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Britain, US chart regulations to ease risks in global banking

Sitting in an office in Dubuque, Iowa, or Prescott, Ariz., a corporate treasurer who needs to borrow $10 million or $20 million doesn't necessarily think of a local banker first. Tapping the keys of a video terminal, or phoning a middleman, the executive is just as likely to find a competitive interest rate on that loan from a Japanese or Swiss bank as from an American one. In fact, he may find it more easily.

And this is one reason bankers in the United States are happy to see the beginnings of an international regime to regulate banking worldwide.

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Last week, Britain and the United States announced that banks in both countries will soon have to abide by the same minimum capital standards. Banks will be judged by the riskiness of loans in their portfolios and required to keep a uniformly applied percentage of those loans as backup - primary capital - in case of trouble. This is already the way it is done in Britain; it is new in the US.

Primary capital consists of common stock, retained earnings, and minority interests in subsidiaries. A bank can increase primary capital by a sale of shares to the public.

The Anglo-American agreement, which was pushed by Federal Reserve chairman Paul A. Volcker and Bank of England governor Robin Leigh-Pemberton, is the first global regulatory link ever on banking. It won't be the last.

Banking analysts say these two nations will begin lobbying the Japanese to adopt the same standards, since Japanese banks have been growing rapidly into worldwide lenders. They'll try to bring other European nations on board, too. Eventually, tax and accounting standards that affect banks in the industrialized world might have to be harmonized, also.

There are three main reasons behind the linkup:

Banking is already a global business. Not only are there branches of Citibank, Barclays, Cr'edit Suisse, and Sumitomo all over the world, but by phone or computer link a big borrower can easily track down the most attractive interest rate from virtually anywhere.

That's the beauty of global competition; the flip side, however, is that the entire system is so interwoven that if one or more big bank fails because of risky loanmaking, that would reverberate throughout the world.

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Risks in the banking industry are sobering. The third-world debt crisis, for instance, is far from over. Banks - especially those in the US - still carry billions of dollars of shaky loans on their books.

Behind all the technical issues, the ``real concern,'' says Dennis Aronowitz, director of Boston University's Morin Center for Banking Law Studies, ``is that if and when the international banks have to write down LDC [less-developed country] loans - from Mexico, Brazil, or elsewhere - there be sufficient capital on the books to absorb the hits.''

But in bolstering the capital-to-asset ratios as insurance against such a catastrophe, banks become less competitive in loanmaking, especially when compared with Japanese banks.

In the US, all banks, whether or not they are involved in LDC loans, are required to keep at least 6 percent of assets as capital. Japanese banks need keep only about 2 percent as backup.

This gives them a competitive advantage.

``It doesn't cost as much for a Japanese bank to book a loan as it does a US bank,'' says Kirk Willison, spokesman for the American Bankers Association.

Thus Japanese banks have been growing partly at the expense of more conservative American banks. The top four banks in the world are now based in Japan.

Finally, it makes sense to set the capital-asset ratios according to the risks that individual banks take.

By weighing risks - without going as far as having the government allocate credit by sanctioning only certain types of loans - bank regulators such as the Fed hope to keep from penalizing banks that manage their portfolios more conservatively.

In the new rating system, vault cash has zero risk. Short-term US Treasury notes (for British banks, short-term British gilts) would have 10 percent risk. The risks increase up to 100 percent for standby letters of credit.

Still, supervising banks is much like shooting at a moving target.

Not only are banks slipping over and under national boundaries, they are also rapidly developing a variety of new financial products. This process is known as the ``securitization'' of bank assets and includes such creatures as letters of credit, interest-rate swaps, repurchase agreements, and foreign-exchange contracts.

It is difficult for regulators to wrestle with these off-balance-sheet risks, since they make their way out into the secondary market. That's good in that it removes the risk from the bank - but it is a risk within the system nonetheless.

If there is massive failure of letters of credit or other such items, there might not be sufficient capital to cover them: Since they are not loans on the balance sheet, they generally have not been backed up.

Mr. Willison of the ABA also points out that US banks have been forced to make riskier and riskier loans because of their inability to enter the lucrative securities business. If loans are riskier, then capital standards must be safer. But, Willison says, ``if you can't agree to this in a world market, the US banks lose out'' to the Japanese, who make those riskier loans without compensating reserves.

Banking competition is vertical and horizontal at the same time. Like the Japanese banks, thrifts and financial companies (General Motors Acceptance Corporation, etc.) in the US don't have to meet these capital standards, Willison says.

That is unlikely to change. Banks are approaching equal footing with their counterparts in other countries, however. And regulators are slowly working to bolster their safety.

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