Bloomberg News

Bank-Capital Rule on Sovereign Debt Targeted by EU Lawmakers

January 23, 2012

(Updates with European Parliament comment starting in seventh paragraph. For more on Europe’s debt crisis, click on EXT4.)

Jan. 23 (Bloomberg) -- European Union lawmakers are seeking to close a loophole in bank-capital rules that allows lenders to escape holding reserves against possible losses on the crisis- hit region’s sovereign debt.

A European Parliament committee will discuss overhauling the measure to ensure that lenders hold enough capital to reflect the true risks of government bonds on their books, according to two of its members. Still, they said any measures should only take effect after the current market turmoil subsides to avoid compounding the EU’s fiscal woes.

The idea that Europe’s sovereign debt is devoid of risk was shattered by the onset of a crisis that has threatened the survival of the euro. Greece negotiated with private creditors to lower its debt levels as part of a second international bailout since 2010. Portugal and Ireland have also sought financial support to stave off defaults.

“I don’t think anyone is zero risk,” said Sharon Bowles, chairwoman of the assembly’s economic and monetary affairs committee. “We should dispense with the concept. It can maybe be the case that you don’t have to hold capital in certain circumstances. It’s just using this terminology turns us into idiots.”

Bowles’s committee will consider the zero rating at a meeting on Jan. 24, as part of a broader debate on proposals to implement bank rules drafted by the Basel Committee on Banking Supervision in the EU.

Not ‘Economic Reality’

“I am convinced that the zero risk-weight does not correspond with the economic reality any longer,” Othmar Karas, the Austrian lawmaker who is in charge of drafting the Parliament’s response to the proposals, said in an interview.

Regulators should overhaul a minimum liquidity rule for banks that was drawn up in Basel, Karas told reporters in Brussels today. The requirement, known as a liquidity coverage ratio, would require lenders to hold enough easy to sell assets to survive a 30 day credit crunch. It has been criticized by banks for being overly focused on sovereign debt.

The definition of what counts as an easy to sell asset should be expanded to include gold and some equities, Karas said.

Global regulators have attacked the zero weighting, saying it allows banks to ignore the dangers they face from writedowns of government bonds, making them more vulnerable to economic turmoil in the 27-nation bloc.

Budgetary Discipline

Ideas include a review of the rule for countries receiving EU bailouts, or making the zero risk-weight conditional on a nation adhering to the region’s rules on budgetary discipline, Karas said in an interview.

Lawmakers’ scope of action is limited in the short term because it could worsen the region’s fiscal crisis, according to both Karas and Bowles, a U.K. member of the EU assembly.

Karas’s draft report published last month calls for the European Commission, the EU’s executive arm, to set out options for scrapping the zero weighting “as soon as possible, while taking into account potentially destabilizing effects” of making such proposals “during periods of market stress.”

Bowles said lawmakers should take action “that’s stronger than just calling for a report -- but it can’t happen right now.” It’s “not the moment to actually switch over” from the zero risk-weighting, she said in an interview.

The Bank for International Settlements has attacked the current EU rules, saying they allow banks to apply a “one-size- fits-all” approach to government debt that isn’t in line with standards agreed by the Basel Committee.

Deficiency

“Although sovereign assets are still a relatively low-risk asset class, they should no longer be assigned a zero risk- weight,” it said. “The deficiency is not in the Basel standards but in the way the global standards have been applied in some countries and especially in the European Union.”

The EU should consider scaling back its implementation of Basel rules if the U.S. doesn’t also take steps to apply the standards, Karas said today. The EU should identify rules that could lead to “distortions of competition,” if they are applied in Europe but not in the U.S., Karas said.

Still, the EU should aim to beat the Basel committee’s timetable for forcing lenders to boost their core capital, Karas said. A Basel requirement for lenders to have core reserves equivalent to 4.5 percent of their assets, weighted for risk, should be brought forward to 2013 from 2015, he said.

EU governments and the parliament must together agree on the final wording of the capital rules before they can become law in the region.

--Editors: Peter Chapman, Stephen Taylor

To contact the reporter on this story: Jim Brunsden in Brussels at jbrunsden@bloomberg.net

To contact the editor responsible for this story: Anthony Aarons at aaarons@bloomberg.net


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