Basel II Delayed: Complexity is Not Clarity
May 2, 2005
The legal implementation of the new Basel II capital accord has been delayed, according to a statement released by US bank regulators on Friday. The four federal banking agencies (the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of Thrift Supervision) said that "additional analysis is needed before publishing a notice of proposed rulemaking (NPR) with respect to the U.S. implementation of the 'International Convergence of Capital Measurement and Capital Standards: A Revised Framework,' generally known as the Basel II Framework."
EAD = max {0, (CE + .4 * PFE + .6
* NGR * PFE - CA)}
CE =
current exposure Click here to see the year-end 2004 Basel II factors for the largest US banks using the current data from the Federal Deposit Insurance Corp. Note that Citibank and Fleet National Bank are the only two banks with assets > $100 billion with EADs over 100% (using the CE measure without including any mitigating factors). In our view, CE has a far greater value to regulators and investors as a measure of risk when displayed alone, without the inclusion of mitigating factors. This same comment can be applied with equal force to the entire Basel II proposal. Bachus Legislation Gains Momentum Some observers in Washington are trying to use the delay in Basel II as a pretext to suggest to gulible members of the media that Basel II will be killed. More significant and worrisome to the regulatory and investment communities, however, is the possibility that Basel II will proceed with the current level of complexity, but with the added dimension of political interference by the Congress. Unless the proponents of Basel II adjust their strategy and focus on getting the basic risk measures in place in simple, easily understandable terms, then we believe that the opponents will use the unduly complex structure of the current proposal to attempt to block adoption of the entire Basel Framework or politicize it in such a way as to make the end result useless or worse. Representative Spencer Bachus (R-AL), chairman of the House Subcommittee on Financial Institutions and Consumer Credit, has introduced legislation in the House (H.R. 1226 ) "To establish a mechanism for developing uniform United States positions on issues before the Basel Committee on Banking Supervision at the Bank for International Settlements, to require a review on the most recent recommendation of the Basel Committee for an accord on capital standards." Passage of the Bachus legislation, which already has 34 co-sponsors, will essentially kill Basel II and make the entire process of reporting bank risk factors an expression of how much money the big banks pour into the pockets of politicians. Under the bill, if the various bank regulators are unable to agree on a common position on Basel II, then the views of the Secretary of the Treasury would prevail, a possibility that should frighten even the most vociferous opponents of the new capital accord. Proponents argue that the legislation is necessary to ensure that all of the regulators have an equal voice in the Basel II process, but the reality is that the criteria listed in the review sections of the bill would effectively kill the process. For example, the legislation mandates that the Office of Thrift Supervision would have an equal voice in the Basel process, this even though no thrifts are likely to participate overtly in Basel II (however, all banks that participate in Shared National Credits will be required to report internally using the Basel II credit metrics). With the rest of the world working feverishly to align their banking systems to work together under Basel II it seems foolishly insular for the Republican-controlled Congress to pursue legislation that is not ultimately in the national interest. Further decoupling our bank regulatory system from the rest of the world only serves to accelerate the day when America's ability to influence international regulatory policy comes to a screeching halt. Of course, it may be that Bachus and his colleagues from both parties may just be grandstanding so that they can induce the various constituencies involved, including the community banks and S&Ls;, to fill up the collection plate for the 2006 mid-term election. Such is the logic of Washington. To summarize our view of the current atmosphere on Capitol Hill, we quote Mark Twain: "Suppose you were an idiot. And suppose you were a member of Congress. But I repeat myself." The full Committee is expected to hold hearings on the Bachus
legislation on Basel II on May 11th and the co-sponsors include the ranking
members of both parties. Unfortunately, we doubt whether any members of Congress
or their staff understand risk management or the Basel II proposal well enough
to argue these points. Our sister publication, Washington & Wall
Street,
will attend the hearing and report on the event in full.
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