G7 urges banks to boost capital

The Group of Seven industrialised nations on Friday night endorsed plans to force banks to hold more capital to guard against risks that contributed to the credit crisis, as part of an initiative to strengthen the financial system.

The G7 also signalled “concern” about sharp movements in currencies that it said threatened global economic stability. The new language is a sign of heightened global unease about the weakness of the dollar – and lately sterling – relative to the euro.

The moves on capital charges are intended to reduce the incentive for banks to invest in complex credit products, hold such assets in their trading portfolios and create off-balance sheet investment vehicles – three activities at the heart of recent turmoil.

The proposed changes form part of a 65-point action plan prepared by the Financial Stability Forum – the body charged with co-ordinating the response to the credit crisis – and presented to the G7 on Friday.

Officials told the Financial Times that the programme would be adopted in full, though changes to capital rules would be phased in gradually to avoid disrupting already fragile markets.

But there were no plans for co-ordinated international intervention to fight the current crisis.

“Whatever needs to be done in the short run to alleviate problems will be done country by country,” a senior G7 policymaker said.

The G7 nations warned the slowdown might get worse as they endorsed the recommendations to alleviate market turbulence. “The turmoil in global financial markets remains challenging and more protracted than we had anticipated,” it said. “There have been at times sharp fluctuations in major currencies, and we are concerned about their possible implications for economic and financial stability.”

The FSF called for the creation of a “college of supervisors” from different countries to oversee each of the largest global financial institutions, and urged market participants to create a more robust infrastructure for the over-the-counter derivatives market.

It said regulators should issue guidance on liquidity risk by July, and said banks should make extensive disclosures on their risk exposures by mid-2008. It set out plans to overhaul the credit rating process for structured products and called on regulators and investors to become less reliant on them.

The FSF called for currency swap arrangements between central banks to provide offshore liquidity in different currencies to be extended.

It said regulators must ensure that bond insurers had adequate capital.

The FSF raised the possibility of rule changes to make capital requirements more counter-cyclical – forcing banks to set aside larger cushions of capital in good times. There was no commitment to do this. Nor was there any proposal to intervene in bankers’ pay. In-stead, the FSF urged banks to tie their pay schemes more closely to long-term profits and said regulators should work with the private sector to develop ways to mitigate the risks associated with pay incentives.