Last updated: October 25, 2010 11:54 pm

Pandit and King clash over Basel III

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Vikram Pandit and Mervyn King clashed on Monday over Basel III proposals and new international rules on capital standards.

The Citigroup chief executive and the governor of the Bank of England took diametrically opposed positions on attempts to increase banks’ capital adequacy and risk management. The US banker attacked the moves for going too far and risking exacerbating problems that had led to the financial crisis, while the central banker said they did not go far enough.

The contrasting views underline the tension between banking chiefs and regulators at a time when policymakers around the world are overhauling financial sector rules to avoid a repeat of the recent turmoil.

Mr King said the plan agreed last month to increase banks’ capital buffers sharply “on its own will not prevent another crisis”.

He added: “Only very much higher levels of capital – levels that would be seen by the industry as wildly excessive most of the time – would prevent such a crisis.”

In his speech at the Buttonwood Gathering in New York, Mr Pandit disputed that notion, decrying “a bidding war in which some regulators internationally are now attempting to outdo Basel – and one another”.

The Citi chief abandoned his usual caution to warn that, on most issues, Basel III “is either silent, doesn’t go far enough or makes the problem worse”.

Mr Pandit said Citi, in which the US government has a 12 per cent stake, would “meet and exceed” Basel III’s higher capital requirements but the new rules would encourage banks to increase debt levels, “piling risk into the system”.

In his view, the focus on increasing capital requirements in times of crisis only to lower them when conditions improve will be counterproductive and hamper economic growth.

Mr Pandit said the new regime’s requirement that banks measure the riskiness of a loan by looking mainly at customers’ credit histories would make it difficult for many consumers and companies to get access to funds.

“Under Basel, the ‘sweet spot’ business model for banks in the developed world will be to take retail deposits from ‘mom and pop’ [small but stable customers] and lend only to big business and the wealthy,” he said. “I don’t believe this is the banking system we want.”

By leaving out hedge funds and private equity groups, the regime would also lead to the creation of “another shadow banking system” and “create new incentives to rebuild some of the worst features of the very environment that led to the crisis”, he added.

“Shifting risk into unregulated or differently regulated sectors won’t make the banking system safer. On the contrary, overall risk in the system could actually rise,” Mr Pandit said.

In his speech at the same conference, Mr King said reforms might need to go further and could include demanding capital levels many times higher than the levels set out in Basel III, splitting up banks or requiring the use of debt instruments such as contingent capital that left creditors more exposed when things went wrong.

His comments provide a forewarning of the position the central bank is likely to take as it extends its control over the UK’s financial regulation.

The first meeting of its new financial policy committee – given the job of overseeing financial stability in a similar fashion to its interest rate-setting role – is expected this year.

Mr King said the Basel III rules on capital requirements, agreed globally last month, were a “step in the right direction” but were not enough.

The Basel III proposals will force banks by 2019 to more than triple the proportion of highest-quality assets they hold as a buffer against losses.

Mr King dismissed concerns that nine years was too short a timetable. But he said increased capital levels alone would be inadequate – shortly before UK lender Northern Rock went bust in 2007 it was judged to have the highest capital ratio of any leading British bank.

“If it is a giant leap for the regulators of the world, it is only a small step for mankind,” Mr King said. “Basel III on its own will not prevent another crisis.”

Mr King argued that a tax on bank balance sheets – such as the one promised by the UK ruling coalition – was also deficient because it was impossible to judge the level at which it should be set.

He added that singling out banks as “too important to fail” was dangerous because, by subjecting critical institutions to special measures, authorities risked making an implicit subsidy into an explicit one.

He framed the problem in terms of making sure that banks paid the proper price for the risks they took in relying on short-term funds and deposits to support long-term lending. In economic jargon, he said: “The damaging externalities created by excessive maturity transformation and risk-taking must be internalised.”

Measures that might help ensure stability in the banking system included raising capital to “several orders of magnitude” higher than its post-Basel III levels, Mr King said.

That might include banks holding much more contingent capital – debt that converts into equity when an institution gets into trouble.

Banks might have to be split up, separating their more routine utility parts from their more casino-like operations, he said.

Or, in an idea that would mean the radical reshaping of the banking system, banks could be forced to match each investment made with funding over an equivalent time period, Mr King said.

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