The U.S. Treasury on Thursday said that it wants the world’s banks to maintain stronger capital and liquidity standards by the end of next year to prevent a re-run of the global financial crisis from which the financial sector is gradually recovering.

The Treasury would require banking institutions to focus more on higher-quality capital that will help them absorb big losses. Capital requirements for all banking institutions should be increased. Also, financial institutions, which are large enough to affect the overall financial system, should be required to hold more capital than smaller firms.

The Treasury intends to reach a comprehensive agreement on new international capital and liquidity standards by December 31, 2010 and put into effect the new rules by 2012. According to the Treasury, banking institutions should be forced to stick to non-risk-based limits on leverage and conservative liquidity standards.

As the financial institutions largely contributed to the recent global financial crisis by investing in risky assets without maintaining sufficient reserves, regulators are calling for sturdier supervision for them.

The U.S. government was forced to pass a $700 billion package through Troubled Asset Relief Program (TARP) last year to rescue the struggling institutions, which was facing massive losses due to the subprime crisis and housing collapse.

Though some of the biggest banks have fully repaid their obligations from TARP, government money is still locked in some very big companies like Citigroup (C), Bank of America (BAC), American International Group (AIG), mortgage lenders Fannie Mae (FNM) and Freddie Mac (FRE), and automakers General Motors and Chrysler. Repayment of TARP money by these companies still remains uncertain.

The new rules, if enacted, would somewhat limit bank profitability, but a proper implementation would bring stability to the overall sector. Also, the rules would likely drive institutions to sell more equity, which would dilute shareholders wealth, but would mitigate the risk of collapse.

Zacks Investment Research
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