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FSB's Carney warns G20 of risk of fragmented banking rules

By Huw Jones

LONDON (Reuters) - The world's banking system risks fragmentation that could hurt growth if countries cannot settle their differences over how to handle big banks that run into trouble, a top policymaker said on Monday.

Mark Carney, chairman of the Financial Stability Board (FSB), is due to report to leaders of the G20 group of economies this week on the slow progress so far in tackling the last of the big post-crisis reforms: making sure banks are not too big to fail.

The United States and Europe have clashed on their different preferences for how to avoid future taxpayer bank bailouts.

Carney, without referring to individual countries, said he would stress the need for the G20 to cooperate.

"The fragmentation of the international financial system that results from such nationally focused policies could reduce global growth by putting up barriers to the efficient allocation of capital and liquidity," Carney told a news conference.

Taxpayers had to shore up lenders in Britain, the United States and elsewhere during the 2007-09 crisis because there was no fail-safe way of winding them down without the market mayhem seen after Lehman Brothers was allowed to fail in September 2008.

Carney, who is also Bank of England governor, will update G20 leaders at a summit in Russia on Thursday and Friday, setting a 2014 deadline for finalising the changes needed.

"A core message from the FSB to the summit is that what the G20 does ultimately determines the openness of not just the global financial system but the global trading system," he said.

Bankers say privately that solving too-big-to-fail will be hard but that success would make other post-crisis reforms almost irrelevant as lenders would not act recklessly again in the knowledge there will be no more public rescues.

The slow progress has prompted some countries to take unilateral measures as trust among supervisors over banks is still not strong enough.

The European Union is annoyed with U.S. plans to impose heavier capital requirements on foreign banks as a safeguard to keep its taxpayers off the hook if they get into trouble.

Britain has also been criticised for putting pressure on foreign banks to become fully fledged subsidiaries and thus required to hold a pot of capital and cash locally.

Carney said nationally focused policies could reduce global growth by hindering efficient allocation of capital and liquidity.

"Reforms that strengthen the resilience of the national and global system can also prevent regulatory arbitrage, reduce contagion and reduce incentives to ring-fence national systems," Carney said.

The G20 has already agreed that 28 of the biggest banks in the world, including Goldman Sachs (NYS:GS), HSBC (LSE:HSBA) and Deutsche Bank (GER:DBK), must hold more capital than their smaller, more domestically focused peers from 2016.

The G20 will now debate if the biggest banks should also be required to have a minimum amount of so-called loss absorption capacity like bonds that could be tapped if they fail.

Carney said most of the big banks could hold that cushion at the group level but critics say this will raise issues of trust in other countries where the bank has branches.

He will try to persuade leaders to allow their regulators to sign agreements with counterparts in other countries so that when a bank is in trouble, there is a clear blueprint on how it will be handled to avoid uncertainty and taxpayer exposure.

The FSB will prepare proposals for consideration by the end of 2014 on the nature, amount, location within the group structure and possible disclosure of loss-absorbing capacity.

Carney said developing a mindset of cooperation among supervisors was crucial: "This is new territory. The work on too big to fail brings that to the fore in many respects."

(Editing by William Schomberg)