Standardised approach in US depends on credit risk ruling

Any decision on Basel II will depend on the route the interagency takes on credit risk, says FDIC.

The decision whether to allow US banks to take the basic indicator approach or standardised approach to Basel II will depend for the most part on the route the US Interagency authorities take on credit risk, a regulator has said.“Any decision to allow the standardised approach for operational risk will be closely tied to the decision on credit risk. I don’t know whether we’ll be opening the door for standardised on operational risk if it is not there on credit risk,” said Mark S Schmidt, regional director for the the Federal Insurance Deposit Corporation.Speaking at the American Bankers Association Operational Risk Conference, Schmidt acknowledged that consultation responses to the latest Notice of Proposed Rulemaking largely implored the US regulators to give banks the choice of approach but also defended the thinking behind the American single approach model. “Most of the comment letters urged us to include in the final rule the standardised and basic indicator approaches. When we started we looked at a lot of potential proxies for operational risk but the Advanced Measurement Approach (AMA) was the best of the proxies available and that was the rationale that the US used in leaving the BIA and the SA out of the proposal,” Schmidt said.“Our agency decided early on that Basel II is designed and aimed at the largest banks in the country and therefore they should take the most sophisticated approach to calculate capital. The NPR discussed the alternative approaches and made it clear that we would at least consider the application of the other methodologies,” he added.As matters currently stand, the regulators’ NPR only includes a provision for US banks to follow the AMA for operational risk and the Internal Ratings Based Approach (IRB) for credit risk in complying with Basel II. Unlike their counterparts elsewhere in the world, American banks cannot opt to take the simpler, standardised approach for either discipline. While the frustration of banks at the regulators’ rigid adherence to a single model appears to be getting through loud and clear, other pertinent issues raised in response to the NPR, such as the retention of the leverage ratio, the imposition of a 10% “safety” floor and wider concerns over divergence from the international accord, were ignored by the regulators at the meeting, who focused instead on more palatable areas of consultation feedback. “We asked in the NPR whether credit card fraud that comes from a third party should be considered operational risk or credit risk. Only two comments explicitly endorsed the proposal to count it as op risk with another five that seemed to be generally supportive. That’s something we’ll have to be looking at as we approach a final rule,” said Stacy Coleman, assistant director at the Federal Reserve Board.“We also asked whether home equity lines of credit should be considered to be treated as operational risk like we proposed on credit card fraud and there wasn’t a great deal of support for that really. Some responders said that it should remain on the credit side for the purposes of calculating remaining capital while another three were concerned about the proposed treatment of credit card fraud because it would make an unnecessary inconsistency with the international accord,” Coleman added.Wider issues of inconsistency between the US and international implementation process were not touched upon. The next step in the Basel II implementation process, either the issuing of the final rule or a further NPR to address concerns raised in the latest one, is expected before the end of the year.