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G20 seeks to limit risk in banking

A year after the collapse of Lehman Brothers plunged global finance into chaos, G20 leaders will try to force banks to build bigger capital safety cushions, while avoiding a clash over bonuses.

business Updated: Sep 21, 2009 12:23 IST

A year after the collapse of Lehman Brothers plunged global finance into chaos, G20 leaders will try to force banks to build bigger capital safety cushions, while avoiding a clash over bonuses.

Nearly six months have passed since the last G20 summit in London and the top world economies have since edged closer to agreeing new regulations to prevent or mitigate future bank failures, but some hard bargaining remains.

Bonuses looked likely to be the hot issue, with European capitals seeking to force London and New York to cap the massive payouts they feel encourage excessive risk taking.

But signs of consensus have emerged ahead of the summit Thursday-Friday in the American city of Pittsburgh, with leaders anxious to avoid an embarrassing row on the issue -- a highly symbolic one for angry taxpayers.

The US Federal Reserve agreed to tie compensation more closely to risk and to defer payments, while French President Nicolas Sarkozy appears to have stepped back from his earlier demand for mandatory caps.

A deal therefore looks possible on bonuses and checking bankers' enormous salaries, but G20 chiefs are keen to reach a wider accord on a package of measures to strengthen banks.

On the table will be recommendations from the "Basel Committee on Banking Supervision" aimed at drawing lessons from the collapse of Lehman and the crises that hit European groups Fortis and Dexia and Iceland's Kaupthing.

The committee, representing central bankers and regulators from leading G20 states and other nations, wants banks to simplify their structures to make it easier to wind down their international operations in the event of a crisis.

These "Basel II measures" have been welcomed by European governments, which would now like to see the G20 as a whole adopt them as the foundations of a new, more stable international financial system.

Washington, however, would like to move past Basel and -- within three years -- strike a broader deal to increase the amount of capital each bank needs to hold as a back-up in case its liabilities threaten to overwhelm it.

US Treasury Secretary Timothy Geithner came to a meeting of G20 finance ministers in London this month to urge "greater urgency" in making banks increase their capital reserves as a buffer against hard times.

France and Germany, among others, believe Basel II goes far enough, and are resistant to the idea of renegotiating minimum capital levels, fearing that US banks -- which they see as having lax accountancy standards -- will benefit.

Part of the US plan would be for banks to hold fewer assets in complex securities, a mixture of debt and equity, and more in liquid assets. Such a rule would hit European banks harder than American ones.

The subject "obsesses the Americans", according to one source involved in the pre-summit negotiations, and some observers predict it will become the main sticking point.

"If the way the rules are applied is such that it puts European institutions at a disadvantage, it won't be acceptable," warned Thomas Philippon, a French professor at the Stern Business School in New York.

While differences remain on bonuses and bank liquidity, there are other areas on which the G20 leaders are closer to agreement.

They could approve new rules on leverage, a bank's ratio of capital to liabilities, and the need for so-called "living wills", plans to allow dead banks to continue trading while their partners disentangle their business.

Basel II would also ensure banks make more detailed disclosures of their exposure to complex products such as asset-backed securities, and seek means to discourage them from becoming too big or too complex to be allowed to fail.

All these ideas may be moot, however, if the leaders fail to agree on Geithner's liquidity rules before the expected economic recovery begins to encourage a return to risk-taking in the world's economic capitals.