Financial reform results seen thin at G20

 

World leaders will talk tough about tighter financial regulation at the Group of 20 summit in Pittsburgh this week, but concrete reforms are likely to remain a distant prospect.

High on the agenda for U.S. President Barack Obama and other leaders will be proposals for restraining banker pay and making banks patch up their balance sheets to help prevent a repeat of the near meltdown of the financial system.

G20 leaders will try to thrash out new ways to control over-the-counter derivatives markets, blamed for amplifying the global financial crisis, and to increase oversight of hedge funds, credit rating agencies and debt securitization.

Outlines for reform could emerge from the summit. French President Nicolas Sarkozy has dropped his calls for fixed limits on banker bonuses and the United States has stressed it sees the need to discourage incentives for risk-takers.

But the G20 has no law-making power and any real changes will be left to national authorities.

"G20s don't make the detailed decisions... But they can create the conditions" for reforms, said EU Ambassador to the United States John Bruton in an interview.

Those conditions, analysts said, have become less conducive to far-reaching change over the past year.

When Lehman Brothers collapsed in September 2008, freezing world capital markets, policymakers were galvanized into an urgent drive for tighter regulation. 

A year on, economies are stabilizing, markets are rebounding - with the benchmark U.S. stock index, the Dow Jones industrial average, up about 50 percent since March - and G20 governments have done little to tighten oversight of banks and capital markets.

Obama's plans are bogged down in the U.S. Congress which is distracted by a debate about healthcare.

Furthermore, introducing tough new capital requirements for banks now could hurt their balance sheets just when governments want them to lend more to build on signs of economic recovery.

"The simple fact remains that financial institutions cannot take steps to further increase the amount of capital they hold and at the same time lend that capital to businesses and consumers" Stephen Green, chairman of the British Bankers' Association and HSBC bank, wrote in a letter to British Prime Minister Gordon Brown ahead of the G20.

SALVAGING THE MOMENT

At the summit, Obama and leaders of Britain, Germany and France can be expected to try to reignite the urgency of a year ago and regain momentum for financial reform, partly by targeting the flashpoint issue of executive pay.

Bonuses may be linked to the long-term performance of investment decisions and the health of bank balance sheets so as to discourage short-term risk taking.

"There is a high level of anger in Europe about the fact that the remuneration packages have been designed to emphasize short-term returns" said Bruton, former Irish prime minister.

"It is politically unrealistic not to respond to this... given that the taxpayers, many of whom are earning only a fraction of what some of these people are earning, are having to keep these people in business." 

If the G20 can achieve consensus on new banker pay limits, making them stick may be hard as the sense of crisis fades, credit rating agency Moody's said recently.

Jaret Seiberg, policy analyst in Washington, D.C., for Concept Capital, an investment research firm, said investors in bank stocks can expect "many negative headlines" but "but real progress is less likely."

Nonethless, long-term profitability at U.S. and European investment banks is likely to fall by more than a quarter due to new rules, JP Morgan said in a report earlier this month.

Deutsche Bank, Goldman Sachs and Morgan Stanley will see the biggest fall in return on equity, while French banks and Barclays are likely to see to least impact, JP Morgan estimated.

PACE OF REFORM

The Pittsburgh summit will be the third since the Lehman collapse. Debates on details and timing for reform are growing heated. The Financial Stability Board FSB.L, the G20's policy coordinating arm, last week cited "challenges in maintaining an appropriate balance and pace of regulatory reform."

Europe is suspicious about a U.S. push for banks to adopt a leverage ratio or cap on how much they can borrow in relation to their own capital, an established feature of U.S. banking.

French bank Societe Generale on Monday rejected the U.S. proposal as a "crude and simple" idea.

Europeans say the focus should be on making the existing risk-based Basel II international bank capital accord work better and for all countries, including the United States. 

There is a worry in Europe that adopting a leverage ratio that goes beyond being just a "backstop" to Basel II would undermine the Basel rules. There is still no consensus on how to define a leverage ratio or what assets should be included.

The G20 might produce a consensus on capital standards, but it will take much longer to settle on "the exact levels of the new capital and leverage ratios and even longer to agree to the new liquidity regime" said Joe Engelhard, policy analyst at investment research firm Capital Alpha Partners in Washington.