Capital Requirements Gain Controversy

If there's anything that you would think the G-20 would be able to agree on when it meets in Pittsburgh this week, it's capital requirements. Capital levels at banks were insufficient to absorb the losses they incurred over the past two years, leading to the global financial crisis. Indeed, there's widespread agreement among leaders that capital requirements should increase, but a vast disparity about how much. Europeans don't want their banks to maintain levels as high as U.S. officials are calling for.

The Wall Street Journal has an article about this issue today. It explains the chief European complaint:

European leaders mostly agree about the need for more stringent capital requirements. But French and German officials contend the U.S. is pushing policies that would require foreign banks to raise much more capital than U.S. institutions, constraining their ability to issue credit and possibly hampering economic growth.

Don't misunderstand this seemingly misleading statement. The U.S. officials want similar capital levels globally. The WSJ clarifies:

Because U.S. banks such as Citigroup Inc., Bank of America Corp., and J.P. Morgan Chase & Co., were required to hold more capital than most of their foreign competitors before the crisis, European banks have a longer way to catch up. European leaders also say U.S. banks appear to be on better footing because the U.S. has recapitalized many of them with taxpayer money.

A lot of good those higher capital levels did Citi, BoA and company! So the problem is twofold. First, Europeans don't want to put their banks under undue stress to require them to acquire more new capital than U.S. banks must. Second, Europeans don't like that the U.S. government has already given its banks a head start through its capital injection-style bailout.

I have a few thoughts.

First, couldn't these two complaints find a way to cancel themselves out? Why not shape capital requirements to specify "private" capital? That way, U.S. banks would have nearly as much trouble as European banks, so the timeline for compliance can be pushed out to accommodate both.

Second, it's really important that these capital levels are uniform, for global competition's sake. Any banking system with lower capital requirements has a competitive advantage. It also has a greater risk of crisis.

Speaking of that risk, my jab at Citi, BoA and company is actually kind of demonstrative. I noted just yesterday the problem of capital requirements in preventing crises: it's impossible to know how high that capital would need to be. As U.S. banks proved all too conclusively, even higher capital levels aren't a silver bullet when markets lose their mind.

Still, there's an additional problem that Europeans have with seemingly equal global capital requirements. The WSJ notes:

The U.S. now wants to increase capital requirements for the largest banks in a way that makes the overall measure of capital less sensitive to risk. European officials say that's not fair -- in part because of differences in accounting standards. Some bank balance sheets appear up to twice the size under European accounting rules than they would under U.S. standards.

Again, this seems like a problem that could be solved. How about global accounting standards that reconcile what similar capital levels should look like from nation to nation, despite accounting disparities? The goal here is safety, not satisfying arbitrary numbers. When all assets, liabilities and equity are taken into consideration, make that capital cushion uniform in terms of safety, if not nominal amount.

Overall, the news that global leaders are having trouble agreeing on this issue is troubling. If they can't get over the capital requirements hump, I fear that the G-20 will accomplish very little in mapping out new financial regulation. We aren't talking about particularly controversial new measures here, like carbon emission standards or compensation. We're talking about responding to the global financial crisis' chief ailment and making safer banks by revising an age-old requirement -- their need to hold capital. If the G-20 can't even figure out a compromise or come some sort of meaningful consensus on this issue, then that creates a pretty grim outlook on the subjects that evoke passionate debate.

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Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation. More

Indiviglio has also written for Forbes. Prior to becoming a journalist, he spent several years working as an investment banker and a consultant.

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