May 25 (Bloomberg) -- Federal Deposit Insurance Corp. Chairman Sheila Bair said European regulators need to force their banks to hold more capital to help stabilize financial markets and promote economic growth.

“In Europe they do need to focus more on the adequacy of the capital base of their banking institutions,” Bair said in an interview yesterday in Beijing, on the sidelines of the U.S.- China Strategic and Economic Dialogue. She said European banks should face leverage limits and be required to hold more and higher-quality capital to insulate the global economy from financial instability.

Greece’s budget woes have triggered a debt crisis in Europe that has dominated this week’s discussions between U.S. and Chinese economic officials. U.S. Treasury Secretary Timothy F. Geithner and Chinese Vice Premier Wang Qishan sparred over how much global spillover will result from Europe’s difficulties, with Geithner predicting a small effect while Wang voiced concern it would trigger a “chain reaction.”

European officials should be “making it clear to the markets and the international community they have good strong rules in place to ensure the capital base of the banking system going forward, which would help their economic recovery, which in turn would help the rest of the global economy,” Bair said. “There have been a lot of concerns about what will happen in Europe and to what extent it could impact the Chinese economy and the U.S. economy.”

U.S.-China Talks

Geithner and Secretary of State Hillary Clinton are leading a U.S. delegation of about 200 officials during the two days of talks. Geithner will then depart for London, Frankfurt and Berlin to meet with European officials and reinforce his call for coordinated efforts to fight off the crisis and rein in government spending.

Federal Reserve officials including Fed Governor Daniel Tarullo have voiced concerns of a threat to the U.S. and world economies as trade shrinks and banks incur losses on European investments.

Drew Matus, a senior U.S. economist at UBS Securities LLC in New York, said that financial stability is the true source of concern, even though there may be little direct impact on the U.S. economy.

“The concern should be the stability of financial markets, which the Fed seems to have focused on,” Matus said in an e- mail. “There is a lot of good news in the U.S. economy that seems to be getting ignored because the world’s focus is elsewhere.”

Basel III

Bair said regulators around the world need to work together on the next round of capital standards for banks, known as the Basel rules because of the town in Switzerland where banking policy makers meet. Negotiations are under way for the next round of international standards, known as Basel III, which Bair said must meet “very aggressive” goals.

Bair rejected financial-industry concerns that a U.S. proposal would derail the Basel effort by legislating bank capital standards as part of the financial overhaul under debate in the Congress. The Senate passed a proposal, offered by Senator Susan Collins, a Maine Republican, that would require lenders with more than $250 billion in assets to meet capital standards that are at least as strict as those that apply to smaller banks.

The measure would set a “common-sense floor” for big banks, without forcing specific methods on regulators, Bair said. She said the practical outcome would mean that all banks, regardless of size, would be subject to the same leverage limits and barred from letting their risk-based capital ratio fall below about 8 percent.

Bank Leverage

“As we get further from the crisis and hopefully continue with a more vigorous economic recovery, there obviously will come pressures again for the banks to start becoming more leveraged because it would increase their returns on equity,” Bair said. “Having some good rules in place now to make sure that those capital cushions remain relatively permanent, I think would be a good thing.”

The American Bankers Association wrote regulators on May 19 asking for their support in getting Congress drop the provision before the final vote on the financial regulation package. The Senate and the House of Representatives have each passed versions of the legislation that now must be reconciled.

“The Collins amendment raises significant issues with respect to cross-border capital regulation and disrupts long- standing U.S. policy on such regulation,” ABA President Edward Yingling. “It would undermine critical efforts to coordinate global capital standards and invite retaliation by foreign governments.”

Bair said Congress needs to put some “overarching constraints” on regulators to avoid a repeat of the 2008 financial crisis, which she said was exacerbated because of the “absurdity” of policies that allowed big banks to reduce their capital holdings based on risk-modeling practices. She said the FDIC would work with Congress to keep the measure in the final bill.

--Editors: Brendan Murray, Vince Golle

To contact the reporter on this story: Rebecca Christie in Beijing at rchristie4@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net

Sourced from www.businessweek.com