EU FINANCE ministers are today expected to discuss a temporary relaxation of the Basel II rules that govern how much capital banks must hold to prevent a worsening of the economic crisis.

Peer Steinbrück, German finance minister, is expected to urge his European colleagues to help alleviate capital pressures on banks during the crisis so they are able to lend to businesses that lack liquidity.

But, at the same meeting, ministers will also consider longer-term measures to encourage banks to build up extra capital buffers in periods of economic prosperity so they are better prepared to weather economic storms.

They are expected to endorse a working group report that says there is a “strong case” for curbing “pro-cyclicality” – the way in which financial activity tends to amplify and exacerbate the ups and downs of business cycles – through accounting changes and measures which encourage banks to build up better capital “buffers”.

A draft, seen by the Financial Times, also reveals that the European Commission intends to present legislation to introduce “dynamic provisioning” for Europe’s banks in October. This would make it easier for banks to build up provisions through accounting in good times, which could then be used in downturns.

Rules of this nature in Spain helped banks there to come through the recent crisis relatively unscathed.

Berlin’s concerns, however, are more immediate, with officials increasingly alarmed that there is potential for a severe credit crunch in the second half of this year as banks seek to restore capital levels by reining in corporate credit.

Mr Steinbrück and Karl-Theodor zu Guttenberg, economics minister, attacked banks at the weekend for failing to pass on to companies the benefit of cheap liquidity that the European Central Bank has provided to financial institutions.

Ministers have threatened to force banks to maintain lending in the coming months amid growing frustration that a €500 billion banking rescue package and the passage of a “bad bank” law have failed to solve the problem.

However, Berlin is also conscious that, in forcing banks to hold more capital in the downturn, Basel II may amplify its effect by restricting banks’ ability to lend. “The German government has always made clear that these Basel II rules have a pro-cyclical effect in the crisis,” Thomas Steg, deputy spokesman for Angela Merkel, chancellor, said yesterday.

Ideas that EU finance ministers could discuss include a temporary cap on the maximum risk gauges that determine how much capital banks must hold. Another proposal would modify the capital-holding implications of a credit-rating downgrade on a particular asset so that the impact on banks becomes less severe.

“It is particularly important for German companies that the pro-cyclical effect of Basel II is lessened. This needs to be tackled quickly as the risk of a credit crisis in the real economy will intensify during the summer,” said Werner Schnappauf, director general of the Federation of German Industries. – (Copyright The Financial Times Limited 2009)