LONDON (Reuters) - A deal on bank capital rules won’t see world leaders take their foot off the reform pedal but will instead clear the decks for them to focus more squarely on an even harder issue — tackling too-big-to-fail banks.
The Basel III measures agreed on Sunday are the lynchpin of efforts by the Group of 20 leading countries to learn from the world’s financial crisis but other reform pledges still need completing and new initiatives are in the pipeline.
The G20 will now devote more time at its November summit in Seoul to stepping up scrutiny of derivatives markets and shine a light on off-balance sheet “shadow banking” sectors.
Improving supervision and curbing the influence of credit rating agencies will also figure prominently, sources familiar with G20 workings said.
But “too-big-to-fail” is becoming the top priority.
Even before the ink on Basel III had a chance to dry, top regulators were warning on Monday that big banks face extra capital requirements to make doubly sure that taxpayers won’t have to ride to the rescue again.
Basel III — which demands banks hold top-quality capital of more than triple what they do now, but with a long transition time built in — will not be enough to deal with internationally active banks, Financial Stability Board Chairman Mario Draghi said.
“We want systemically important financial institutions to have loss-absorbing capacity beyond these standards,” he said.
Regulators want to end “moral hazard” — the temptation for banks to take risks — as governments won’t allow them to collapse because of the damage it would wreak on the economy.
The FSB will make recommendations to the November G20 summit with a capital surcharge on big banks set to be one.
That may be easier said than done.
With Basel III, there was G20 consensus that bank capital rules needed tightening but there is so far no agreement on slapping surcharges on some banks.
Tackling “too big to fail” will likely take the form of a menu of solutions for G20 leaders to pick through, ranging from surcharges and forcing banks to compile “living wills” to ensure speedy wind-ups if in trouble, to agreements between countries on dealing with an ailing cross-border bank.
“The area that is probably the most difficult is the whole area of living wills and winding up arrangements,” said Patrick Fell, a director at PricewaterhouseCoopers in London.
“But if your objective is to look at the system you have to focus on the too-big-to-fail issue,” Fell said.
If regulators do end up agreeing to slap capital surcharges on big banks, they may have to accept hybrid forms like contingent capital, said Harald Benink, professor of finance at Tilburg University in the Netherlands.
“Basel III is a step in the right direction but it’s not finished. The critical thing lacking is no systemic risk charge for important banks,” Benink said.
The regulators who completed Sunday’s Basel III package appear to be listening.
“The Basel Committee and the FSB are developing a well-integrated approach to systematically important financial institutions which could include combinations of capital surcharges, contingent capital and bail-in debt,” the two bodies said in their statement on Sunday.
The G20 will also turn its attention to other regulatory reforms such as making sure that all member countries are implementing pledges to make derivatives markets more transparent and safer through central clearing of contracts by the end of 2012.
The United States has already adopted a law to this end and the European Union will publish its own draft law on Wednesday.
“We also have to deal with the whole shadow banking system, which has not been addressed in a coherent manner,” the G20 source said.
Regulators in the G20 want to reduce the role of credit rating agencies in determining how much capital reserves banks must set aside.
“Capital alone is not going to save us. We need more effective supervision and there is much in the way to be done by many national authorities,” the source said.
There is also a need to finalize existing G20 pledges such as forging a single set of global accounting rules in 2011.
France takes over as G20 president from November and President Nicolas Sarkozy said last month that regulating commodity derivatives would be one of his top priorities.
Financial industry officials in London are already worried that France wants to regulate commodity prices, a step Britain and others would likely resist.
Reporting by Huw Jones, editing by Mike Peacock