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Basel III Accord Reached: Capital Requirements Set at Minimum 7%

Reuters reported about an hour ago that negotiators had reached a deal on the Basel III reforms for international banking, and that on the key question of capital requirements, the range would fall in between 7% and 9%. The press release from the Group of Governors and Heads of Supervision puts that squarely on the low end.

The Committee’s package of reforms will increase the minimum common equity requirement from 2% to 4.5%. In addition, banks will be required to hold a capital conservation buffer of 2.5% to withstand future periods of stress bringing the total common equity requirements to 7%. This reinforces the stronger definition of capital agreed by Governors and Heads of Supervision in July and the higher capital requirements for trading, derivative and securitisation activities to be introduced at the end of 2011.

Mr Jean-Claude Trichet, President of the European Central Bank and Chairman of the Group of Governors and Heads of Supervision, said that “the agreements reached today are a fundamental strengthening of global capital standards.” He added that “their contribution to long term financial stability and growth will be substantial. The transition arrangements will enable banks to meet the new standards while supporting the economic recovery.” Mr Nout Wellink, Chairman of the Basel Committee on Banking Supervision and President of the Netherlands Bank, added that “the combination of a much stronger definition of capital, higher minimum requirements and the introduction of new capital buffers will ensure that banks are better able to withstand periods of economic and financial stress, therefore supporting economic growth.”

Now, despite being on the low end of the scale, this is more than most people expected out of Basel. It would force banks all over the world to increase their capital requirements and reduce their risk. They’ll have plenty of time to do it; according to the press release, the standards would be phased in by January 1st, 2015, which steps toward the goal to be taken in 2013 and 2014 as well.

The stregthening of what Tier 1 capital actually represents really becomes the key here, and as the years progress, the banks will no doubt try to count additional assets as part of that calculation. There’s also the matter of enforcement; Reuters reports that “Any bank that fails to keep above that buffer would have to curb payouts such as bonuses and dividends,” which is exactly the right way to attack this in my view.

We’ll hear a lot from the banks around the world about how this will tighten credit, because banks will need to hoard reserves. But actually, it will more likely reduce the riskiest kinds of trades, which require progressively higher capital ratios. It might force the banks to consider actually performing their traditional role of lending and allocating investment capital to entrepreneurs.

The next step would be ratification at the G-20 in Korea in November. More from the New York Times, and a good FAQ on Basel from McClatchy.

UPDATE: Felix Salmon tweets that the BIS press release included this: “Systemically important banks should have loss absorbing capacity beyond the standards announced today.”

UPDATE II: Felix unpacks this quite a bit more on his blog, and features this handy chart from BIS:

This actually makes it substantially better than I at first surmised. 7% is essentially a minimum amount. Total capital would have to be set at 10.5%, and an additional 2.5% in boom times, for a total of 13%. And systemically important banks would have to go higher. Excerpt:

The banks aren’t going to take all this lying down, but I’m hoping their reaction is going to be relatively muted. This is a done deal, now, and they just have to live with it. And the banks which embrace the new standards and are proud of exceeding them will ultimately be more successful than those which try to get around them. Indeed, it would be great to see non-bank lenders adopt these standards too, on a voluntary basis. Most shadow banks easily exceed these ratios already, and I’d love to see the ones which don’t slowly wither away.

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David Dayen

David Dayen