The European Union is in the process to writing an international agreement on capital defences for banks into European law. This would determine the level of risk Europe's banks can take and what regulators can do to ensure that financial crises like the one brought on by the collapse of U.S. investment bank Lehman Brothers in 2008 do not happen again.
The so-called Basel III deal would force banks gradually to increase their highest-quality capital — such as equity and reserves — from 2 per cent of the risky assets they hold to 7 per cent by 2019. An additional 2.5 per cent would have to be built up during good times.
But several countries, including the U.K. and Sweden, want to require their banks to build up even higher defences without having to go to the European Commission, the EU's executive arm in Brussels, for approval. There was also some disagreement over what should count as capital. Some countries are warning that Europe could be seen as softening banking rules at a time when it is already under close scrutiny from international investors.
"If we duck the challenge of implementing Basel we could face very important challenges to confidence in Europe this year," warned George Osborne, the U.K.'s Treasury chief.
Basel III was agreed by the world's leading economies after the 2008 financial crisis demonstrated that many banks did not have enough of a capital cushion to absorb sudden losses on loans and other risky activities. Once agreed, the new rules would apply to more than 8,300 banks in Europe, forcing them to build up billions in extra capital by selling shares or assets or reining in bonuses and dividends.
The 2008 financial panic that followed Lehman's collapse hit Europe hard. Between 2008 and 2010, governments across the 27-country-bloc spent €4.6 trillion ($6.1 trillion) propping up struggling banks.
What complicated efforts even more was that the open borders in the EU allow banks to operate freely across the bloc, but when lenders ran into trouble it was national governments — and taxpayers — who had to foot the bill. While the EU is now striving for a single set of banking rules, there is still no pan-European bank resolution fund that could relieve national governments.
The U.K., which had to save three major banks, has seen its debt load almost double since 2007. Meanwhile much smaller Ireland had to seek an international bailout to help stem the losses of its domestic lenders. And many economists fear that the economic recession in Spain may soon reveal massive bank losses there.
Now, the U.K. is leading a group of countries that want to be able to force their own banks to have bigger defences than the ones prescribed by the pan-European rules without first getting approval from Brussels.
"We should make it clear that the crisis did not originate exclusively from weak fiscal policy. It originated also from insufficiently strong banks," said Polish Finance Minister Jacek Rostowski. "So therefore a group of countries including Poland, the Czech Republic, Sweden and the United Kingdom are very determined to see that banking systems in the future should be as healthy as we expect the fiscal side, the budgetary side, to be kept."
That demand is opposed by France and the Commission, which fear that jacking up capital requirements in one country could force banks based there to cut down lending by their foreign subsidiaries. That, they argue, could hurt small states that don't have a big domestic banking system.
To bridge the divide between the two camps, Denmark, which currently holds the EU presidency, has proposed a compromise that would allow national regulators to require an extra capital buffer of 3 per cent. Anything beyond that would have to be approved by the Commission in Brussels, which would examine not only the level of risk in the home state but also the potential impact in neighbouring countries.
After several hours of public discussion, finance ministers retreated into bilateral talks. A possible compromise could include requiring not the Commission, but another European supervisor — the European Systemic Risk Board, which is led by the European Central Bank President Mario Draghi — to approve higher national buffers.
If they cannot find agreement Wednesday, several ministers said they hoped a deal could be struck at their next meeting in two weeks. Once finance ministers have struck a deal, they have to negotiate a final agreement with the European Parliament.
Don Melvin contributed to this story.Suggest a correction