G20 capital rules: Finance ministers and central bankers seem to be getting carried away with their newfound passion for cross-border cooperation and international harmony. Their proposed rules for making the global banking system safer raise fresh questions rather than providing clear-cut solutions to the problems of the day. This is mostly because there is no credible calendar for their new prescriptions on capital and leverage ratios, or for the necessary harmonisation of accounting standards on both sides of the Atlantic.
Take the “bigger and better” prescription for capital ratios, which finance ministers and the Basel committee of central bankers are calling for in surprisingly similar terms (but isn't central banks independence one of the casualties of the crisis?). The consensus is that banks should focus on core Tier 1 ratios, as hybrid debt isn’t as effective at absorbing crisis losses. European banks have traditionally relied more on hybrid capital than US competitors. But telling them now that they should fatten up their capital is sending a confusing message at a time when the same governments are also urging banks to keep lending to the economy. And some already fear that Europe's banks will start building up capital without waiting for better days.
A credible calendar is also urgently needed for the much talked-about but still far away harmonisation of accounting standards. Even within Europe, the definition of what constitutes Tier 1 capital varies from one country to another. Before the work is done, and without agreements between Europe and the US accounting rule-makers, it makes little sense to compare and evaluate banks’ capital adequacy. Not to mention the fact that US regulators have not yet bound their banks to Basel II.
Finally, finance ministers and central bankers are calling for the creation of a leverage ratio that could be incorporated within Basel II. But here again, without an agreement on accounting, which would help differentiate assets according to risk, it would be senseless to force the same leverage norm on, say, Goldman Sachs and the Korea Development Bank. Here too, the authorities have more work to do in delivering a genuinely credible proposal.
