Dividend and bonus rules face reform

Banks will be blocked from paying dividends to shareholders or bonuses if their capital levels fall below a minimum threshold, under the terms of a new, more invasive international regulatory regime unveiled on Thursday.

The Basel Committee on Banking Supervision, which is reviewing the rules governing banks’ strength, said the ban would apply if a bank failed to maintain a yet-to-be determined buffer above a new regulated minimum.

The shock measure, whose details will be fixed over the coming months, is part of a package of reforms that is the most ambitious regulatory response yet to the financial crisis.

There was immediate criticism from regulatory experts, centring on the focus on bonuses.

“It is intellectually wrong-headed,” said Simon Gleeson, partner at Clifford Chance, the law firm. “Bonuses are costs of doing business and are not ‘discretionary’ in the same way that dividends are.”

In a widely expected move, the committee said that hybrid capital – a form of debt that has been substituted for equity – must be phased out as top-ranking capital to “ensure that large, internationally active banks are in a better position to absorb losses”.

Also included in the package are the introduction of a global leverage ratio, a new liquidity regime, new asset risk weightings to reflect counterparty credit risk, and countercyclical capital buffers to ensure banks build up financial reserves in good times.

Analysts at Credit Suisse called the measures “pretty punitive”. They said: “In particular, the new definitions of common equity tier one appear to take a very hard line with the majority of deferred tax assets, insurance equity capital, excess expected losses, unrealised debt losses, minority interests and pension fund liabilities being deducted.”

The measures will be the subject of an impact assessment in the first half of next year.

Nout Wellink, chairman of the committee, said: “The capital and liquidity proposals will result in more resilient banks and a sounder banking and financial system. They will promote a better balance between financial innovation and sustainable growth.”

The 72-page document released on Thursday is the latest regulatory response to the financial crisis. In the summer the committee published details of requirements to allocate more capital to back risky trading activities, which on average have obliged banks to hold three times more trading capital.

The committee made clear that its changes to the tier one capital regime were the key reform. In a consultation document, the committee said the so-called tier one capital base – a measure of top-ranking capital – would have to comprise predominantly common shares and retained earnings.

The committee said: “Innovative hybrid capital instruments with an incentive to redeem through features like step-up clauses, currently limited to 15 per cent of the tier one capital base, will be phased out.” Hybrid capital, blamed by critics for failing banks in the crisis because of its inability to absorb losses, was expected to be outlawed.

All elements of capital would have to be disclosed to improve the transparency of the capital base.

The committee said it would discuss the role that contingent capital instruments could play in banks’ balance sheets at a follow-up meeting next July.

Lloyds Banking Group recently raised £9bn ($14.5bn, €10bn) by switching existing debt into contingent convertible , or CoCo, bonds. CoCos count as debt instruments but convert into equity if a bank’s capital ratio comes under stress.

The committee said the ratio would be adjusted to smooth differences between US and international accounting standards.

Banks will also be required to comply with a new 30-day liquidity coverage ratio.