US regulators warn that Basel II still faces hurdles
WASHINGTON - The big guns of the US federal banking regulators were out in early March, warning of tight and challenging deadlines and urging banks to expedite their plans for implementing the Basel II capital adequacy rules.
They also assured smaller banks that they would be protected from any unintended disadvantages and reiterated that Basel II was not yet a `done deal'.
US Federal Reserve Board chairman Alan Greenspan said US supervisors will propose this summer some options for simple revisions to current capital rules where this would mitigate any unintended disadvantages for small and regional US banks created by Basel II.
"Moreover, as in the past, if competitive or other issues later arise that we cannot now adequately foresee, the Federal Reserve would make appropriate further adjustment to the rules," Greenspan told the national convention of the Independent Community Bankers of America.
US regulators intend a "bifurcated" policy in respect of the Basel II capital rules.Some 20 or so of the largest US banks, representing the bulk of the nation's banking assets, will adopt the Basel II rules in January, 2008. These banks will have to use only the most advanced Basel II approaches to measuring their credit and operational risks. The rest of the US banking system, comprising thousands of smaller banks, will remain under the current, and much simpler, Basel I capital rules that date from 1988.Greenspan noted many community and regional banks are uneasy that they may be left at a competitive disadvantage after the adoption of the Basel II rules by their larger rivals.
The Fed has been studying the competitive implications of Basel II. Some of the studies have been published and others will be published in coming weeks, Greenspan said.
"For some business lines, the studies have suggested that competitive impacts are not likely, while for others, such as some types of small business loans, it does appear that unintended competitive advantages and disadvantages might be created," he added.
The federal banking regulators plan to issue a notice of proposed rulemaking (NPR) on Basel II by mid-2005. The aim is to issue the final rules on Basel II by June 2006, in time for implementation in 2008.
Federal Deposit Insurance Corporation chairman Donald Powell told the conference that bankers would be able to compare the Basel II NPR with the separate proposed changes to capital requirements for all other banks and thrifts in the US.
"It is possible there will be situations where identical assets would receive very different capital requirements, depending on whether they are held by a large Basel bank or by a community bank," Powell said.
Will these differences have any important effects? Powell said for loan pricing - maybe not; for returns on equity - probably; for where loans end up being held in banks of different sizes - probably; for consolidation of the industry - again probably.
A few days later Federal Reserve Board governor Susan Schmidt Bies urged US banks thinking of adopting Basel II by the earliest possible date - January 1, 2008 - to move ahead on several fronts to make a success of implementing on a timely basis.
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 annual Washington conference of the Institute of International Bankers.
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 Basel II's effects on banks. the survey was conducted in the US at the end of last year and the beginning of this.
Acting Comptroller of the Currency Julie Williams told the Washington conference that; "there is no `done deal' here; much could be changed based on information developed in QIS 4 and the public comment process,"That's despite the pressing and immediate mid-2005 deadline for issuing the notice of the proposed Basel II rulemaking.
"We have always known that this would be an ambitious deadline, Williams said. But she added that while the deadlines are challenging, they're not impossible.
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 in early March in the House of Representatives, referring to the bill put forward 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 is the need for banks adopting the advanced internal-ratings based (IRB) approach to credit risk measurement 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?"
