Standard & Poor's, the credit rating agency, has undermined the importance of the proposed new Basel II rules on bank capital by threatening to downgrade banks that implement them more strictly than it thinks they should.

Banks that are active in less risky areas such as mortgages could enjoy a substantial reduction in the amount of capital they are forced to hold, thus improving their profitability.

This is because the new rules are intended to allow banks to match the amount of capital they are obliged to hold with the risks they take in their businesses.

This is designed to make the banking system more efficient and stable. However, Mr Clifford Griep, S&P chief credit officer, said: "Banks could be downgraded if they reduce their risk capital provisions on the basis of the Basel II accord using calculation methodologies with which S&P doesn't agree."

Under the new rules, banks are allowed freedom to determine their risk levels and matching regulatory capital. But S&P's remarks amount to a warning to the regulators charged with supervising the implementation of the rules to stress-test the banks' estimates properly.

Its ratings are crucial to banks' stability because they affect the terms on which they can finance themselves and do business.

S&P said it supported Basel II's goal but was concerned about its "lenient" treatment of risk in some areas, especially mortgages and consumer lending. It said the new rules failed to take account of the variation in credit risk that can occur between economic booms and recessions.

Ms Tanya Azarchs of S&P's financial institutions group said Basel II could allow banks to hold less capital in good times and more in weaker climates. - (Financial Times Service)