Will new Basel rules lead to bonus shrinkage?

BBC business editor Robert Peston on banking system reform

An important milestone has been reached in the reform of the banking system to correct at least some of the palpable flaws that contributed to the worst banking crisis since the 1930s.

Financial regulators and central bankers, the so-called governors' group of the Basel Committee on Banking Supervision, have agreed new global rules for the amount of capital and liquid resources that banks must hold.

A statement should be issued by the Commitee later this evening.

These new rules - which were presented to the governors as a "take-it-or-leave-it" package after negotiations carried out by their officials a few days ago - are intended to protect banks when they make losses and also provide them with insulation against runs.

As I disclosed last week, perhaps the most important and eye-catching change will be an increase in the amount of common equity - known as core Tier One capital - that banks have to hold.

This will rise from 2 per cent of risk-weighted assets (loans and investments) to 7 per cent. And this 7 per cent will include a "buffer" of 2.5 per cent, which can be eaten into in extreme circumstances.

Put simply, the reform ought to mean that banks will have greater ability to absorb losses in future crises without going cap in hand to taxpayers.

But because capital is typically expensive for banks to raise, it may mean that banks progressively increase what they charge for credit and increase the provision of credit at a slower rate.

Central bankers, politicians and borrowers may well point out to banks that an alternative way of financing the cost of servicing increased capital requirements would be to slash the remuneration and bonuses of bankers.

They'll also point out to bankers who may squeal that the new capital rules will be increased in stages from 2013 to 2018, which gives them plenty of time to build up reserves through retaining earnings and selling shares to investors.

That said, it's striking that Deutsche Bank has today announced an anticipatory issue of €9.8bn of new shares - which will both strengthen its balance sheet and help to pay for the 70 per cent of Deutsche Postbank that it doesn't already own.

So in practice, most banks will probably take the view that they will need to get to the 7 per cent core tier one ratio more-or-less immediately, to reassure their creditors and investors.

You can keep up with the latest from business editor Robert Peston by visiting his blog on the BBC News website.

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