TAX NEWS - JUNE 2010

G-20 Seeks To End Uncertainty With New Pledge On Bank Reforms

The world's biggest economies sought Saturday to end market uncertainty over repairing battered banking systems, by sticking with targets for new capital rules but signaling flexibility over how fast to implement them.

A key issue debated by finance ministers and central bankers from the Group of 20 industrial and developing powers at their two-day meeting in Busan, South Korea, was plans for tougher rules on bank capital and liquidity.

The G-20 kept their goals of reaching agreement on the rules this year and implementing them by the end of 2012--if the global economy has emerged from the downturn. But the group's communique stressed that full implementation could take time as some of the thorniest issues like bank capital definition are still far from resolved.

"What is important now is to show maximum determination to achieve the objectives," Mario Draghi, chairman of the Financial Stability Forum. "From this viewpoint the determination to complete the main blocks of the financial sector regulatory reform is really helpful for markets."

The FSB is a global regulatory body that advises the G-20 on the reform of global financial regulation and on the overhaul of global financial supervision.

A key item of these reforms is the revamping of the Basel II capital-adequacy rules, underway at the Basel Committee of international banking regulators. The new rules aim to improve the quantity and quality of banks' capital buffers and to strengthen their liquidity requirements.

While the need for fatter capital buffers has been universally endorsed by all G-20 leaders in the aftermath of the 2008 banking meltdown, the issue of bank-capital reform has proved a contentious one at the Busan G-20 gathering.

Some G-20 members, like the U.S., the U.K. and Canada, have stressed the need for the new rules to be completed as soon as possible in a bid to end uncertainty, while underlining that implementation could be flexible.

Others, particularly some European countries like France, have insisted that enough care should be taken in assessing the impact of these rules on the economy in order to properly calibrate them, so as not to undermine the nascent recovery.

For instance, new liquidity ratios proposed by the Basel Committee have been particularly criticized by European banks for threatening to impose excessive long-term funding requirements on them, which they say could damp credit growth.

In the end, the G-20's carefully crafted communique reads like a compromise for both sides. While G-20 finance ministers reaffirmed their commitment to the deadlines, they welcomed "the progress on the quantitative and macroeconomic impact studies which will inform the calibration and phasing in (of the rules), respectively."

French Finance Minister Christine Lagarde welcomed this nuance.

"The G-20 has recognized the need for differentiation," she said. "We can't do everything at the same time for everybody...We have encouraged the FSB and the Basel Committee to carry on with their work on bank capital requirements, bearing in mind the need for differentiation according to the various banking models."

Indeed, FSB chairman Draghi acknowledged a transition period would be necessary before the rules could be fully implemented everywhere, especially as harmonizing the definition of bank capital across the world would be an arduous task.

"The key thing is to start implementation in 2012 and then we will find out what are the most appropriate transitions times," Draghi said. He cited the definition of bank capital as one of the thorniest issues facing regulators, because of significant differences between countries.

"That is a very important objective, but it does require changes because what some parts of the world see as capital, others don't," he said. "Rules on tax-deferred assets...on minority interests and financial holdings, all of this will have to be unified."

Draghi at the same time made it clear that regulators are aiming for tangible common equity to form the most significant part of banks' core capital. Tangible common equity is a measurement of common equity supporting a company, and doesn't include intangible assets such as goodwill.

"In the end, you want a definition of capital which is capable of absorbing losses when they materialize," Draghi said.

Under current Basel proposals, banks would have to deduct stakes held in insurance companies from their core capital. This has drawn fire from the main French banks for threatening to destroy the French model of banking insurance, which has proved resilient during the financial crisis.

A proposed global bank levy was another issue fraught with tensions for G-20 members at the Busan meeting.

The G-20 communique remained pointedly vague on the issue, only recognizing the existence of "a range of policy approaches" in order to protect taxpayers from possible bank failures, thus reflecting continuing disagreement on the proposal.

France's Lagarde, who favors the tax, said she still hoped the largest possible number of countries would eventually back the levy.

But Canada's Finance Minister Jim Flaherty, a vocal opponent along with Australia and most emerging nations, was more blunt. He described the debate over a possible bank levy as a "distraction" from the core issues, noting that most G-20 members don't support the idea.