BERLIN AND MADRID:GERMANY AND Spain arelaunching a last-ditch effort to soften the details of Europe's plan to strengthen its banking system, pressing for a broader range of capital to be counted towards the mandatory "temporary buffer" for banks.
Under the deal to be signed off last night, European leaders will tell banks to reach a higher 9 per cent threshold of the “highest quality capital”, after revaluing sovereign debt at market rates, an exercise that will require banks to find an estimated €108 billion.
But while the broad terms of the plan are agreed, key technical details are still unresolved, including what form of capital will count towards the new requirements.
The European Banking Authority (EBA) has proposed using the relatively narrow definition of capital it applied during its July stress tests, which was closely linked to the new Basel III standards agreed last year.
However, countries such as Spain and Germany are reviving objections to the criteria and pushing for other forms of capital, such as hybrid debt, to be included.
If regulators agree to water down the criteria, it could add 1-2 per cent to some banks’ core tier-one capital ratios. Morgan Stanley said in that case the fresh capital required could be as low as €50 billion to €90 billion.
Spanish bankers have been watching European negotiations over bank recapitalisation with growing alarm, fearing they will be disproportionately penalised by an overly narrow definition of capital.
European officials say they are determined for the exercise to be credible and argue it is in substance almost the same as the authority’s exercise in the summer. However, some people familiar with the discussion say some tweaks may be required.
The discussions will concern bank capital hawks, who argue that the success of the recapitalisation in winning back market confidence will rest on rigorous implementation.
“The EBA is invested with a big responsibility. They came up with the proposal, now they have to see it through and make sure there is proper implementation,” said one senior figure involved in the process.
A draft of the final summit communique concludes: “There is broad agreement on requiring a significantly higher capital ratio of 9 per cent of the highest quality capital and after accounting for market valuation of sovereign debt exposures, both as of September 30th, 2011, to create a temporary buffer.”
The plan gives banks until June 30th next year to raise the extra capital and suggests that regulators will place restrictions on bonuses and dividends at institutions struggling to reach the new threshold.
“Banks should be subject to constraints regarding the distribution of dividends and bonus payments until the target has been attained,” the draft statement says.
While national regulators have powers to restrict bonuses in this manner, bankers expect the provision will have little practical impact on those institutions that are able to provide a credible plan for hitting the higher capital level.
The debate over capital definitions, expected to be resolved in coming days, echoes the arguments prior to the authority’s last stress tests and could make a big difference to some banks, particularly in Spain and Germany.
In the summer stress tests the authority reasoned that some convertible debt instruments should not be included. They are scheduled to be dropped from the definition of capital once Basel III begins taking effect in 2013 because regulators believe they do not absorb losses in a crisis.
The authority also stood firm against German special pleading for their Landesbanken, and one pulled out of the stress test when some capital was not approved.
Santander, the biggest euro zone bank by market capitalisation, had at the end of June a core tier-one capital ratio of 9.2 per cent under Basel II rules.
But the ratio would fall by about 80 basis points under Basel III, mainly because of the exclusion of intangibles in the form of goodwill on companies acquired. – Copyright The Financial Times Limited 2011