Basel II or Ia? Questions Fed Chairman Ben Bernanke May Face October 25, 2005 First, congratulations to CEA Chairman and former Fed Governor Ben Bernanke for being nominated to be the next Chairman of the Board of Governors of the Federal Reserve System. Our only comment on the nomination is that we hope that when President George Bush fills the two other open seats on the BOG, he will pick as well and at least one senior banker, preferably someone who has taken risk and understands the financial markets as a practitioner. Bernanke's colleagues on the Fed BOG have taken a beating on Basel II and could use reinforcement in the area of financial expertise, preferably a former CEO/CFO/CRO of a major financial institution.
During our swing through DC last week, we heard a lot of speculation as to when the next set of congressional hearings on the stalled Basel II capital accord would be held. We use the word "stalled" because officials of the Fed privately say that they are not sure whether Basel II will ever actually become regulation in the US due to heavy opposition on Capitol Hill and from the community bank lobby.
Several people on Capitol Hill asked what questions we'd ask
federal regulators in the hearings on Basel II to be held in both the House
and Senate, especially in the context of the debate between the hurriedly
contrived Basel Ia proposal and the original Basel II capital accord that is
being implemented by most major industrial nations. Our reponse is below along
with some other comments.
To review, Basel II offers the largest banks an opportunity to
reduce their capital requirements if - emphasis, if - they demonstrate
competency in managing their businesses so as to accurately track projections
for credit metrics such as Probability of Default ("P(D)"), Loss Given Default
("LGD"), Exposure at Default ("EAD"), Maturity ("M"), as well as a host of
operational risk factors. The largest banks have spent the past three years and
tens of millions of dollars developing new ways to measure these factors,
including developing ways to internally rate each commercial or retail customer
much as an outside rating agency or credit reporting bureau does today.
Basel Ia is the poor man's version of the same exercise. It seeks to increase the risk-sensitivity of the capital measures which apply to smaller banks, using the same public data from the FDIC and Federal Reserve Board that IRA uses to generate the proxy Basel II indicators in the IRA Bank Monitor. The Basel Ia rule seeks to give smaller banks some additional leeway in terms of capital weightings by using external ratings and existing bank data to optimize risk sensitivity.
At the recent FDIC hearing on the proposal, Democrats on the FDIC board opposed the Basel II proposal on the grounds that it would drastically reduce capital requirements for the largest banks and place those not adopting Basel II at a serious competitive disadvantage. The regulators plan to develop and implement Basel Ia and Basel II in parallel and to narrow any differences between them "over time."
On October 20, 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--published an interagency advance notice of proposed rulemaking (ANPR) regarding potential revisions to the existing risk-based capital framework. IRA will be responding to the ANPR regarding Basel Ia, but in the meantime, here are some questions we think members of the Congress should ask the regulators, starting with the Federal Reserve Board:
Capital Adequacy
Risk Management
Basel Ia vs. Basel II
Basel II: Advanced Internal Ratings Approach
National Interest: Large Banks vs. Small
The Sound of
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