By Huw Jones
LONDON, Sept 13 (Reuters) - A deal on bank capital ruleswon't see world leaders take their foot of the reform pedal butwill instead clear the decks for them to focus more squarely onan even harder issue -- tackling too-big-to-fail banks.
The Basel III measures agreed on Sunday are the lynchpin ofefforts by the Group of 20 leading countries to learn from theworld's financial crisis but other reform pledges still needcompleting and new initiatives are in the pipeline.
The G20 will now devote more time at its November summit inSeoul to stepping up scrutiny of derivatives markets and shine alight on off-balance sheet "shadow banking" sectors.
Improving supervision and curbing the influence of creditrating agencies will also figure prominently, sources familiarwith G20 workings said.
But "too-big-to-fail" is becoming the top priority.
Even before the ink on Basel III had a chance to dry, topregulators were warning on Monday that big banks faceextra capital requirements to make doubly sure that taxpayerswon't have to ride to the rescue again. [ID:nLDE68C0D3]
Basel III -- which demands banks hold top-quality capital ofmore than triple what they do now, but with a long transitiontime built in -- will not be enough to deal with internationallyactive banks, Financial Stability Board Chairman Mario Draghisaid.
"We want systemically important financial institutions tohave loss-absorbing capacity beyond these standards," he said.
Regulators want to end "moral hazard" -- the temptation forbanks to take risks -- as governments won't allow them tocollapse because of the damage it would wreak on the economy.
The FSB will make recommendations to the November G20 summitwith a capital surcharge on big banks set to be one.
That may be easier said than done.
With Basel III, there was G20 consensus that bank capitalrules needed tightening but there is so far no agreement onslapping surcharges on some banks.
Tackling "too big to fail" will likely take the form of amenu of solutions for G20 leaders to pick through, ranging fromsurcharges and forcing banks to compile "living wills" to ensurespeedy wind-ups if in trouble, to agreements between countrieson dealing with an ailing cross-border bank.
"The area that is probably the most difficult is the wholearea of living wills and winding up arrangements," said PatrickFell, a director at PricewaterhouseCoopers in London.
"But if your objective is to look at the system you have tofocus on the too-big-to-fail issue," Fell said. <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
TAKE A LOOK on Basel III reform [ID:nLDE68B0DC]
Graphic on Basel III http://r.reuters.com/jam23p ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>
If regulators do end up agreeing to slap capital surchargeson big banks, they may have to accept hybrid forms likecontingent capital, said Harald Benink, professor of finance atTilburg University in the Netherlands.
"Basel III is a step in the right direction but it's notfinished. The critical thing lacking is no systemic risk chargefor important banks," Benink said.
The regulators who completed Sunday's Basel III packageappear to be listening.
"The Basel Committee and the FSB are developing awell-integrated approach to systematically important financialinstitutions which could include combinations of capitalsurcharges, contingent capital and bail-in debt," the two bodiessaid in their statement on Sunday.
SHADOW BANKING NEXT
The G20 will also turn its attention to other regulatoryreforms such as making sure that all member countries areimplementing pledges to make derivatives markets moretransparent and safer through central clearing of contracts bythe end of 2012.
The United States has already adopted a law to this end andthe European Union will publish its own draft law on Wednesday.
"We also have to deal with the whole shadow banking system,which has not been addressed in a coherent manner," the G20source said.
Regulators in the G20 want to reduce the role of creditrating agencies in determining how much capital reserves banksmust set aside.
"Capital alone is not going to save us. We need moreeffective supervision and there is much in the way to be done bymany national authorities," the source said.
There is also a need to finalise existing G20 pledges suchas forging a single set of global accounting rules in 2011.
France takes over as G20 president from November andPresident Nicolas Sarkozy said last month that regulatingcommodity derivatives would be one of his top priorities.
Financial industry officials in London are already worriedthat France wants to regulate commodity prices, a step Britainand others would likely resist. (Reporting by Huw Jones, editing by Mike Peacock)