By Omoh Gabriel with Agency report

The plan by international financial community to stave off future global financial crisis by ensuring adequate capitalization of banks is in serious jeopardy as regulators are tinkering with arrangement they had earlier agreed upon.

Capital standards or shareholders fund designed to fortify the global financial system are already eroding as European monetary officials, beset by a debt crisis, rewrite the provisions of the regulations and U.S. rulemaking has stalled.

The 27 member-states of the Basel Committee on Banking Supervision had fought over the new regime, known as Basel III, for more than a year before agreeing in December to require banks to bolster capital and reduce reliance on borrowing.

Now, as they put the standards into effect in their own countries, European Union lawmakers are revising definitions of capital, while the U.S. is struggling to reconcile the Basel mandates with financial reforms imposed by the Dodd-Frank Act.

According to V. Gerard Comizio, a former Treasury Department lawyer who is now a senior partner at Paul Hastings Janofsky & Walker LLP in Washington “The game on the ground has changed in Europe and the U.S.” The realists in Europe realised that their banks cannot raise the capital they’d need to comply.

U.S. banks have reversed course and are more assertively fighting against it. The future of Basel III looks less certain now than it did when it was agreed to.”

Interestingly the Basel committee had revised its capital standards and outlined new rules on liquidity and leverage after the 2008 crisis exposed the vulnerability of the banking system.

Credit markets froze following the collapse of Lehman Brothers Holdings Inc., sending the world economy into its first recession since World War II.

Basel III was meant to create “a much stronger banking and financial system that is much more resilient to financial crises,” said Mario Draghi, who will take over as president of the European Central Bank in November was quoted by Bloomberg as saying.

Lamido Sanusi & Ngozi-Okongo-Iweala

But the Basel standards are not binding, so each country needs to write its own rules putting the agreed-upon principles into effect. The European Commission proposed regulations to parliament last month that would translate Basel III into law.

A majority of EU governments also must endorse them. U.S. regulators led by the Federal Reserve have to come up with their own version, though they don’t need legislative approval.

The proposed EU rules, submitted by financial services commissioner Michel Barnier, omitted a ratio designed to improve banks’ cash positions, deferred decision on a rule to limit borrowing, revised capital definitions and extended some compliance dates.

In the U.S., regulators are stymied because the 2010 Dodd-Frank Act bars the use in banking rules of credit ratings, which Basel III relies on to determine risk.

“Implementation is a big concern in Europe and the U.S.,” said Karel Lannoo, head of the Centre for European Policy Studies in Brussels. “The EU crisis isn’t over; the U.S. isn’t safely out of its mess.

If we can’t get the rules that were supposed to protect the financial system from collapse, we won’t have changed anything to help us the next time around.”

While the Greek debt crisis damped enthusiasm for tightening standards last year, the Basel committee managed to develop reforms to reduce risks in the financial system, according to Lannoo and other analysts.

Increased capital requirements will create bigger buffers against losses. New liquidity rules will ensure banks have enough cash to deal with panicky customers withdrawing funds.

Renewed concern this year that Greece may be unable to pay its debts, and similar worries about larger EU members Italy and Spain, have darkened Basel’s prospects.

The sputtering economic recovery in the U.S. and Europe has hurt, too. The European Commission estimates that the region’s banks will have to raise about $600 billion to comply with the new capital rules.

Banks say that will harm their ability to lend at a time when economies are flailing. U.S. economic growth for the first quarter was revised down to 0.4 per cent, while the second quarter’s initial figure was 1.3 per cent. In Europe, gross domestic product fell from 0.8 per cent in the first three months of the year to 0.2 per cent in the second quarter.

Both the Bloomberg Europe 500 Banks and Financial Services Index and the KBW Bank Index of U.S. bank stocks have fallen about 30 per cent this year. That wiped out more than $700 billion of market value on the two continents.

The European proposal alters the definition of capital that Basel III aimed to tighten when the committee agreed not to allow anything other than common shares to count toward the top- quality bank capital regulators examine.

During the 2010 negotiations, Germany sought to maintain recognition of so-called silent participations — hybrid securities that act like debt and equity at the same time — which some banks rely on for more than half their capital.

While Germany lost the battle to exempt silent participations last year, the EU’s implementation proposal was written to allow the securities to be included if they fulfill certain conditions.

At Landesbank Hessen-Thueringen, a state-owned bank based in Frankfurt known as Helaba, silent participations account for more than 50 percent of the bank’s 6 billion euros ($8.6 billion) of capital.

Helaba withdrew from the Europe-wide stress tests in July after regulators refused to count some of those hybrid instruments as capital.

Italy fought during Basel talks last year to include deferred tax assets — future deductions from tax liabilities resulting from current losses — when calculating top-tier capital. Basel III restricted use of these assets to no more than 10 per cent of a bank’s capital.

The EU’s proposal would allow unrestricted use of deferred tax assets if they comply with certain requirements. Italy modified its tax laws in February to enable the assets to meet those conditions.

Counting tax assets would raise the capital ratio at Banca Monte dei Paschi di Siena SpA, the oldest bank in the world and Italy’s third-largest, by about 1 percentage point, according to a February Mediobanca SpA report on the benefits of the tax-law change to Italian banks. Basel III also sought to put an end to the double counting of capital in insurance subsidiaries, which many European lbanks do.

The proposed EU rules do not require banks to deduct investments in these subsidiaries from their capital, which will allow the double counting to continue, said analysts including Andrew Stimpson at KBW Inc. in London. That would benefit banks such as France’s Credit Agricole SA, whose insurance subsidiary accounts for 10 per cent of income.