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Biggest banks face stiffer capital surcharge

A pedestrian passes a street sign in the Canary Wharf financial district, in east London March 7, 2011.

TOBY MELVILLE/Toby Melville/Reuters

The world's biggest banks face a capital surcharge of up to 3 per cent in a bid to keep taxpayers off the hook next time a lender gets into difficulty, Bundesbank and industry officials said on Friday.

But a surcharge of between 3 per cent and around 3.5 per cent will be imposed if a bank grew significantly and as a result posed larger systemic risks, banking sources told Reuters.

The Financial Stability Board, tasked by the world's top 20 economies (G20) to toughen up financial rules, meets on July 18 to finalize its blueprint.

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Before then regulators will hold a series of preparatory meetings to iron out elements of the capital surcharge plan that are still being contested.

"No final decision has been made," a source familiar with the talks said.

"It's still very fluid," a second source added.

The basic structure, however, is set be in line with what regulators and bankers have been saying over the past year.

Bundesbank board member Andreas Dombret said on Friday that 25 to 30 of globally systemically important financial institutions (G-SIFIs) "will in all likelihood" have to hold 2 to 3 percentage points more capital than others.

"Such capital add-ons do more than merely improve the resilience of a SIFI, in other words reduce its probability of failure," Mr. Dombret said in a speech.

"They surely are also a suitable instrument with which to put a price tag on the implicit guarantee that SIFIs are deemed to enjoy," Mr. Dombret added.

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Initially the surcharge will apply only to the biggest banks such as Goldman Sachs , HSBC , Deutsche Bank and Morgan Stanley .

Other big institutions like insurers whose collapse could destabilize the wider financial system, as did the demise of Lehman Brothers in 2008, would be brought under the net later on.

The surcharge will depend on criteria regulators have already outlined, such as how interconnected the bank is to the rest of the financial system and how easily its operations could be substituted by another lender.

"I think it will be 1 to 3 per cent of capital in six steps, depending on the degree of G-SIFIness," one banking source said.

"It's still under discussion if pure investment banks are seen as less important for the stability of the system than diversified banks," a second European banking source said.

European bank shares appeared little moved by the well aired prospect of a capital surcharge, with the sector down 0.3 per cent, outperforming the broader market which was off 0.7 per cent.

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The capital surcharge will be on top of the new global Basel III minimum capital of 7 per cent set for all banks from 2013.

The blueprint will be published by the FSB late July for public consultation before G20 leaders endorse them in November.

The biggest of the G-SIFIs would hold around 10 per cent in Core Tier 1 capital, the main benchmark of a bank's stability.

It remains unclear when the capital surcharges would kick in, but many of the biggest banks already hold capital at these levels due to pressure from local supervisors in countries like Switzerland, Britain and the United States.

Some banks may need to change the mix of capital.

Much will hinge on whether the surcharge has to be in the purest form of capital - common equity - or whether banks will be allowed to include some hybrid debt known as contingent capital or CoCos which convert to equity under stress.

Bundesbank's Dombret said CoCos should be included among the instruments acceptable as a surcharge but banking sources said hard line countries like Britain appear to be winning the argument for common equity.

"We would like to be able to meet the SIFI buffer with CoCos but they are leaning more to the purest form of equity," they said.

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