By Pallavi Gogoi
AP Business Writer
NEW YORK (AP) -- At the core of an international agreement to head off future financial meltdowns is a requirement that banks keep more money on hand in case of trouble.
The new rule released recently by the Basel Committee on Banking Supervision aims to fortify banks worldwide and prevent them from spiraling into the kind of global financial crisis that brought the world to its knees in 2008.
Banks will have about eight years to comply fully with the rules, but the proposed changes could have immediate effects on the U.S. economy. Some questions and answers about the new global banking rules:
Q. What is Basel and how does it have so much power?
A. The Basel Committee is a group of top central bankers from 27 nations who meet regularly and look for ways to manage risk for banks worldwide. The U.S. is represented by Federal Reserve Chairman Ben Bernanke. It is the only forum that the world relies on to create a common standard for large global banks.
Q. What's the main change this year?
A. The most dramatic change proposed by the Basel Committee was a more than three-fold increase, from 2 percent to 7 percent, in the "core capital ratio," or the amount of money banks need to set aside to help absorb losses on loans. The fear is that if banks have less capital than their losses, they cannot meet payments on their own debt, and they usually fail. Capital is expressed as a percentage of a bank's assets.
Q. Who stands to benefit?
A. Consumers and some shareholders, perhaps. Most American banks already meet the new standard, and some actually exceed it, according to Richard Bove, banking analyst at investment firm Rochdale Securities. Many of the larger U.S. banks raised enormous amounts of capital after American regulators required them to do so last year on the heels of the financial crisis.
That means the rules could help free up some capital for lending to American consumers, in the form of mortgages or credit cards. It will also benefit shareholders of the stronger banks who will likely see higher dividends.
It "should be a positive catalyst for banks with strong capital and in a position to increase dividends," Fred Cannon, banking analyst at Keefe, Bruyette & Woods, said in a report.
Q. Who stands to lose?
A. Smaller community banks or credit unions that are already struggling with high loan losses and foreclosures. Many of them have found it hard to raise capital, and they will struggle with the new requirements.
Small businesses that rely on community banks for their borrowing needs could have an even tougher time getting loans. That could hurt job creation.
"Right now, we need banks to lend in local economies, not focus on new requirements," said Sean Egan, managing director of Egan Jones Rating Agency. Egan believes that smaller banks will rush to comply with the rules rather than waiting years to comply. "They will try to make up for the higher capital requirements by lending at higher rates and stiffer terms," Egan said.
Q. Will these new rules prevent another meltdown?
A. Possibly. If banks are forced to hold a higher percentage of capital for all the loans they write, it will prevent the kind of zero-down, zero-interest loans that were offered during the real estate boom. And if banks are stronger, they will be able to withstand the kind of losses that they faced during the last financial crisis.
However, not everyone agrees that the capital requirements are strong enough to avoid another meltdown.
Said Simon Johnson, an economics professor at the Massachusetts Institute of Technology and a former International Monetary Fund chief economist: "Lehman Brothers had 11.6 percent (of the same kind of) capital one day before it failed. The new capital requirements will not even reach that inadequate level."
Published: Tue, Sep 21, 2010
