THE UNITED STATES AND BRITAIN are taking an important first step toward international regulation of banking. The Federal Reserve Board and the Bank of England are proposing joint standards linking bank capital reserves to the riskiness of their loan and investment portfolios.
Chairman Paul Volcker of the Fed termed the action "a breakthrough . . . a step toward international consistency." Robin Leigh-Pemberton, governor of the Bank of England, said the move represented "a landmark in international supervisory cooperation."Cooperation between the two central banks - which they hope can be extended to Canada and Japan - recognizes the growing internationalization of banking and concern that regulatory competition among nations could encourage bank customers to channel business to countries where standards are lax. ''Regulators in the two countries," Mr. Leigh-Pemberton said, "were under
pressure to introduce as level a playing field as possible in the globalized
Capital - shareholders' equity, earnings retained from previous years, and reserves set aside for possible loan losses - has a special function in banking. It is intended to ensure both that shareholders have a sizable stake in the performance of their institutions and that the banks themselves have a
financial cushion to absorb significant losses. Capital is considered adequate if it functions as it should, covering all expected losses. It is inadequate if it fails to do so.
In 1985 the regulators increased the minimum requirements for primary capital to 5.5 percent from 5 percent of a bank's assets.
Under the proposed agreement, no attempt is being made to establish overall capital adequacy standards. Instead, following recent British practice, the amount of capital required would be based on the riskiness of a bank's loans and investments. Thus, a bank whose portfolio is riskier than most would require more capital than one with more conservative holdings.
The proposal calls also for banks to set aside capital to back perhaps hundreds of billions of dollars in so-called off-balance-sheet financing, things like standby letters of credit that do not make a direct claim on a bank's assets but which, if a customer defaults, the banks may be called upon to make good.
The new measure is similar to one proposed last year by the Fed and the two other federal bank regulatory agencies, the Comptroller of the Currency and the Federal Deposit Insurance Corp. Mr. Volcker cautioned against overemphasizing the differences between the two proposals but acknowledged that there were some delicate subjects, including a provision that would require banks to maintain capital against their total debt extended to consumers by way of credit cards and bank involvement in interest-rate and currency swaps.
Banks heavily involved in consumer banking and international lending thus might find themselves obliged to add to their capital funds, while so-called wholesale banks without significant overseas or off-balance-sheet activity might find their capital more than adequate.
The step must be considered only a beginning. The need to bring about cooperation in other economic and financial areas may be even more urgent. The fact that the Fed and the Bank of England have worked side by side for many years undoubtedly made it easier for the two institutions to act in concert as they have.
Other agencies moving toward joint action, such as the Securities and Exchange Commission and its counterparts overseas, should be encouraged and motivated by their initiative.