Bank Regulators Back Taking More Flexible Approaches to Risk

In another indication that regulators are losing faith in uniform capital standards as the way to control risk at banks, officials of the Federal Reserve and the Comptroller's Office last week endorsed more flexible approaches.

Speaking at a financial markets conference in Coral Gables, Fla., on Thursday, Jack Guynn, president of the Federal Reserve Bank of Atlanta, praised a plan to let big banks decide for themselves how much capital to set aside for market risk. He said regulators need to focus on the results of bank decisions, not the details of bank operations and capital levels.

At the same conference on Friday, Douglas E. Harris, senior deputy comptroller for capital markets, said regulators should be wary of requiring banks to disclose more financial information in an effort to better quantify risk.

His reasoning: Since risk measurements are ultimately subjective, requiring banks to divulge more data doesn't always give regulators a better handle on the risks posed by interest rate shifts or market swings.

Also at the conference, which was sponsored by the Atlanta Fed, Federal Reserve Board Chairman Alan Greenspan spoke on Friday of the difficulty of measuring the risks posed by over-the-counter derivatives. His speech did not, however, draw any regulatory conclusions from the observation.

The common thread in the regulators' remarks was noted by Mr. Harris, who said before his speech, "One of the things that is surprising to me is how much convergence there has been among regulators' views concerning disclosure and risk management."

The Atlanta Fed's Mr. Guynn said regulators are taking a step in the right direction by relying on big banks' own computer models to determine how much capital must be set aside to account for market risk - the risk that swings in the value of securities, currency, and derivatives will cost banks money.

But he said this move, agreed to in November by the international Basel Committee on Banking Supervision, should be just a first step in reshaping bank regulation. He applauded a Fed proposal - which has not won support from other regulators - to let banks decide for themselves how much capital to set aside for market risk, then face penalties if their trading losses exceed the capital cushion.

But he said even bolder steps are needed to break out of the "vicious cycle" that now traps banks and their regulators. "We all know what the cycle is," Mr. Guynn said.

"Legislators and regulators write elaborate rules to circumscribe banks' activities. This body of statutes and regulations, in turn, prompts banks to find convoluted and inefficient ways to conduct their business.

"If regulators can find effective ways to focus on the results of banks' decisions, then banks should have substantially less incentive to find ways around regulations."

He concluded, "I hope for a time when perhaps we can move away from an accounting measure of capital ratios to a test of viability based on future earnings."

Mr. Harris said the OCC is now using "data filters" that combine call report numbers and economic data to identify banks with high exposure to interest rate shifts.

The banking agencies have proposed adding numerous interest rate questions to the call report in an effort to incorporate rate risk into capital standards, but some regulators say privately that they now want to back away from the plan.

"It is currently popular to call for more information," Mr. Harris said. "However, more does not always mean better."

He also cautioned that risk measures "are subjective to the extent that they are ultimately based upon personal judgment.

"Risk management is as much an art as it is a science."

James C. Allen contributed to this report.

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