New Banking Rules Coming

  According to reports in European media, global bank regulators & #160;have agreed tough new rules for banks that could see & #160;defined limits placed on lending, dividend payouts and hard and fast rules on the quality of capital.But the proposed changes won't be introduced until the end of 2010 at the earliest, and if they follow other rule changes from the Basle Committee, there will be a transition period to allow all banks to come into line, according to a report in the latest edition of the Financial Times.This is a far more important issue than the kerfuffle on bankers pay and bonuses.The reports give us a flavour of the shape that our new bank liquidity and capital rules will take when APRA, the lead regulator, issues a discussion paper shortly.This week APRA released a revamped discussion paper on remuneration that was mostly unchanged from an earlier draft. It will however now not apply until April 1, 2010, instead of the earlier start date of January 1.According to the reports, the main impact of the proposed changes will be to force & #160;many European banks to restructure their capital bases and & #160;tens of billions of euros in fresh capital in the next 12 months.The accord on the shape of new regulations follows the Group of 20 finance minister's statement & #160;at the weekend in London.The rules will force banks to substantially improve the quality and extent of the capital buffers they hold to absorb shocks, such as the credit crunch and recession of the past two years.The FT said in its report that at least half of the capital cushion of banks must comprise common equity and retained earnings under measures agreed by the powerful Basle committee of central bank governors and bank regulators.The Basle committee also agreed to put & quot;hard & quot; limits how much banks can borrow. It is likely to set a ceiling on borrowings of no more than 25 times assets. There will be no exceptions for less risky assets.It also agreed that bank supervisors should be able to limit the ability of banks to make payouts to shareholders through dividends or buy-backs when times are good, enabling them to build & quot;counter-cyclical & quot; buffers against bad times.This is a response to pressure from regulators and governments for some sort of counter cyclical policy to prevent bubbles developing and force banks to hoard capital from the good times. This is likely to need a change in local and international accounting policies.The Group of 20 finance ministers referred directly to this in their statement on bank regulation on the weekend when they said: & quot;We call on banks to retain a greater proportion of current profits to build capital, where needed, to support lending & quot;.This will upset investment banks and brokers who have already started spruiking the line that Australian banks could return & #36;A16 billion in excess capital over the next few years.They still might, but will have to assure APRA that they have ample capital reserves to allow that to happen.The Basle committee is expected to issue & #160;definite rules & #160;by the end of this year and then change them to take account of feedback to start by the end of 2010.Australia's big four banks, the Commonwealth, Westpac, ANZ and National, are not likely to be impacted much by the changes, although they each have some sort of hybrid or floating rate note on issue and listed on the ASX.CBA's Perls have a hybrid look to them being a preference share stapled to a note. The 4th issue is currently listed and & #160;the bank this week issued the prospectus for the fifth issue of Perls.The NAB has a floating rate security; Westpac and the ANZ have preference share hybrids listed. Suncorp and Bank of Queensland also have preference shares issues listed on the ASX.Unlike European banks, these issues do not account for a high proportion of capital.But what will hurt will be the strong suggestions that regulators gain some control over bank dividend and buybacks to allow them to build up liquidity buffers.The Financial Times has reported that some major European banks have up to a third of their capital base in hybrid securities which will have to be replaced in the next year by fresh ordinary share issues.Overall, Australian banks have high levels of ordinary issued shares in their capital bases. & quot;European banks are expected to be hardest hit by the Basle committee moves as complex securities constitute a large part of their capital cushions than their US peers. The securities, a mixture of debt and equity, are known as hybrid capital. & quot;The list of banks that need to raise common equity could include Germany's Commerzbank and Lloyds Banking Group. & quot;But analysts and others say that any bank around the world that has taken a capital injection from a government during the crisis will have to refinance because many of these issues are in preference or convertible type securities which were found & #160;not to be as strong as ordinary shares during the crisis.The reason for this weakness is that these shares often depend upon the financial strength of the holder to convert the shares by paying an amount of money: when liquidity is under pressure, holders tend to hoard funds, and are reluctant to pay them to another party. & quot;Hybrid capital covers a variety of instruments, such as preference shares, that are not pure equity but have traditionally been deemed close enough to it to count towards a bank's tier one capital ratio - the key measure of financial strength, & quot; The FT reported. & quot;Some European banks have traditionally held a lot of their capital in hybrid form in an effort to minimise the dilution to equity investors from having to raise fresh funds. Regulators in Europe have allowed banks to hold more hybrid capital than their US counterparts - up to a third of total tier one capital in some jurisdictions. & quot;But that has proved problematic in the financial crisis, since hybrid capital does not have the same loss-bearing capacity as true shareholders' equity. & quot; & #160;European banks have been buying back hybrids at prices well under market to generate capital profits, which have then been used to load up core capital.Others (including Macquarie Group) have been buying back debt at deep discounts and booking profits and using that to replenish capital and reserves.  

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