LONDON, October 27 (Global Risk Regulator) – Some European banks will face a major challenge in getting their top quality capital levels to the 9% agreed by European Union leaders at their crisis meeting in Brussels, according to financial regulation experts. The EU target is two percentage points above the international minimum of 7% wanted by global banking regulators.

PwC’s Gay said $106 billion was a lot of capital to raise, noting that appetite for investing in banks is not particularly high at present. That’s because returns on equity are under pressure as a result of the tougher capital and liquidity rules embodied in the Basel III bank capital adequacy package promoted by the Group of Twenty (G20) biggest economies. Basel III stipulates a minimum 7% Tier 1 (top quality) capital ratio.

It was not immediately clear how the EU leaders’ agreement on a 9% level fits in with the controversial, so-called “maximum harmonisation” approach to bank capital reform of the European Commission, the EU’s executive arm. The Commission is proposing that when applied in the EU the Basel III minimum capital requirements should operate also as a ceiling, whereas Basel capital standards have never stipulated a maximum (see “EU not sticking to Basel III – harmonisation a priority” in July/August 2011 issue of GRR newsletter). Neither is it immediately clear how today’s agreement might apply to those European banks that fall into the category of global systemically important institutions (G-SIFIs), on which the G20 wants to impose capital surcharges of up to 2%.

In their summit statement, the EU leaders said there was broad agreement on requiring banks to hold “a significantly higher capital ratio of 9% of the highest quality capital and after accounting for market valuation of sovereign debt exposures, both as of September 30, 2011, to create a temporary buffer, which is justified by the exceptional circumstances.”

The capital target will have to be attained by June 30, 2012, based on plans agreed with national supervisors and coordinated by the European Banking Authority, the EU’s banking watchdog.

The statement said national supervisory authorities under the auspices of the EBA “must ensure that banks’ plans to strengthen capital do not lead to excessive deleveraging, including maintaining the credit flow to the real economy.” Supervisors must take into account a bank’s current exposure levels, including those of its subsidiaries in all EU member states, and the need to avoid “undue pressure on credit extension in host countries or on sovereign debt markets.”

In financing the capital increase, banks should first use private sources of capital, including that raised through restructuring and conversion of debt to equity instruments.

“In effect the European financial problems in 2011 have driven governments to bring forward the higher capital requirements that Basel III wanted,” said PwC’s Fell.

Basel mandated a tightening of requirements over an extended period of ten years, partly to avoid a contraction of credit, he noted adding: “The EU has front-loaded it.”

“To meet the mid-2012 challenge banks will need to manage their capital programmes carefully. They might find they adopt a quick fix now, but implement a more cost-effective strategy when the market has got over the bulge in the next few months,” Fell said.

(Euro summit statement: www.consilium.europa.ue)

David Keefe (dkeefe@globalriskregulator.com)