UPDATE 4-Biggest banks may face stiffer capital surcharge

Fri Jun 17, 2011 3:01pm EDT

* Regulators aim for July 18 deal on 2-3 pct surcharges

* Some elements still being contested

* Regulators leaning towards pure equity surcharges

* Fed also sees 3 pct surcharge for biggest banks - source (Adds Fed position, analyst comments, updates shares)

By Sakari Suoninen and Huw Jones

FRANKFURT/LONDON, June 17 (Reuters) - The world's biggest banks face a capital surcharge of up to three percent in a bid to keep taxpayers off the hook next time a lender gets into difficulty, Bundesbank and industry officials said on Friday.

But a surcharge of between 3 percent and around 3.5 percent will be imposed if a bank grew significantly and as a result posed larger systemic risks, banking sources told Reuters.

The Financial Stability Board (FSB), tasked by the world's top 20 economies (G20) to toughen up financial rules, meets on July 18 to finalise its blueprint.

Regulators will hold a series of preparatory meetings to iron out elements of the capital surcharge plan that are still being contested, even though many top banks already hold capital in line with the top end of the planned surcharge.

"No final decision has been made," a source familiar with the talks said. "It's still very fluid," a second source added.

(For a Breakingviews on the capital spat between regulators and bankers, see [ID:nN17164817])

The capital surcharge will be on top of the new global Basel III minimum capital of 7 percent set for all banks from 2013.

The blueprint will be published by the FSB in late July for public review before G20 leaders endorse it in November.

Bundesbank board member Andreas Dombret said on Friday that 25 to 30 of globally systemically important financial institutions (G-SIFIs) "will in all likelihood" have to hold 2 to 3 percentage points more capital than others.

"Such capital add-ons do more than merely improve the resilience of a SIFI," Dombret said in a speech, adding that the extra capital requirement could put a price on the implicit guarantee such big firms enjoyed.

The blueprint is about a year behind schedule due to bickering among G20 countries over whose banks will be deemed G-SIFIs, and whether other measures, also in the blueprint, such as effective wind-up mechanisms could be a substitute for surcharges at some banks.

A top British regulator has signaled that total core capital of around 15 percent is best in an ideal world, some five percent above where UK banks are now.

Switzerland wants its two biggest banks, UBS (UBSN.VX) and Credit Suisse (CSGN.VX), to hold core equity capital of 10 percent and a further 9 percent in hybrid debt known as contingent capital.

The Federal Reserve is the leading U.S. negotiator and has been advocating that the SIFI surcharge be about 3 percent for the largest banks, according to a person familiar with the discussions, under a system where the size of surcharge would be based on the size of the bank.

SIX STEPS

The surcharge will depend on criteria regulators have already outlined, such as how interconnected the bank is to the rest of the financial system and how easily its operations could be substituted by another lender.

"I think it will be 1 to 3 percent of capital in six steps, depending on the degree of G-SIFIness," one banking source said.

While the biggest banks are fighting to keep from having to hold even a half-percentage point more capital than the new 7 percent baseline, the differences being discussed are not great enough to force banks to raise extra capital or dramatically restructure their businesses, bank analysts said.

"They will not force anybody to raise capital," said Paul Miller, a bank analyst at FBR Capital Markets.

Regulators, he said, "are going to give them very long time periods to meet those standards."

JPMorgan Chase (JPM.N), for example, would not split itself into pieces to avoid having to hold an extra 2.5 percent capital while its competitor Wells Fargo (WFC.N) faced a 1 percent surcharge and smaller banks none, Miller said.

The Financial Times reported that Citigroup (C.N), JPMorgan, Bank of America (BAC.N), Deutsche Bank (DBKGn.DE), HSBC (HSBA.L), BNP Paribas, Royal Bank of Scotland [ABNNV.UL] and Barclays (BARC.L) would face a surcharge of 2.5 percent, while Goldman Sachs (GS.N), Morgan Stanley (MS.N), UBS and Credit Suisse, would be hit with a smaller, 2 percent capital add on.

But a banking supervisory source disputed this breakdown, adding there was disagreement over how many "buckets" there should be, which would determine which banks were grouped together.

European bank shares .SX7P gained 1.4 percent Friday, while U.S. bank shares were up 0.8 percent in afternoon trading, as measured by the KBW Bank Index .BKX.

Goldman Sachs analyst Richard Ramsden said the stock market has marked down the prices of the biggest bank stocks in anticipation the surcharge will be four percentage points.

He predicted the final levies will be two to three points, reducing bank profits by less than the market is anticipating.

Ramsden recommended buying shares he sees as being overly penalized, including JPMorgan Chase, American Express (AXP.N), US Bancorp (USB.N), State Street Corp (STT.N) and PNC Financial Services (PNC.N). Big bank stocks, on average, should rise about 6 percent if the final surcharge is three percent instead of the four points the market expects, he said.

It remains unclear when the capital surcharges would kick in, but many of the biggest banks already hold capital at these levels due to pressure from local supervisors in countries like Switzerland, Britain and the United States.

PURE EQUITY

Some banks may need to change the mix of capital.

Much will hinge on whether the surcharge has to be in the purest form of capital -- common equity -- or whether banks will be allowed to include some hybrid debt known as contingent capital, or CoCos, which convert to equity under stress.

Bundesbank's Dombret said CoCos should be included among the instruments acceptable as a surcharge but banking sources said hard line countries like Britain appear to be winning the argument for common equity.

The United States is also pushing hard for the surcharge to be made up of common equity.

"There is considerable risk that once some form of hybrid is permitted, a slippery slope effect ensues, whereby national regulators approve increasingly diluted forms of capital under political pressures," Fed Governor Daniel Tarullo said in a speech earlier this month. (Additional reporting by Dave Clarke in Washington, David Henry in New York and Philipp Halstrick and Jonathan Gould in Frankfurt; Editing by Alexander Smith and Tim Dobbyn)

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