Last week our subscription news service, Washington & Wall Street, reported that several members of Congress had accused the Federal Reserve Board of "lying to us" regarding adoption of the New Basel Capital Accord or "Basel II." Based on these outbursts, which come as the mid-term elections in the US are just 13 months away, it was pretty clear that in Washington, at least, Basel II was not going to be the subject of a rule making procedure during 2005.

On Friday, several US bank regulators announced a one-year delay of the adoption of Basel II, this following the hearing before the House Financial Services Committee two days before. The regulators had attempted, unsuccessfully, to delay the hearing, but instead the meeting populated exclusively by opponents to the accord served as the catalyst for a full-scale retreat by the Federal Reserve Board. The news coverage today says that the Fed, led by Governor Susan Bies, "hashed out" a compromise schedule on Basel II adoption, but fact is she got spanked by Rep. Barney Frank (D-MA), ranking minority member of the House Financial Services Committee.

More than a few people noticed the irony that as the US Congress, driven by various parochial interests in the community banking industry, delays adoption of Basel II, the EU is moving forward with the new bank capital requirements. Last week, the European Parliament approved the Basel II accord for all 25 of the member states, clearing the way for final go-ahead before the end of the year by the community's finance ministers.

The US banks of all sizes which have lobbied for the prevention or delay of Basel II, mostly for insular reasons, have succeeded only in making themselves more vulnerable to the very consolidation they allegedly fear. The die is cast. A global tide of Basel II enabled institutions that perform their own internal risk ratings of obligors is awakening to feed on America's low hanging fruit. We have only ourselves to blame for this result.

In our contribution last month to Global Risk Regulator, we noted that the EU does not yet have a unified bank supervisory structure to implement Basel II, even if the bureaucrats in Brussels have the vision to make a political statement supporting the new bank capital accord. Basic issues, like the definition of bank insolvency and the template to be used to for gathering bank data, remain to be settled in Europe, but nonetheless they are moving forward with Basel II - as is the rest of the industrialized world.

In the US, meanwhile, the small minded men and women who populate the House Financial Services Committee seem content to let the disproportionate political sway wielded by the community bankers derail the entire Basel II effort. We predicted that precisely this outcome would be realized nearly two years ago, but it is only now, after months of inaction by the Congress and the Bush Administration, and with a contentious mid-term election facing the House, that Democrats and Republicans alike have chosen to make Basel II adoption an issue.

Politics aside, though, the fact that the US bank regulators have not been able to come to agreement on the basic benchmarks to be used for calculating economic capital under the Basel II accord is a big factor in deciding on a delay, according to our sources.

The chief risk architect at one of the top-three US money center banks told The IRA on Friday that his bank still does not have a final number for operational risk in the bank's overall capital equation. "We have a range of values for the advanced measurement approaches ("AMAs") to assessing operational risk under Basel II," opined this risk veteran, "but I can't pick one number and say with 100% certainty that it is right."

The same source notes that all of the international banks based in the US will continue to move forward with implementation of Basel II for their offshore operations, even if the US regulators delay the process for a year. "The delay is not going to change our preparations very much if at all because all of the other jurisdiction in which we operate are going forward with Basel II."

Comments by Fed Governor Susan Bies that "the Federal Reserve would not be comfortable qualifying any bank based on the results (of recent analysis), if Basel II rules were to be applied today," illustrates the problem, namely that the measures are too complex (and thus indefinite) to be applied in the real world. Sources in the risk community confirm comments by Bies and other regulators that review of the last quantitative impact study (QIS4) of the likely effects of Basel II on US banks is still not completed and that some of the responses were so varied as to undermine confidence in the entire data collection effort.

The QIS4 findings reportedly showed that the capital held by the 26 participating banks could fall significantly under the proposed Basel II formulas, according to news reports. One federal official was quoted as saying that some banks had provided "zero" for some of the exposure risks weightings, a response termed "unacceptable."

It seems that until US regulators figure out precisely how the new Basel II framework will measure capital adequacy for banks, and are able to publicly present this methodology for all to see and evaluate, it will be impossible to get the Congress or powerful constituencies like the community bankers to sign off on the new bank capital accord. We don't want to strain any of the dutiful public servants at the Fed or OCC, but would it be too much trouble to sit down with each of the top ten money center banks and actually calculate the initial economic capital position for each under Basel II? By publishing these results, the rest of the US banking industry would then have some public reference points to guide them.

At the end of the day, many bankers and policy makers blame the confusion and lack of leadership within the US bank regulatory community, and not the increasingly partisan atmosphere in the Congress, for the delay on Basel II. Adding compexity through the inclusion of operational risk as an explicit part of the capital adequacy equation is part of the trouble, but a lack of purpose and attention to the national interest lies at the heart of the continuing squabble among the Fed, OCC and FDIC, a sibling wrangle that will only further delay American adoption of Basel II.

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