By Balazs Koranyi and Francesco Canepa
FRANKFURT (Reuters) - Financial regulators reached a long-sought deal on Thursday to harmonize global banking rules, capping a decade-long effort to make banks more resilient although falling short of their own initial hopes.
Facing fierce opposition from the banking industry and calls from the U.S. administration to backtrack on some measures, policymakers struck a compromise agreement on rules forcing banks to hold more capital and cash to avoid a repeat of the 2008 financial crash.
Conceived in the aftermath of the global financial crisis when taxpayers had to rescue some of the world's biggest lenders, the rules, known as Basel III, aim to shield governments by having private investors suffer losses first.
"Today's endorsement of the Basel III reforms represent a major milestone that will make the capital framework more robust and improve confidence in the banking system," European Central Bank President Mario Draghi, the chairman of Basel's oversight body, said in a statement.
The final step in the deal will be for legislators around the globe to ratify the agreement, another potentially time consuming exercise.
Thursday's compromise focused on the way large banks self-assess the risks they take and whether the new rules would be fair for banks on either side of the Atlantic.
European banks complained that the compromise proposal would put them at a disadvantage to their U.S. rivals by requiring bigger capital buffers against mortgages.
The Americans argued that they have done more to repair their balance sheets after the crisis so they are not weighed down by poor legacy assets like the Europeans.
French banks in particular resisted and Paris finally relented only when a long phase-in period was proposed, putting the rules into full force only by the start of 2027.
In addition, local supervisors will have the power to mitigate the impact of these new measures during the phase-in period.
With Thursday's deal done, regulators are now promising stability, shifting their focus to implementation and pledging no new major regulation.
The reforms do have their shortcomings, however.
The 'bailing in' of private investors has not worked as intended so far, a reduction in banks' heavy exposure to government debt has not been tackled and so-called shadow banks, a loosely regulated sector outside Basel's scope, are slowly taking business away from regular lenders, creating new risks.
The Basel reforms have been a particular boost for shadow banking - financial intermediaries ranging from hedge funds to special purpose vehicles - because financial firms are facing easier regulation and lower liquidity requirements just as their banking rivals adjust to costly new rules.
Shadow banks have outpaced regular lenders in international credit growth for most of the past decade. In the European Union alone they have assets of more than 40 trillion euros, the European Systemic Risk Board said earlier.
"The priority has now shifted from the solvency of banks, which has improved substantially, to the liquidity of the shadow banking sector, particularly funds and asset management companies that are exposed to the risks of sudden panic-driven runs," French central bank governor Francois Villeroy de Galhau said this month.
Bail-ins, where bond- and shareholders and possibly depositors take losses before governments, have also been a problem, particularly in the failure of two Italian banks earlier this year, when a loophole in euro zone rules was utilized to channel state funds to them.
The state support raised questions about the viability of bail-in and whether governments could in the worst case hit large depositors.
Another issue not tackled is the so-called "doom loop" between banks and governments.
In need of safe assets, banks often hold lots of government debt, which is generally deemed risk free. But if a sovereign were to fail, such a tight-knit relationship would inevitably bring down banks as well, exacerbating any crisis.
Euro zone and Japanese banks are in particular exposed to the sovereign and have resisted proposals for risk weights for government bonds.
Timing has also been an issue. Many of the Basel rules are implemented with big lags and will not take effect for years to come, well over a decade after the start of the original crisis.
(Editing by Hugh Lawson)