Continuing urgent work to finalize the Basel III Accord, the Basel Committee has asked for views on new standards that would stipulate that capital must absorb risk to prevent losses in the event of government support for a troubled banking organization. All internationally-active banks – not just systemic ones – would need to issue contingent or convertible equity instruments that stand ahead of other equity-holders (both Tiers 1 and 2) to ensure shareholder loss in the event of government support and, regulators hope, to limit moral hazard. However, the proposal could prove very costly, especially in concert with all the pending new capital requirements, in part because it would raise the cost of capital for any bank deemed by investors as possibly subject to government intervention. This would reverse the reductions in bank cost of capital that regulators have argued will offset reduced return on equity under Basel III. Enshrining a capital buffer against government intervention could also reinforce expectations that some banks are too big to fail despite ongoing work to create new resolution protocols for complex and cross-border banking organizations.
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