THE NEW BANK RULES / THE NEW YORK TIMES EDITORIAL ( RECOMMENDED READING )

Editorial

September 13, 2010

The New Bank Rules

Sunday’s agreement by international banking regulators to require banks to increase their capital cushions should reduce the risk of another financial meltdown. Bankers’ appetite for risky investments has not been quenched, and regulators will have to be vigilant.

The most significant rule approved by the Basel Committee on Banking Supervision — a group of regulators from 27 countries, including the United States — means banks will have to boost their reserve of common equity (common shares and retained earnings) to 7 percent of their assets, up from 2 percent currently, if they don’t want to face limits on dividends they can pay to investors.

The group also suggested that in boom times, national regulators should require banks to set aside up to an additional 2.5 percent of their assets to prevent the emergence of new credit bubbles. Regulators are still hashing out even more stringent capital requirements for the world’s biggest banks — those whose bankruptcy would threaten the entire banking system.

The bankers and their lobbyists did not go quietly. Regulators agreed that the new capital rules won’t start to kick in until 2013 and won’t be fully in place until 2019. The countercyclical buffer is not a requirement but only a recommendation to national regulators. Provisions to ensure banks have enough money to pay all of their debts coming due over one year were watered down and pushed back until 2018.

There are still weaknesses that banks will almost certainly try to exploit to reduce the amount of capital they must set aside. There are no clear rules on how banks should value liquid assets that are not openly traded, a gap that national regulators will have to fill. The new rules are risk-weighted: the more speculative their investment, the more capital banks must set aside. Yet determining the risks of these assets will still rely largely on the rating agencies that failed so miserably to assess the risk of mortgage-related securities.

Despite the weaknesses, the new rules are a considerable improvement over the status quo, and the United States and the other members of the Group of 20 leading economies should endorse them. Even then, the rules will only be as good as the commitment of national regulators, starting with the Federal Reserve and the Federal Deposit Insurance Corporation. And given the international nature of banking — any global regulation will only be as strong as the weakest regulator.