The global financial system is radically flawed and radical solutions are needed, so regulators must resist attempts to dilute proposed reforms, a top European watchdog said on Monday.

The worst market turmoil since the Great Depression has sparked a fundamental rethink of how banks and markets are supervised following the failure to spot the risks that led to the financial crisis.

But regulators fear the process could lose momentum as the world economy recovers and critics try to water down the proposed measures.

A lot of proposals for more stringent capital and liquidity requirements are currently up for consultation, but they are already meeting a lot of pushback from banks and politicians, chairman of the Dutch markets regulator, Hans Hoogervorst, said at a conference in Australia.

His host country's central bank added its support to proposals for banks to hold more capital on their balance sheets against potential losses, even though the ideas have met with a cold reception from local lenders, which sailed through the global financial crisis nearly unscathed.

Hoogervorst said there was considerable risk that future leverage ratio requirements would be both too low, and non-binding if objectors got their way.

There is already huge resistance against this proposal, Hoogervorst told the conference, run by Australia's corporate regulator, the Australian Securities and Investment Commission.

Banking chiefs have said a leverage ratio, which the United States is pushing to be used more widely, was not popular in Europe as it failed to capture risks on assets.

Last week, the head of Santander, Europe's second biggest bank, said reforms to reduce risk could be very onerous and hit profits across the industry.

Indeed, analysts at JP Morgan estimate top banks would see annual profits slump by $110 billion if proposals to increase capital and liquidity and other changes were implemented. Economic growth would be undermined and banks costs would rise, they said.

MORE CAPITAL NEEDED

Reserve Bank of Australia Governor Glenn Stevens supported the thrust of the reforms that are being worked on under the Basel process.

Speaking at the conference, he said holding more capital on bank balance sheets was a sound idea, even though local lenders had skated through the crisis thanks to a solid economy, strict supervision and good management.

Despite the fact the economy has come through pretty well so far, it probably wouldn't hurt for there to be a little more capital and more attention to liquidity, Stevens said.

And more attention paid to the possibility that the funding markets that banks rely on can seize up, he added.

Stevens attributed the banks' stable performance to a strong economy that had provided growth opportunities for its domestic lenders.

You don't have to go and do exotic things in foreign markets. Here, there was plenty of growth at home doing plain vanilla things, he said.

Australia's prudential banking regulator has proposed new liquidity rules that would require local banks to park more of their money in high-quality assets, such as government bonds, causing some banks to grumble that funding costs could rise.

The Australian Prudential Regulation Authority (APRA) is expected to release guidelines on proposed new liquidity rules next year once the Basel reforms are finalized by the end of 2010.

The head of APRA, John Laker, told the conference that changes had to be made before inertia and resistance built up.

(Edited by Neil Fullick)

Australia