In this report, FedFin assesses the details – such as they are – in the EU’s capital agreement to identify its implications for the global bank-regulatory framework and U.S. implementation of the Basel III standards.  To do so, we have reviewed the European Council statement and the release and methodological note provided by the European Banking Authority. While critical details are unresolved, those to date suggest to FedFin that most affected banks will be able to recapitalize with less deleveraging than initially anticipated because the new framework remains essentially a Basel II one.  Although new valuations are required for sovereign debt and capital for the trading book must be substantially recalibrated for these holdings, the definition of capital and other risk weightings remain very favorable.  Importantly, the EU standards also promote the issuance of contingent capital, which would then count as “core Tier 1” if certain conditions are met. To the degree the sovereign-support facility also agreed upon (in principle) last night provides insurance for certain sovereign issuances, then these would get a very favorable capital weighting.  Similarly, the new guarantee fund for EU bank debt would not only ease liquidity problems, but also create a strong incentive for counterparties around the world to hold these instruments to bolster their regulatory capital.  We conclude that all this has bought the EU – and everyone else – essential time, but the ability of banks to support asset growth is uncertain and the broad framework of Basel III is sure to be revisited.

 

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