FRANKFURT (MNI) – The European Central Bank expects its new
liquidity measures to give a significant boost to the banking sector and
the economy, and it is keen to prevent new capital rules from marring
this salubrious effect.

ECB President Mario Draghi and Governing Council member Erkki
Liikanen on Thursday expressed grave concerns about the state of the
Eurozone’s banking sector, warning that tensions had already resulted in
weaker lending and growth.

New ECB liquidity support measures announced last Thursday,
however, should help alleviate these problems, Draghi said. These
measures, which include two three-year LTROs with unlimited allotment,
looser collateral rules and a lower reserve requirement, “should be felt
tangibly in the financial sector and the real economy over the coming
weeks and months,” the ECB chief predicted.

Still, the ECB is worried that new capital rules — requiring
Europe’s biggest banks to increase their core tier 1 capital ratios to
9% by mid-2012 — may at least partially offset the positive impact of
new measures by encouraging further deleveraging of the banking system,
well-placed Eurosystem sources told MNI.

Indeed, Draghi noted Thursday that the new capital-raising
requirement for banks is “not an easy process.”

To reach the 9% capital ratio, finding new capital is the best of
three options, but it is “expensive in a depressed market and faces
resistance from shareholders,” Draghi observed. “Selling assets is less
preferable and curtailing credit to the real economy is even worse,” he
added.

To avoid banks choosing the latter two options, the ECB and other
Eurozone officials are pushing the European Banking Authority to modify
its capital rules in a way that would eliminate the incentive for banks
to dump assets or restrict lending, Market News International reported
earlier Thursday.

Sources said that under a new proposal being discussed in official
circles, banks would be required not to reach a 9% ratio but to raise a
specified, fixed amount of capital by the mid-2012 deadline.

Based on figures that banks provided to the European Banking
Authority as of end-September, the regulators would calculate the amount
of capital each bank would have needed to hit the 9% ratio at that time.
Each bank would then be required to raise the specified level of capital
regardless of what they had done with their assets since then or what
they might do with them in the future.

Because banks would be required to raise the same amount of core
tier one capital regardless of subsequent balance sheet moves, they
would no longer have the same incentive to dump assets as a means of
meeting the capital requirement. Making a capital boost a regulatory
requirement would also remove shareholder pressure on banks.

The decision about whether to switch from a capital ratio to a
fixed amount of capital that each bank must raise lies in the hands of
supervisors and regulators. It is too early to tell whether regulators
will adopt the recommendation, one Eurosystem source said.

Given the central bank’s severe concerns over the banking system
and possible credit crunch — reflected in its own unprecedented,
aggressive liquidity policies — the ECB is likely to fight hard against
any rules it expects to hurt the banking system in the near-term.

–Frankfurt newsroom +49-69-720-142; e-mail: jtreeck@marketnews.com

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