Concern is growing among regulators that efforts to minimise the knock-on effects of a Greek government default would undercut the global drive to make banks safer by forcing them to hold more capital.
The German government and the European Central Bank are at loggerheads over how to involve private-sector holders of Greek bonds in a second bail-out of Greece.
Berlin wants a “soft restructuring” or extension of bond maturities, which ratings agencies and investors regard as a default. Some banking regulators suspect the German government is pushing for a form of technical Greek default but wants to shield its own banks – and those in the rest of the eurozone – from a big part of the impact by exploiting loopholes in banking regulation.
Under current rules, most banks do not have to hold capital against sovereign bond stocks because they are considered to be very safe. A default would normally trigger a change in risk-weighting and prompt higher capital charges.
But some European Union negotiators are looking for a way around that rule, because they are worried about the potential impact on banks that are already struggling to meet the new, tougher “Basel III” capital requirements.
They have identified two possible loopholes in the global rules and the European law that implements them in the 27-member bloc. One gives regulators the authority to provide guidance on what constitutes a default, and another defines a default as a failure to make payments for 90 days or more.
In theory, EU regulators could use either to say a restructuring did not count as a default for purposes of regulatory capital. Some negotiators are talking of a “temporary default” of less than 90 days already.
“Thus a properly structured reprofiling could leave bank regulatory capital levels unaffected [and] an ‘enterprising’ regulator could mitigate the impact even of a payment default,” said a regulation expert.
That possibility has appeal because it would reduce disruption in the broader market. But it has also raised hackles among some members of the Basel Committee on Banking Supervision who have spent the past three years fighting for higher capital requirements. Those rules, which tighten the definition of capital, effectively require all banks to hold top quality “core tier one capital” equal to 7 per cent of their assets, adjusted for risk.
They are particularly irked that French and German banks, whose regulators generally sought to slow down and weaken the new standards, would be among the main beneficiaries of the loophole. The topic is expected to come up at the Basel committee meeting this month, as part of a larger agenda item on how the rules are being applied across the world.