European finance ministers early on Thursday failed to reach a deal that would force banks to build up higher capital cushions against financial shocks amid disagreements over the powers of national regulators.
The 27-country European Union is in the process of writing an international agreement on capital defenses for banks into European law. The so-called Basel III deal was negotiated by the world's largest economies in the hope of avoiding a repeat of the financial meltdown brought on by the collapse of US investment bank Lehman Brothers. The 2008 crisis demonstrated that many banks did not have enough of a capital cushion to absorb sudden losses on subprime mortgage loans and other risky activities.
Danish finance minister Margrethe Vestager, whose country currently holds the EU presidency, called the new rules "one of the most important files taking the lessons from the financial crisis."
Once enacted, Basel III would require lenders to increase their highest-quality capital - such as equity and cash reserves - gradually from 2% of the risky assets they hold to 7% by 2019. An additional 2.5% would have to be built up during good times.
The new rules will apply to more than 8,300 banks in Europe, forcing them to compile billions of euros in extra capital by selling shares or assets or reining in bonuses and dividends.
What is at issue in Europe now is that some states, led by the UK, want to set even higher capital requirements for their own banks than the ones set out in Basel III. They argued that since there is no pan-European bank resolution fund - and it's therefore national taxpayers that have to foot the bill if something goes wrong - it's national governments that should get to decide what makes their banks save.
In more than 15 hours of talks, Vestager hashed out a complex system of checks that would allow national regulators to set higher capital requirements for their own banks as long as they don't hurt growth in other EU states.
Several smaller European states do not have a big domestic banking system, so they depend on subsidiaries and branches of foreign banks to provide loans to businesses and households. The EU's executive Commission is worried that if some states unilaterally set higher buffers for their domestic lenders, those banks would cut down on their foreign activities.
After the meeting, three EU officials said that all states apart from the UK were willing to agree to the latest compromise proposal. Another official said that Bulgaria also objected to parts of the deal. The officials were speaking on condition of anonymity to discuss confidential talks.
Their resistance puts Britain and Bulgaria in an interesting position, since they do not have enough votes in the council of ministers to block a deal on capital rules at their next meeting in two weeks. If all other states stick to the compromise, they can force the agreement onto the holdouts - a first in EU financial decision making.
The ministers are under pressure to make progress on the new rules since the first capital increases are supposed to go into effect already on January 1 and they still need to find a compromise with the European Parliament. Some ministers also warned that Europe - in the midst of a severe debt crisis that has already pushed three countries into international bailouts - was in particular need of shoring up trust in its banking sector.
"If we duck the challenge of implementing Basel we could face very important challenges to confidence in Europe this year," warned George Osborne, the UK's Treasury chief.
The financial panic that followed Lehman's collapse hit Europe hard. Between 2008 and 2010, governments across the 27-country-bloc spent £4.6 trillion ($6.1 trillion) propping up struggling banks, weighing heavily on national budgets.
The UK, which had to save three major banks, has seen its debt load almost double since 2007. Much smaller Ireland had to seek an international bailout to help stem the losses of its domestic lenders. And many economists fear that the economic recession in Spain may soon reveal massive bank losses there.