April 10, 2008 / 11:40 PM / 9 years ago

Banks urged to boost capital amid credit crisis

NEW YORK/WASHINGTON, April 10 (Reuters) - Banks are facing calls to boost their capital levels, but doing so will be painful, and some wonder if capital adequacy is even the biggest problem to resolve in the banking system now.

Some of the most important members of the global banking system -- from central bankers to bank chief executives -- are converging on Washington D.C. this weekend to discuss the problems plaguing the financial sector.

High on their list of solutions is higher capital requirements for banks, to shore up confidence in the sector. The Financial Stability Forum, which includes central bankers and global regulators, is expected to recommend on Friday that financial institutions lift capital buffers where appropriate.

But the Institute of International Finance, a global financial services lobbying group, cautioned in a report on Wednesday that even if some firms need to rebuild capital, it would be a mistake to make international capital requirements even more conservative than they already are.

Those two recommendations reflect the broader challenge regulators now face: they must restore faith in the global banking system through measures like boosting capital requirements, but must not burden banks with new rules so onerous that they add to recessionary pressure unnecessarily.

"I think it's way broader than capital levels. I think what will happen is that the whole regulatory investment financial and lawmaking community is beginning to take a look at the whole subject of appropriate regulations of the financial industry," said Steve Bartlett, chief executive of the Financial Services Roundtable, which lobbies on behalf of big financial firms.

Few dispute that banks need more capital. Financial institutions have written down some $300 billion of subprime mortgage assets, among others, and many believe the final total of write-downs could be two or three times that amount.

Those losses give banks two choices: raise equity or shed assets. Financial institutions have so far raised about $180 billion of equity, according to Lehman Brothers' estimates. The gap of more than $100 billion between the equity raised and the assets written down could force financial institutions to trim more than $1.5 trillion of assets, Lehman estimates.

Forcing banks to hold even more capital than their current requirements would likely make a slowing economy even worse, said Gene Ludwig, former U.S. Comptroller of the Currency.

"Banks will have to pay a lot of money for that capital, and because they'd be paying a lot for capital and are less leveraged, they'll do less lending, which exacerbates recessionary tendencies," said Ludwig, now chief executive of Promontory Financial Group, a bank consulting firm.

In the United States, investment banks have traditionally had easier regulations when it comes to capital, but many expect that to change.

Investment banks in recent weeks have begun borrowing directly from the Federal Reserve, in a move designed to shore up their balance sheets.

U.S. Senate Banking Committee Chairman Christopher Dodd thinks that when investment banks access the Fed's discount window they should have to adhere to some of the same regulations applied to commercial banks.

If that means requiring more capital, investment bank profits could be hurt, and they may have to turn their focus away from trading to other areas such as retail brokerage and asset management.

"This is not good for the trading businesses," said Brad Hintz, senior analyst with Sanford C. Bernstein.

Some investors believe regulators need to do a good deal more than just tweak some rules.

Nandu Narayanan, a portfolio manager at hedge fund Trident Investment Management, reckons banks should be forced to come clean on the full extent of their weak assets. When investors fully understand what's on bank balance sheets, they'll be more willing to supply banks with more capital, he said.

"The job of regulators is not to make a few small changes and convince everybody that things are okay -- it's to force people to come clean about their problems, so new investors know exactly what they're getting into," Narayanan said.

For a related FACTBOX, click on [ID:nN10340739] (Editing by Braden Reddall)

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