The heads of state and finance ministers at the Toronto G20 summit agreed [1] that in future banks should keep enough capital on their balance sheet to overcome the consequences caused by the aftermath of Lehman Brothers’ collapse in 2008. The ruling is likely to have profound consequences for banks both in the UK and overseas. In the UK under new rules agreed the plan will bolster the banks’ balance sheets by as much as £130bn which is equivalent to £5,200 for every household in Britain.
Under the previous international banking accords, the banks were obliged to hold only 8pc of safe capital mostly equity on their balance sheets to provide a buffer against insolvency. The new rules sketched out at the G20 summit threaten to go some way further. Capital requirements act as an effective speed-limit for banks, with higher requirements preventing them from making bigger profits and a reduction in lending. The G20’s final communiqué said: “The amount of capital will be significantly higher, and the quality of capital significantly improved, when the new rules are fully implemented. This will enable banks to withstand, without government support, stresses of the magnitude associated with the recent financial crisis.” The rules will be enforced by the G20’s Financial Stability Board, though potential sanctions against banks which fail to abide by them have not yet been agreed.
During the crisis, British banks have had to bolster their balance sheets by £127bn, with around half of this coming from the taxpayer, according to Bank of England figures from the turn of the year. Since then, banks have raised a further £15bn from the open markets as they seek to improve their financial health. The G20 agreement implies that this balance sheet rebuilding and effective fall in bank profitability will have to be permanent. Mr Osborne the UK Chancellor of the Exchequer also stressed that regulators would demand “higher quality capital” which normally are shares rather than other less reliable items such as deferred tax assets and software, so as to ensure banks would not attempt to circumvent the rules.
The consequences for the financial system and wider economy are likely to be far reaching, with banks needing to continue focus cash towards strengthening their balance sheets and therefore reluctant to lend. Any increase capital levels held by the banks whilst being an insurance against failure is also a real cost to the economy as it makes credit both more expensive and less available.
G20 countries are to be allowed time to implement the rules, so that there is no immediate rush to re-capitalise so that it will not have a negative effect on economic activity. The communiqué said that the countries will adopt the new standards “over a time frame that is consistent with sustained recovery and limits market disruption.” It does introduce a new era and an ongoing reduction on the size bank lending abilities.
The decision on how much the 8pc capital ratio should be increased by will be taken at the next G20 meeting in South Korea in November. The indication is that the target may be well into double figures. However implementation will not take place until 2012. The new rules are likely to be resisted by banks in France and Germany, which hold less capital on their balance sheets than their UK or US counterparts.
The summit concluded that the financial sector should make a ‘fair and substantial contribution’ towards fixing the economic crisis. It added: ‘Some countries are pursuing a financial levy’. However, the UK failed to persuade all other world leaders to follow its lead on a new banking levy. The coalition introduced a £2billion per annum super tax on balance sheets as indicated in the Emergency Budget.
Together with the austerity measures introduced by all major countries in Europe and the potential effects on both the public and private sectors growth could also be affected by these banking changes. It strongly suggests that the UK and most of Europe will not get back to previous growth levels for many years to come.