US regulators warn on Basel II challenges, reiterate no `done deal'
WASHINGTON, March 14 - Top US banking regulators today underlined the timetable challenges facing the US in implementing the Basel II bank safety rules, urged banks to expedite their plans and warned of obstacles in the way.
Acting Comptroller of the Currency Julie Williams reiterated that Basel II is not a "done deal" in the US.
US Federal Reserve Board governor Susan Schmidt Bies urged US banks thinking of adopting the complex Basel II rules by the earliest possible date - January 1, 2008 - to move ahead on several fronts to make a success of implementing on a timely basis.
Both supervisors spoke at the annual Washington conference of the Institute of International Bankers, which represents some 150 international banks operating in the US.
Bies said several important implementation issues still need to be worked out.
"But the focus on enhanced risk management in Basel II - especially in the advanced approaches - means that banking organisations should not view Basel II preparations with a checklist mentality."
Banks should instead be looking at how to make the fundamental changes needed for better risk identification, measurement, management and control.
"Throughout the process, it will be critical that you regularly communicate with your primary supervisor about whether you plan to `opt-in' to the advanced approaches and about your timeframe for compliance," Bies told bankers at the conference.
The US plans a bifurcated policy on the Basel II rules, with a small number of large, complex international banks - the core or mandatory banks - being obliged by US regulators to adopt the risk-focused regime. Another group of banks - the opt-in banks - can apply to operate under Basel II, which aims to get banks to align their capital more accurately to the risks they face.
Analysts say the total number of banks likely to come under Basel II in the initial stages is expected to be around 20 or so, but these will represent the bulk of the country's banking assets. All Basel-II banks in the US will have to use the most advanced approaches to measuring their credit and operational risks.
The rest of the US banking system, comprising thousands of smaller banks, will remain on the current, and much simpler, Basel I capital adequacy rules that date from 1988.
Bies said that the notice of proposed rulemaking on Basel II that the four principal US federal banking supervisory agencies plan to issue this summer is unlikely to alter materially the criteria set for qualifying as a core bank. The proposed threshold, set last year, for a mandatory bank is that it has $250 billion or more in total banking assets or $10 billion or more in foreign banking assets.
She confirmed that the staffs of the agencies - the Fed, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation (FDIC) and the Office of Thrift Supervision - are also drafting a notice of proposed rulemaking suggesting possible changes to the current Basel I rules as they apply in the US. This advanced notice will be published close to the publication of the Basel II notice.
Bies said the US regulators are very sensitive to the competitive implications of having two sets of rules for the banking industry.
The regulators are "seriously considering" making some targeted adjustments to existing regulatory capital rules and looking for ways to enhance their risk sensitivity without increasing the regulatory burden, Bies said, echoing remarks made last week by Fed chairman Alan Greenspan.
Greenspan said the regulators would propose some options for simple revisions of the current capital rules where this would reduce any unintended disadvantages for small and regional US banks created by Basel II.
"Regulators recognise that Basel I can be enhanced and that the Basel II standardised approach (the simplest of the credit risk approaches) is not well suited to the needs or our domestic-focused community banking organisations," Bies said today.
She said there's substantial work to be done by both supervisors and banks to achieve the January 1, 2008 start-date. The supervisors are currently reviewing the results of the fourth quantitative impact study (QIS 4) into the effects of Basel II on banks that the US conducted at the end of last year and the beginning of this.
She said she wanted to assure banks that US supervisors are sensitive to the need to co-ordinate their efforts and will do their best both to make compliance manageable for global banks and to improve co-ordination with foreign supervisors.
US regulators are committed to applying the same rules to foreign-owned banks that are applied to US domestic ones, Bies added.
Acting Comptroller Williams told the conference that the supervisors are committed to "the integrity of the US rulemaking process".
"There is no `done deal' here; much could be changed based on information developed in QIS 4 and the public comment process," said Williams who presides over the Office of the Comptroller Currency (OCC), the federal agency that supervises some 2,000 national, non-state chartered US banks.
That's despite the pressing and immediate mid-2005 deadline for issuing the advanced notice of the proposed Basel II rulemaking.
"We have always known that this would be an ambitious deadline, given the complexity of the proposal and the many concerned parties whose views we are absolutely committed to providing with a thorough hearing at every stage of the process. Once all the comments have been fully considered, we expect to publish the final Basel II rules and final supervisory guidance by mid-year 2006," Williams said.
She added that while the deadlines are challenging, they're not impossible.
But she noted that some "thoughtful and knowledgeable" bankers and policymakers have expressed misgivings about Basel II's models-based approach and its complexity.
US supervisors fully expect some of these concerns to be reiterated in comments on the proposed rulemaking. "If we don't have good answers to good issues that are raised in the rulemaking process, appropriate revisions to the proposal must be made," Williams said.
She said that there is still some likelihood that the US Congress would again become more active in the Basel II debate as the QIS 4 results come in. She noted that a Basel-related law was introduced last week in the House of Representatives, referring to the bill introduced by Congressman Spencer Bachus that aims to ensure US financial services firms are not competitively disadvantaged by Basel II.
Williams said one of the most vexing issues facing the Basel Committee on Banking Supervision, the architect of Basel II, is the need for banks adopting the advanced internal-ratings based (IRB) approach to measuring their credit risk to reflect economic downturn conditions in their estimates of loss given default (LGD).
"As has been the case with many elements of the Basel II framework, the challenge here is to balance the theoretical with the practical - an IRB process designed to capture unexpected credit risk losses should incorporate systematic volatilities in loss severities. Risk data must capture the broad range of historical loss possibilities. But what if a bank has never experienced such losses?"
Williams noted that the Basel Committee's capital task force will be studying the LGD question, as well the outstanding issue of the treatment of trading book risks, this week. The Basel Committee itself, on which the OCC, the Fed and FDIC are represented along with senior banking supervisors from Canada, Europe and Japan, will review the same issues at its regular quarterly meeting at the end of this month.
Williams was appointed Acting Comptroller pending the appointment of a replacement for John (Gerry) Hawke, who retired as Comptroller in October.
President George W Bush in late February proposed lawyer and former US Treasury Department official John Dugan as the new Comptroller. The appointment has to be confirmed by the US Senate.
Just over 100 countries have said they intend to implement the Basel II rules, either in accord with the Basel Committee's suggested timetable or later. The Basel Committee recommends that banks using the simpler and intermediate Based II approaches to measuring their risk should start from end-2006, while banks using the most advanced approaches should implement them from end-2007.
(Bies speech: www.federalreserve.gov; Williams speech: www.occ.treas.gov; (Bachus introduces Basel Bill: http://financialservices.house.gov)
David Keefe (dkeefe@globalriskregulator.com)
