The Basel Committee on Banking Supervision is considering extra reserve requirements and tougher oversight for smaller lenders that aren’t caught by measures to protect the world economy from meltdown. The possible firewalls will be discussed at a two-day meeting of the group that starts tomorrow, according to two people familiar with the talks that will also consider changes to a draft liquidity rule for banks.

Competition may be distorted “if a globally systemic bank has to face surcharges while other banks which are very large in domestic markets are exempt,” Patricia Jackson, head of prudential advisory at Ernst & Young LLP in London, said in a phone interview. “It could be a problem if you have equally important banks competing in a national market but one carries a much bigger capital requirement because it also has international business.”

Deutsche Bank AG, BNP Paribas SA and Goldman Sachs Group Inc. are among 29 lenders targeted last year by the Group of 20 nations for capital surcharges of as high as 2.5 percent of their assets, weighted for risk. This week’s discussions will focus on capturing banks that escaped because their insolvency would have limited global impact, said the people who couldn’t be named because the meetings are private.

International Retreat

One reason for regulators to press ahead with the new rules is to prevent lenders scaling back their international business, Jackson said.

“If you impose surcharges on banks judged to be globally systemic but not on other large lenders then you are going to encourage banks to retreat into their home markets,” she said. This could have “negative consequences for international activity such as trade finance.”

The measures would go beyond minimum capital and liquidity rules for banks, known as Basel III, that were agreed by international regulators in 2010. The Basel committee hasn’t identified which nationally important lenders will face the additional measures, the people said.

Regulators will this week discuss the process for drawing up the extra rules, including whether the Basel group should prepare a list of banks that would face surcharges or instead leave the task of identifying systemic lenders to each national regulator, the people said.

‘Herd Issue’

Mark Carney, chairman of the Financial Stability Board, has called for the stricter rules to be approved by the end of the year. The Basel committee is drafting the requirements for the FSB, which brings together regulators, central bankers and financial ministry officials from G-20 countries.

“There could be nationally systemic banks that when looked at globally are not individually critical, but when looked at together could present problems -- a herd issue,” said Patrick Fell, a director at PricewaterhouseCoopers LLP in London.

This might occur “if you have several lenders in different countries that are focused around a particular product or a particular funding style,” he said.

The FSB and Basel committee will publish a progress report on the plans next month.

The measures for these smaller banks “will follow the same sort” of line as the requirements agreed to last year for globally systemic banks, Rene van Wyk, who represents South Africa’s central bank on the committee, said in an interview in Pretoria on March 7.

Van Wyk said the Basel group will this week also “present some calibration points and technical calculations” on a draft liquidity rule, known as the LCR or liquidity coverage ratio, without changing the “fundamentals” of the standard.

The Basel committee includes banking regulators from 27 nations including the U.S., U.K. and China.