April 12 - This is a round-up of some recent news on the implementation of the Basel II international bank capital rules in the US and Australia:
WASHINGTON - US mortgage rates are likely to be largely unaffected by the co-called bifurcated US policy on adopting the risk-focused Basel II international bank safety rules, a study by US Federal Reserve economists says.
As a result Basel II is unlikely to have any direct impact on competition in the home loan market between the small number of large US banks that will adopt the new rules, and the thousands of small and regional banks that will remain on the simpler Basel I capital rules that date from 1988.
The reason is that mortgage rates would continue to reflect the capital requirements of government-sponsored housing enterprises, or GSEs, such as Fannie Mae and Freddie Mac, says the study, the latest in a series of reports on the likely impact of Basel II on competition in the US banking industry. Another on consumer credit cards is expected by mid-year.
US regulators have said they will propose this summer some options for simple revisions of the current capital rules where this would mitigate any unintended disadvantages for smaller banks arising from Basel II. Many US banks fear they could suffer competitively because the risk-sensitive Basel II rules could result in adopting banks enjoying lower capital charges than their smaller, Basel-I compliant rivals.
But Fed chairman Alan Greenspan reiterated earlier this month that the Fed's studies so far suggest that Basel II "would have at most modest competitive impacts". However, Greenspan noted the studies do indicate that there may be some potential effects on regional banks in the market for loans to small and medium-sized firms.
The latest study, issued yesterday, says the most significant competitive impact of Basel II in the mortgage market might be to put pressure on GSEs to lower their guarantee fee to Basel-II compliant banks for prime mortgages. And Basel II adopters might have increased profits from some mortgages relative to non-adopters because they will capture some of the deadweight losses that occur under the current capital rules imposed on depositories and on securitisers. But non-adopters would likely retain their mortgage market positions, the paper says.
The US banking supervisory agencies plan to issue their proposals for implementing Basel II by the middle of this year with the aim of finalising them by mid-2006. The Basel II regime would then come into effect for the largest US banks, estimated at 20 or so but comprising the bulk of the nation's banking assets, from January 1, 2008. These banks would be required to use only the most advanced Basel-II approaches to measuring their risks.
(An Analysis of the Potential Competitive Impacts of Basel II Capital Standards on US Mortgage Rates and Mortgage Securitization is available on the Fed's website: www.federalreserve.gov)
WASHINGTON - US Federal Deposit Insurance Corporation (FDIC) chairman Donald Powell has reiterated the agency's view that any risk-based capital framework like Basel II must include a "straightforward capital floor".
Powell said some observers are suggesting that Basel II will make obsolete current requirements for FDIC-insured banks to meet certain leverage requirements. "The leverage ratio is a simple, clear-cut minimum amount of capital banks need to hold as a percentage their assets," he told a derivatives conference at the end of last week.
"In our view, phasing out the leverage ratio suggests we are willing to contemplate a significant expansion of the federal safety net," Powell said.
But he said the FDIC, which insures deposits at nearly 9,000 US banks and savings associations, continues to support the view that there should be limits on regulators' discretion about the level of capital at which banks are permitted to operate.
The FDIC is one of the four federal banking supervisory agencies responsible for implementing Basel II in the US. The others are the Fed, which runs the country's central banking system, the Office of the Comptroller of the Currency, which regulates some 2,000 national, or non-state chartered, banks, and the Office of Thrift Supervision.
(www.fdic.gov)
SYDNEY, Australia - Australian supervisors issued this week a discussion paper on implementing the standardised method of measuring bank credit risk, the simplest of the Basel II credit risk approaches.
The paper is the first of eight discussion papers that the Australian Prudential Regulation Authority (Apra) plans to issue in coming months on various aspects of implementing Basel II in Australia.
Apra expects to issue its final version of Basel II in early 2007 with the aim of bringing the regime into effect at a common start-date of January 1, 2008. Apra's timetable therefore differs from the one suggested by the Basel Committee on Banking Supervision, the body of senior banking supervisors from North America, Europe and Japan that devised Basel II. The Committee recommends end-2006 as the start-date for banks using the simpler and intermediate approaches to assessing their credit and operational risks, and end-2007 for banks using the advanced approaches.
Most Australian banks, building societies and credit unions are expected to adopt the standardised credit risk approach under which banks use external estimates of credit-worthiness, such as those developed by the leading credit rating agencies, to estimate the chances of their borrowers defaulting.
A later paper will cover implementation of the foundation and advanced internal-ratings based (IRB) approaches, both of which are based on a bank's own estimates of default probability. Australia's big four banks - Australia and New Zealand Banking Group, Commonwealth Bank of Australia, National Australia Bank and Westpac Banking Corp - intend to adopt the advanced IRB approach. The four banks account for an estimated 70% of the country's banking assets. The advanced IRB approach allows banks to use their own estimates of both exposure at default and loss given default.
(www.apra.gov.au)
David Keefe (dkeefe@globalriskregulator.com)
Europeans want quick agreement on fair value option
BRUSSELS, April 26 - Europe's financial regulators hope to move fast to resolve at least part of the wrangle that's marred the adoption of new international accounting rules in the European Union, now that accounting rule-makers have essentially agreed limits on the so-called fair value option.
Officials with the European Commission, the EU's Brussels-based executive arm that's responsible for initiating financial regulation in the 25-nation bloc, are optimistic that member states will in May support the amended rule. That's particularly so now that the amendment has won the backing of banking supervisors with the European Central Bank and the Basel Committee on Banking Supervision.
The banking regulators feared that unlimited use of the fair value option, which is part of the notorious IAS 39 accounting rule on valuing financial assets and liabilities, would allow weak banks to undervalue their liabilities, for instance, and possibly threaten financial stability.
But last week the International Accounting Standards Board (IASB), the London-based accounting rule-maker that developed the new international accounting rules known as International Financial Reporting Standards (IFRS), agreed in principle on an amended form of the fair value option that meets regulator fears, while allowing financial firms scope for appropriate use.
If further procedural steps are concluded without a hitch, the IASB would hope formally to publish the amendment by the first half of June. It would take effect from January 1, 2006 with earlier application of the amendment permitted. Commission officials hope to match the IASB timetable in terms of EU agreement on the amendment
The dispute over the fair value option was one of the two reasons for the Commission's adoption of a diluted version of IAS 39 last year, a move that earned Europe's regulators a lot of criticism. They were accused of undermining the ultimate goal of creating a single set of global accounting rules. IFRS started coming into effect in January in many countries, including those of the EU where it applies to some 7,000 companies with listings on EU stock markets.
The Commission "carved out" from IAS 39 provisions relating to the fair value option and also to hedge accounting, this latter stemming from objections from some banks to the valuing of derivatives at current prices. At the moment, EU firms can't use the fair value option in respect of their liabilities.
Commission officials say resolving the fair value option argument is a more important step than finding an answer to the hedge accounting problem. That's because the fair value option is a key "measurement issue", and also because under EU rules member states have no choice but to operate the carve-out. However, member states and firms are free to ignore the hedge accounting carve-out and to stick with the original IASB provisions. But officials say resolving the hedge accounting problem is technically much more difficult, and there's not much sign of progress on this front.
The fair value option exists because IAS 39 has two ways of valuing the financial assets and liabilities that form the bulk of the balance sheets of banks, insurers and investment firms. It stipulates the use of fair value, or current market prices, to measure derivative contracts as well as bonds and shares held for trading, for instance. Other items that may be more difficult to measure at fair value - loans and receivables, for instance - or which are long-term investments such as bonds held for maturity, are valued on an amortised cost basis.
The option exists so that firms can choose to measure any item at fair value to avoid accounting distortions. These could arise, for example, where an asset is required to be measured at fair value while its matching liability is valued at cost.
Last week's amendment approval by the IASB came after a year or more of argument. Banks and insurers would have preferred to retain unfettered use of the option. An IASB exposure draft, or formal consultation document, proposing detailed limits on the option was overwhelmingly rejected by all parties last year except the regulators. A "principles-based" amendment put forward by IASB staff at the end of 2004 opened the door to negotiating a workable solution that received general support from regulators, firms, auditors and accounting bodies at an IASB-organised round table meeting in London in March. The amendment aims to get firms to observe the spirit of the option, which is to prevent accounting distortions and not to provide a means of masking financial weaknesses. Firms have to state clearly whey they are using the option and how it fits into their asset-liability management policies.
European Central Bank president Jean-Claude Trichet told the IASB earlier this month that the Bank supports the amendment. The Bank is the central bank for the 12 EU nations that have adopted the euro as a single currency.
Earlier Dutch central banker Arnold Schilder, who heads the accounting task force of the Basel Committee, urged the European Commission to back the compromise. The Basel Committee is the body of senior banking supervisors from North America, Europe and Japan that in effect regulates international banking. Schilder said the amendment strikes the right balance between the IASB, financial institutions and regulators.
IASB sources say the final version of the amendment, which will incorporate points made at the Board's April meeting and at the London round-table, will be voted on by the Board at its monthly meeting in mid-May. Last-minute upsets are thought unlikely. Commission officials say the first chance for member states to discuss the amendment will be the May 20 meeting in Brussels of the Accounting Regulatory Committee (ARC), the body of accounting experts from the EU countries that advises the Commission on the adoption of IFRS measures.
The final version of the amendment as approved by the IASB won't be available for that ARC meeting, officials note. But ARC members are likely to approve in principle at the May meeting, and give their agreement to the final version at ARC's July gathering, before the summer break.
Perhaps the biggest hurdle to speedy progress is the need to translate the amendment into the EU's 19 official languages. It may be necessary for the Commission to give approval on the basis of the IASB's English version alone, ahead of translations into other languages, if the amendment is to be activated in the EU in line with the IASB's planned January 1, 2006 date.
Separately meanwhile, the US Securities and Exchange Commission last week reaffirmed its support for the convergence programme between the IASB and the US Financial Accounting Standards Board, the accounting rule-maker responsible for developing US generally accepted accounting principles, or GAAP.
David Keefe (dkeefe@globalriskregulator.com)
