The overhaul of the global financial system is almost complete.
Major banks will be required to meet sharply higher capital levels under an agreement reached by global banking authorities meeting in Basel, Switzerland, this week.
Under the deal, banks will be required to hold "core" capital that is equivalent to less than 6 per cent of assets, said Franz-Christoph Zeitler, the vice-president of Germany's central bank, implying that levels will rise significantly from the current Tier 1 capital ratio of 4 per cent.
The new capital requirements are aimed at avoiding a repeat of the credit crisis that froze the global economy two years ago and forced government rescues of major financial institutions. Mr. Zeitler said the targeted capital levels resulted from a compromise between regulators and banks, which have long complained that higher reserve requirements would impede lending and hurt the recovery. Banks would get five to 10 years to adjust to the new, stricter requirements, according to a report by Reuters.
Core capital holdings dictate the value of assets that lenders must keep as reserves to cover future losses. Agreement on capital buffers is one of the final pieces of the regulatory overhaul that the Group of 20 nations ordered in the aftermath of the financial crisis. Finding the right level has been an intellectual and political challenge, as regulators have endured regional differences, technocratic headaches and an aggressive financial lobby on their way to a compromise.
Setting a standard for reserve capital has proved difficult because it goes directly to banks' profits - the more cash and other assets that they are forced to keep on hand, the less they can earn through interest on loans. Bank executives and regulators have tangled for months over how much tighter capital requirements would hurt the global economic recovery by restricting credit. Earlier this year, finance ministers and central bankers gave a little ground by agreeing to give the banks adequate time to adjust to new standards. But policy makers have held firm on their demand that banks must maintain bigger reserves.
"The rules will create a considerable need for additional capital," Mr. Zeitler said. A German newspaper said this week that the Basel Committee also had agreed to require banks to hold an emergency buffer equal to 3 per cent of assets on top of the core capital requirement, but officials weren't commenting on that possibility Wednesday.
The Basel agreement was set by junior officials; central bankers and chief regulators take over in Basel next Sunday in a meeting that is to be chaired by European Central Bank president Jean-Claude Trichet.
"In this weekend's negotiations, we want to decide the final package," said Axel Weber, Mr. Zeitler's boss at the Bundesbank. "No country will be able to push through its national position. There will be compromises and everyone will have to be ready to move away from their negotiating position."
The talks on financial regulation are being held under the auspices of the Basel Committee, a collection of banking regulators from more than a dozen countries that set guidelines for national regulators. The idea is to create an international framework that prevents countries from seeking a competitive advantage by subjecting their banks to weaker standards than those faced by rivals in other countries.
On Sunday, the Basel Committee's oversight body, called the Group of Governors and Heads of Supervision, will meet to review Wednesday's compromise. Bank supervisors are under pressure to come up with a broad regulatory proposal in time for the next G20 summit in Seoul in November, the deadline leaders set to lay out their vision for a revamped regulatory system that is less prone to failure.
Nancy Hughes Anthony, head of the Canadian Bankers Association, said it is "premature" to conclude that a compromise by officials would be embraced by their political masters. Just as important as capital levels is the kind of assets banks will be allowed to retain as reserves, something that will complicate analysis of whatever is agreed this weekend in Basel, she said. "I'm hopeful that it will come out soon," Ms. Hughes Anthony said, but "it's not done until it's done."