to the conclusion that the Basel III regulations, which have not yet entered into force and on whose applications no experience has yet been gathered, are insufficient to address the risks of globally systemically important banks," Hans-Joachim Massenberg wrote on behalf of The Association of German Banks.
Regulators have been contemplating a big bank capital surcharge since last year, when the Basel Committee agreed on a framework to raise capital standards to 7% by 2019. That figure did not include the surcharge or an additional countercyclical buffer.
But bankers said any surcharge should be set low to ensure it did not cause unintended consequences.
"In our view, this means initially setting low additional requirements which — if justified — can subsequently be tightened. In this way, the imminent risk of overstraining the financial sector could be avoided," Massenberg wrote.
The Basel III process has moved much more rapidly than previous rounds largely due to promises made by the leaders of the Group of 20 nations to more tightly regulate systemic institutions to prevent another financial crisis.
Still, it's unclear if the new capital requirements under Basel III, including the G-SIB surcharge, would prevent another crisis. Several industry representatives emphasized that point in their letters to regulators.
"We do not accept the view that more capital is always the answer and strongly believe that excessive capital requirements are economically inefficient, permanently reducing the economic growth potential of the nation," Hugh Carney, senior counsel for the American Bankers Association, wrote in a letter. "Moreover, while they can inhibit the ability of banks to support the economy, they can also create competitive discrepancies."
Striking a similar message, Paris-based BNP Paribas S.A. said the level of the surcharge was "grossly overestimated."
"Capital does not help reducing systemic factors nor even truly protect against failure," BNP wrote in an unsigned letter. "Is there anyone who seriously believes that the crisis in bank perceptions that we are currently experiencing because of sovereign indebtedness would be less worrying had large banks been more heavily capitalized? In reality, the last crisis showed that taxpayer's money had to be used mostly because of inadequate governance and risk management, poor supervision and lack of resolution tools."
The Association of German Banks agreed, saying alongside the capital conservation and countercyclical buffer, the additional capital requirement was "much too high." It recommended regulators adopt a range between 0.5% to 2%.
Of equal concern among banks was where they might fall on the list of 28 G-SIBS — still unpublished. Although the largest U.S. banks are likely to be on that list, including Bank of America Corp., Citigroup, and JPMorgan Chase & Co., it's unclear what other international banks will be included.
Robert Driver, a policy advisor of prudential capital and risk for the British Bankers Association, along with others, pressed regulators to name all of the G-SIBs.
"In the interest of transparency, the 28 banks should be revealed," wrote Driver. "In order for the process to be credible, firms will need to know exactly where [they] are played in the framework, and it naturally follows without this it they will not be able to manage their business in a way conducive to reducing systemic risk."
Adding more anxiety is that even once a bank is on that list, it's exact surcharge is shaped by several factors, including size, interconnectedness, global activity and complexity.
Bankers took issue with how transparent regulators will be in reaching those assessments.
"The range and number of buckets used to adjust the surcharge to so-called bank's systemic profile do not appear to have scientific ground and cannot be easily reconstructed," BNP wrote. "Designing and adopting a regulation distinguishing 28 banks in four buckets out of an undefined sample of 73 banks, without a clear updating pattern, will be, in this context, a formidable, if not insurmountable, legal challenge!"
The Japanese Bankers Association echoed that sentiment, arguing that disclosures of G-SIBs and individual bank buckets should be addressed carefully in light of the impact on markets.
"The JBA believes that information regarding G-SIB surcharges are extremely important not only for the financial institutions involved, but also for investors who may be impacted by restrictions of external distribution of earnings," the association wrote.
Banks said they are unable to determine their own systemic importance and therefore their surcharge with any degree of accuracy.
ABA's Carney said that was due to differences in internal models. Even if banks tried to measure themselves against the other 73 large internationally active, changes made every three to five years would make it difficult to complete long-term capital planning.
"The inability of a bank to estimate its surcharge with any accuracy frustrates bank management's ability to make fundamental business decisions on an informed basis and creates uncertainty regarding the amount of capital that must be held," wrote Carney. "Given the potentially severe supervisory consequences of holding too little capital, uncertainty regarding the magnitude of the regulatory surcharge will require banks to hold a much higher amount of capital in the form of an "uncertainty surcharge."
Driver of The British Bankers' Association called on regulators to revise the methodology they use on a much more frequent basis than the proposed three to five years the committee has suggested.
The Japanese Bankers Association also said it was necessary that approaches be structured in such a way that G-SIBs "could sufficiently predict their own bucket and therefore consider measures for it."
Observers criticized the basic methodology of determining systemic importance, with some saying it was not analytical enough.
Eva Wong, secretary, for The Hong Kong Association of Banks, said such an approach was a step in the right direction, but appears "to be simplistic for attempting to measure systemic risk."
Others took a much more critical position, saying that size, itself, should not be considered a dominant factor in making such assessments. Rather it should be viewed as part of a larger picture.
"We believe that size is thus strongly overweighted, which is a conceptual flaw in our view," Massenberg wrote. "An intrinsic feature of big banks is that they are heavily interconnected, internationally active, have a large volume of assets under management and provide global payment and clearing services."
The trouble with an over reliance on size is that if all firms reduced their size, that wouldn't change necessarily change the overall risk in the system — or for the individual bank.
"A potential issue here is if rankings are based on parameters that are based mostly on size, all firms could reduce their size and therefore systemic risk, but proportionately they may not change, and therefore would retain their position in the respective buckets despite the reduction or risk," Driver wrote.
Lastly, institutions argued that G-SIBs should be allowed to use other instruments beyond common equity Tier 1 capital — like contingent capital, bail-in capital and capital surcharges — to meet the additional loss absorbency requirement.
"The tentative decision to restrict the composition of the capital surcharge to common equity Tier 1 should be thoroughly motivated and assessed," Giovanni Sabatini of The Italian Banking Association. "It should be kept in mind that meeting the additional capital requirements will come at a cost for G-SIBs, thus reducing their ability to sustain the real economy. This is a crucial point, since the question of the overall impact of the financial regulatory package in accumulation and their respective interplays remains unresolved and indeed largely untouched."
