US regulators restrict Basel II adoption amid agency infighting

In Congressional hearings yesterday, top US bank regulators sharply criticised the proposed Basel Accord revisions, and used their criticisms to justify plans to apply the new set of international banking regulations to only the top 10 banks in the country.

Other banks can adopt Basel II only upon application to the regulatory authorities. Also, banks will only have the advanced internal ratings-based approach available to them on the credit risk side, and the advanced management approach on the operational risk front. The basic indicator approach (BIA) and the standardised approach (TSA) will not be applied to US banks.

“For most banks in this country, Basel I is now — and for the foreseeable future will be — more than adequate as a capital framework,” said Roger Ferguson, vice chairman of the Board of Governors of the Federal Reserve at the hearings before the Subcommittee on Domestic and International Monetary Policy, Trade, and Technology of the Financial Services Committee, in the US House of Representatives. He continued, “US supervisors do not believe the benefits would exceed the costs of requiring most banks to shift to Basel II.”

There were signs of regulatory turf battles, however. Ferguson was the most Basel II-friendly of the three regulators who spoke. He generally spoke positively about the Basel Accord revisions and fully backed the inclusion of operational risk in Pillar I. “As a bank supervisor and as a central banker, I have to say that we have not found the arguments of the operational risk sceptics to be convincing.”

He also said banks that engage in specialised activities, such as securities processing and custody, will probably see their regulatory capital requirements on those activities rise. These banks have been leading the anti-Basel II movement in the US under the umbrella of the Financial Guardian Group, a lobbying organisation headed by Karen Shaw Petrou, who also testified.

In contrast, the testimony of Donald Powell, chairman of the Federal Deposit Insurance Corporation (FDIC) and John Hawke, comptroller of the currency and head of the Office of the Comptroller of the Currency (OCC), were both significantly more negative about the Basel proposals.

Powell raised several “critical issues” that “need to be addressed before a commitment is reached to implement Basel II in the US”. In contrast, Ferguson seemed certain that Basel II would be applied. Powell said the Accord “must ensure that appropriate minimum capital requirements are maintained. Second, the new Accord must ensure that internal risk estimates used as inputs to the new capital formulas are estimated in a sound and conservative fashion and are evaluated consistently going forward using a uniform interagency process. In addition, the competitive impact of the new Accord must be fully explored and assessed.”

The OCC’s Hawke went even further, reminding the audience that his organisation “has the sole statutory responsibility for promulgating capital regulations for national banks” and that it “will not sign off on a final Basel II framework until we have fully considered all comments received during our notice and comment process — as we would with any domestic rulemaking.” Later he continued: “If we determine through this process that changes to the Basel proposal are necessary, we will press the Basel Committee to make changes, and we preserve our ability to assure that any final US regulations applicable to national banks reflect those views.”

Specifically, Hawke criticised the advanced IRB approach and the AMA for operational risk, calling them “untested, with only limited industry practice to substantiate their practicality”. He added: “Moreover, the agencies have not fully assessed the effect of Basel II on regulatory capital, risk management systems, data requirements, supervisory programs and credit availability.”

Even more critically, he said: “I have consistently expressed profound concern about the level of detail and specificity of the Basel proposal. In my view, the complexity generated in Basel II goes well beyond what is reasonably needed to implement sensible capital regulation.” He also maintained that a charge for operational risk should be kept under Pillar II.