US minimum bank asset ratios suggested for larger banks

European banking supervisors might follow the example of US regulators and develop the concept of well-capitalised banks with higher minimum protective capital than required under the Basel bank capital adequacy Accord, according to some European regulators.

They were commenting on a paper that said the minimum 8% capital-to-asset ratio required by the Basel capital Accord might be an insufficient backstop for the largest banks.

“The authorities might wish to consider setting higher early warning levels for these banks to enable action to be taken while they were still able to operate,” said the paper.

Banking authorities probably need to take into account the likelihood that reductions in the capital of a large bank could affect its access to financial markets, even when its capital exceeds the minimum by the 1988 Accord, the paper said.

The Basel I Accord determines the minimum proportion of their assets that large banks must set aside to guard against losses from banking risks. The more complex, risk-based Basel II Accord, which the Basel Committee hopes will come into force in late 2006, retains the 8% minimum.

The paper noted that in the US, which sets perhaps the highest requirements for banks that want to be in the well-capitalised category, large banks maintain substantial excess capital. Under US rules, well-capitalised banks must have a minimum total risk-assets ratio of 10% with a tier 1 ratio of 6%, against 4% under Basel I. Tier 1 capital is shareholders’ equity plus published reserves.

Regulators commenting on the paper said other countries might consider going down the US route.

The paper’s authors said evidence suggests that banks large enough to have a credit rating target a solvency standard that is significantly more conservative than that required by the current Basel Accord. The suggestion, said the paper, is that bank access to important credit markets like the swap markets may significantly influence the choice of a solvency standard.

“If large banks generally have to target solvency standards that are much higher than those implicit in the current Accord, to have the flexibility to carry out the type of business in which they are engaged, this may indicate that the current level is already quite low,” the paper said.

The paper, on regulatory and economic solvency standards for internationally active banks, is co-authored by Patricia Jackson, head of the UK central bank’s regulatory policy division, her colleague Victoria Saporta and William Perraudin of Birkbeck College, London. Their views do not necessarily reflect those of the Bank of England.

It was prepared for a workshop on an economic assessment of the Basel II banking Accord currently taking place in Basel, Switzerland. The workshop is organised by the Basel Committee on Banking Supervision, the architect of the Basel accord, the Centre for Economic Policy Research and the Journal of Financial Intermediation.