Banking Law Prof Blog

Capital Adquacy in a Time of Bank Failures - Basel II, Pillar Two

As the probability of increasing bank failures looms large in the public consciousness, more attention will appropriately focus on capital adequacy.  How Basel II implementation will square with the need for an adequate capital buffer against hard times is an even more critical question today than it has been over the past couple of years.

Take a good look at the Federal Banking Agencies' issuance of Final Guidance on Basel II, Pillar Two (which covers supervisory review of capital adequacy):  http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20080715a1.pdf

Remember that the three pillars of Basel II are:

Pillar One:  Minimum risk-based capital requirements;

Pillar Two:  Supervisory review; and

Pillar Three:  Market disciplinethrough enhanced public disclosures.

(ag) July 29, in Capital Adequacy/Basel II

Basel II Final Rules - At Last

The Federal Reserve Board announces adoption of Final Capital Rules that accord with Basel II.  The new capital standard is more risk-based and places U.S. banks on a more equal footing with their global competitors.  It is mandatory for large, internationally active banking organizations (so-called “core” banking organizations with at least $250 billion in total assets or at least $10 billion in foreign exposure) and optional for others.

Link:  http://www.federalreserve.gov/newsevents/press/bcreg/20071102a.htm

(ag) Nov. 2, 2007, in Capital/Basel II

U.S., Canada, Europe, Japan & Australia Cooperate on Financial Issues

The global nature of the financial sector and the interdependence of national financial regulation have become very significant.  Therefore, it is good news that Comptroller John Dugan has been named Chairman of the Joint Forum, a group of senior financial sector regulators from the United States, Canada, Europe, Japan, and Australia.

This international group was formed under the aegis of the Basel Committee on Banking Supervision, the International Organization of Securities Commissions, and the International Association of Insurance Supervisors, to deal with issues common to the banking, securities, and insurance industries, including supervision of conglomerates.

Comptroller Dugan's term runs through December 2009.

(ag) Sept. 25, in Basel II, International Banking.

Finally! Federal Banking Agencies Reach Agreement on Basel II

The FRB, OCC, OTS, and FDIC announced agreement on a phased-in implementation of Basel II in the U.S. -- with new rules on how to compute large banks' risk-based capital.  Look for a new Final Rule to replace the current Notice of Proposed Rulemaking.

For smaller banks, there will also be a new proposed rule to allow non-core banks the option to adopt a standardized approach under the Basel II Accord, replacingthe  proposed rule for "Basel IA".

Link:  http://www.federalreserve.gov/boarddocs/press/bcreg/2007/20070720/default.htm

(ag) July 22, in Capital/Basel II

FDIC Viewpoint on Basel II

FDIC Chairman Sheila Bair showed her sense of humor in a recent speech at the 2007 Risk Management and Allocation Conference in Paris.  Noting that her assigned topic was "The Dream of a Single Global Standard", she recognized that the real question is, "When Will the Americans Finish the Rule?"

Chairman Bair's position is that to answer that question, as well as the question, "How much capital is enough?", one must consider four risks:

1. The risk inherent in letting the banks decide for themselves how much capital is enough;
2. The uncertainty of whether capital requirements can be tied appropriately to risk;
3. The problem that even if banks and supervisors could somehow work together to average out the subjective and divergent risk inputs, the advanced framework may still deliver insufficient capital; and
4. The very real possiblity, given the U.S. subprime mortgage market as a current example, that bank regulators are not capable of determining the appropriate level of stress to build into Basel II advanced capital calculations.

Link to speech:  http://www.fdic.gov/news/news/speeches/chairman/spjun2507.html

(ag) July 10, 2007, in Capital Requirements/Basel II 

The View from Down Under - Basel II

Here's another web comment received this week, this one from Australia:

"Chairman Bair's comments, to me at least, show that she is a regulator through and through. She does not appear to be concerned about the long-term health of the system or whether US banks are able to compete overseas, provided depositors will be covered when they crash. I know the FDIC was badly burnt in the S&L episode, but penalising the large and well managed banks for what happened in the S&L sector is not the way to go, IMHO.
If this is the way that the US finally goes with this all I can see in the future is the large US banks being bought out by their overseas competitors as their cost base is better and the US not being in a position to regulate any large banks.
It will not happen overnight - but over the next 10 to 20 years that is the way they will drift."

Thanks to Ozrisk!  Link to website: http://ozrisk.net/

(ag) Mar. 3, 2007, in Capital Requirements/Basel II

FDIC says Basel II should not be about the lowest possible capital requirements

FDIC Chairman Sheila Bair's remarks to the Global Association of Risk Professionals on Monday, Feb. 26, 2007, highlight the differences between the FDIC and other federal banking agencies about Basel II.  (A comparison with Susan Bies' speech to the same group -- reported in this blog on Monday -- makes that difference clear.)  That's to be expected:  FDIC as insurer will take the hit for financial institutions if capital requirements are set too low.

Chairman Bair recognizes the issues in play:  "With Basel II, bank regulators are playing for high stakes. Our decisions will determine whether the effort becomes a compliance exercise, or truly improves risk management. Our decisions could affect the severity of the business cycle and the allocation of credit across economic sectors. We risk accelerating the contraction of our community banking sector, and our large banks have expressed concerns about international competitive imbalances."

Here's her starting premise:  "From day one, back in 1999 with the first consultative paper, Basel II was supposed to be about improvements in risk management and not about dramatic reductions in capital requirements."

She believes in the importance of capital as a cushion against failure:  "While effective supervision is crucial to any regulator's ability to promote bank safety-and- soundness, the effectiveness of supervision can be fatally undermined if the regulations do not require an adequate amount of capital."

Although Chairman Bair hears big bank complaints that they are being disadvantaged in the international arena, that's not her real concern:  "For bank capital requirements to become a tool for international competition, creates the potential for a competition in laxity. A race to the bottom in bank capital standards would be a profoundly negative development for the future stability and health of the global financial system."

Link:  http://www.fdic.gov/news/news/speeches/chairman/spfeb2607.html

(ag) Feb. 27, 2007, in Capital Requirements/Basel II

A Swan Song about Basel II

Soon-to-be-departing Federal Reserve Governor Susan Schmidt Bies spoke to the Global Association of Risk Professionals Basel II Summit in New York on Feb. 26, 2007. 

Here are some of her key points:

1. "The Federal Reserve's main reason for pursuing Basel II is the growing inadequacy of current Basel I regulatory capital rules for the large, internationally active banks that are offering ever more complex and sophisticated products and services. We need a more risk-sensitive capital framework for these particular banks, and we believe Basel II is such a framework. "
2. "U.S. supervisors support the 2005 Basel/International Organization of Securities Commissions (IOSCO) revisions to the 1996 Market Risk Amendment (MRA). "
3. Two important recent events related to Basel II implementation in the United States,occurred on February 15, 2007:  A report by the Government Accountability Office (GAO) on U.S. implementation of Basel II AND issuance of proposed Basel II supervisory guidance by the U.S. banking agencies.

Governor Bies talks around the complaints we hear from other countries' banking regimes, that the U.S. is "foot-dragging", that the U.S. implementation will not conform to the full Basel II framework, and that the U.S. regime will be too conservative.  See what you think!

(ag) Feb. 26, 2007, in Capital Requirements/Basel II

Link:  http://www.federalreserve.gov/boarddocs/speeches/2007/20070226/default.htm

Saturday Smiles

Thanks to a fellow bank blogger (who prefers to remain nameless for his/her own risk management purposes) for this Auditor's Bedtime Story:  http://ozrisk.files.wordpress.com/2007/02/the-auditor-bedtime-story.pdf

Here's the Link to the the Blog "Risk Management in Australia":  http://ozrisk.net/

I received this link together with the following comments about Basel II that are worth considering:

"Professor,
The way in which the US regulators are implementing the Basel II standards is causing no little amusement and consternation overseas.
Overall, and IMHO, the US regulators seem to be unsure if their role in all this is to regulate to try to ensure the safety and soundness of the US banking system or to try to protect the smaller players against the bigger ones through the capital requirements. This confusion is driving this current muddle. You cannot have it both ways.
The real problem here is that the way it is going it is going to do either (or both of) hobble the major banks in their competition overseas or make the system less secure through allowing a drop in capital in the system overall. If there is less incentive (by way of a dropped capital charge) to improve your riskmanagement then the banks are less likely to do it.
Basel II was designed to give capital concessions when a bank is managing its risks better - that is the way it is built. Smaller banks cannot spread their risks as well, so they should attract a higher capital charge.
I have put up a few posts on this process over the last few months (http://ozrisk.net/tag/basel-ii/us-implementation/). I look forward to putting up more as this process works itself out."

(ag) Feb. 24, 2007, in Capital Requirements/Basel II

More Opportunity to Comment on Basel II Proposals

The Federal Banking Agencies issued 3 proposals relating to Basel II for public comment.  According to FDIC's Press Release:  "Two of the proposed documents issued Thursday relate to the Basel II advanced approaches for calculating risk-based capital requirements: the advanced internal ratings-based (IRB) approach for credit risk and the advanced measurement approaches (AMA) for operational risk. These guidance documents have been updated since they were previously issued for public comment in 2003 and 2004. The third document proposes guidance on the Basel II supervisory review process for assessing capital adequacy and is being issued for the first time."

Link:  http://www.fdic.gov/news/news/press/2007/pr07013.html

(ag) Feb. 16, 2007, in Capital Requirements/Basel II

Capital Reform – Basel 1-A and Basel II

On Dec. 5, 2006, FDIC’s Board of Directors adopted the Joint Federal Banking Agency Proposed Rule which would revise the current capital rules for banks not required to follow Basel II.  The Basel II banks are only the very largest.  Basel 1-A could apply to all the rest – although they retain the option to remain subject to the existing risk-based capital rules.  Comments on the Basel 1-A proposal will be accepted for 90 days following Federal Register publication.

In addition to the Basel 1-A Proposal, FDIC seeks comment on whether the largest banks, which FDIC has proposed be required to follow Basel II’s Advanced Approach, should be allowed to follow the Standardized Approach adopted by foreign banking regulators – or the Basel 1-A standard. 

FDIC’s Board has also extended the Comment Period for its Basel II Proposed Rule (approved by FDIC’s Board Sept. 5, 2006, with a comment period originally set to expire on January 23, 2006) so that the Comment Period on both the Basel II Proposal and the Basel 1-A Proposal will run concurrently, encouraging banks to consider the interplay.  So, in plain English, concerned parties have until sometime in early March 2007 to submit Comments on both the Basel II and the Basel 1-A Proposals.

One of FDIC’s concerns is that Basel II may allow the biggest banks to operate with less capital than is required for smaller banks, giving the big banks an inappropriate competitive advantage because of the operation of the capital rules.  FDIC Chairman Sheila Bair has said,  “Capital reform must not result in significant reductions in capital in the system or in competitive inequities among different types of depository institutions.”  Link to Chairman Bair’s Nov. 14, 2006, Speech to Women in Housing and Finance: http://www.fdic.gov/news/news/speeches/chairman/spnov1406.html

Background on International Capital Standards and U.S. Capital Standards:    Innovative (and potentially risky) financial products as well as risk-assessment techniques have evolved substantially since the last regulatory requirements on this subject.  Capital reform is definitely needed – and this need is clearly recognized by all financial institution regulators.

Highlights of the Basel 1-A Proposal: 
1. Expanding the number of risk weight catgories (adding three);
2. Allowing banks to use external credit ratings to risk weight certain exposures;
3. Using loan-to-value ratios to risk weight most residential mortgages;
4. Increasing the credit conversion factor for certain commitments with an original maturity of one year or less;
5. Assessing a capital charge to reflect the risk in securitizations with early amortization provisions where the securitizations are backed by revolving exposures;
6. Removing the 50% limit on the risk weight for certain derivative transactions.
7. A banking organization cannot pick and choose among the Basel 1-A provisions.  By electing to follow 1-A, it would have to apply all provisions.

Link to Basel 1-A Proposal:  http://www.fdic.gov/news/news/press/2006/pr06112.html

Link to Basel II Proposal:  http://www.fdic.gov/news/news/financial/2006/fil06086.html

Link to FDIC Proposal for Risk-Based Capital Standards relating to Market Risk:  http://www.fdic.gov/news/news/financial/2006/fil06087.html

FDIC & the ILC Applications: Decision by January?

FDIC Chairman Sheila Bair indicated in response to questions at Monday's ABA Convention that she hopes to have a decision on the pending Industrial Loan Company applications by the time FDIC's six-month moratorium expires in January 2007.  FDIC continues to be beseiged by comments.  The WalMart application in particular has generated strong opinions.

So, which way is the wind blowing?  The October 2006 issue of Independent Banker, ICBA's monthly magazine, carries an extensive interview of FDIC Chairman Sheila Bair by ICBA's Kelly Pike.  In a wide-ranging discussion of the issues facing FDIC and the banking industry, Chairman Bair identified the ILC applications as one of the most controversial issues her agency faces.  About the pending ILC applications, she said, "I can't guarantee what that decision will be.  It may be a decision they don't like, but we need to move forward and make it."

In the same article, Chairman Bair discussed Deposit Insurance Reform, Regulatory Burden, and Basel II.

Link to a report about Bair's Oct. 16, 2006, remarks:  http://www.nafcu.org/Template.cfm?Section=News&template=/contentManagement/contentDisplay.cfm&contentID=21643

Link to Independent Banker article:  www.icba.org/files/ICBASites/PDFs/coverstory1006.pdf

(ag) Oct. 19, 2006, in Industrial Loan Companies, Deposit Insurance, Basel II, Federal Banking Agencies - FDIC

FDIC Chairman's Current Issues: Deposit Insurance Reform, Capital Reform, and Economic Inclusion

FDIC Chairman Sheila C. Bair gave two speeches this week that merit attention.  Chairman Bair addressed the American Bankers Association Convention on Oct. 16, 2006, and America's Community Bankers Convention on Oct. 17, 2006.

In her recent remarks, Chairman Bair highlights the following topics of current focus:  1.  Deposit Insurance Reform, including merger of the BIF and SAIF funds, the one-time assessment credit, and the new proposed assessment rate structure (to be set in early November -- check out the rate calculator on FDIC's website for a preliminary idea of what this could mean for your bank); 2.  Capital Reform, meaning Basel II -- although Chairman Bair indicates that this is not just a big bank issue.  FDIC supports a capital structure that does not place community banks at a disadvantage; and 3.  Economic Inclusion.  Providing financial services to the unbanked is a key issue for this new Chairman.

In the speech to America's Community Bankers, Chairman Bair covered the topics discussed above and added discussion about Commercial Real Estate.  She also discussed the role of Community Banks. 

Link to ABA Speech:  http://www.fdic.gov/news/news/speeches/chairman/spoct1606.html

Link to ACB Speech:  http://www.fdic.gov/news/news/speeches/chairman/spoct1706.html

(ag) Oct. 18, 2006, in Federal Banking Agencies - FDIC/Capital/Basel II/Deposit Insurance

Fed Chairman Decries Regulatory Burden, Discusses BSA, CRA, Capital Standards (Basel II) and the Reg Relief Act

In remarks delivered Oct. 16, 2006, before the Annual Conventions of the American Bankers Association (in Phoenix) and America's Community Bankers (San Diego, via satellite), Ben S. Bernanke, the relatively new Chairman of the Board of Governors of the Federal Reserve System, looked at bank regulation through an economist's lens:  cost benefit analysis.  That's good new for bankers.  He appears to be a proponent of reducing regulatory burden. 

Bernanke talked specifically about three key areas bankers often complain about:  BSA, CRA, and Capital Standards.  He also highlighted the following provisions of the Regulatory Relief Act:  authority for the Fed to pay interest on sterile reserves and discretion to lower the reserve ratio (although unfortunately, not effective until 2011); authority for the Fed to pay interest on voluntary deposits with the Fed, including contractual clearing balances and excess reserve balances;  immediately raising the asset ceiling from $250M to $500M for banks that can qualify to extend the exam cycle from 12 months to 18 months if they are well-capitalized and well-managed; and the requirement for the Fed and the SEC to issue joint regulations regarding "broker" exceptions for banks under GLBA.

Link to Speech:  http://www.federalreserve.gov/boarddocs/speeches/2006/20061016/default.htm

(ag) Oct. 17, 2006, in Federal Banking Agencies - FRB, Regulatory Relied, BSA, CRA, Capital Requirements (Basel II)

Modernizing Capital Requirements - Basel II

On Sept. 25, 2006, the Federal Banking Agencies (OCC, OTS, FDIC, FRB) jointly published two Notices of Proposed Rulemaking relating to capital requirements: 

1.  New Risk-Based Capital Rules for Large or Internationally Active U.S. Banks in accordance with Basel II; and

2.  Market Risk Rule 

OCC Bulletin 2006-40 includes a good summary of these two proposed rules, with links to the full Federal Register text.
Link to Summary:  http://www.occ.treas.gov/ftp/bulletin/2006-40.html

For a succinct view of the United States' response to Basel II, which is a "work-in-progress", and remarks relating to the two proposed rules, see "Testimony on the New Basel Capital Accord" presented Sept. 26, 2006 by OTS Director John M. Reich before the U.S. Senate Committee on Banking, Housing & Urban Affairs.
Link to Testimony:  http://www.ots.treas.gov/docs/8/87123.pdf

(ag) Sept. 27, 2006, in Capital Requirements/Basel II