WASHINGTON — Criticism of Basel II continued to grow last week, as top Senate Banking Committee members raised significant concerns and a panel of academics and former regulators weighed in against the proposed capital accord.
“I think you need to tell your international partners there are serious problems here,” Sen. Paul Sarbanes, the lead panel Democrat, told Federal Reserve Board Governor Susan Bies during a Senate Banking Committee hearing Thursday. “You probably ought to say to them, ‘Look, the Congress could nix this thing altogether.’ ”
The plan has already come under fire from a bipartisan group of House lawmakers and some industry groups, even while regulators have attempted to move forward on a new timeline.
Sen. Sarbanes often appeared exasperated with regulators at the hearing and repeatedly cited an impact study released in the spring that found that 13 of the 26 banks surveyed would be able to lower their capital reserves by at least 26%. The Maryland Democrat said such a significant drop in capital poses major safety-and-soundness problems.
“A reduction in capital on this scale would represent a major change in the status of the nation’s banking system,” Sen. Sarbanes said.
Though more tempered in his remarks, Senate Banking Committee Chairman Richard Shelby, R-Ala., raised similar criticisms. He asked regulators several times whether Basel II would put small and midsize banks at a competitive disadvantage.
“It would be an unfortunate result if, instead of improving capital allocation … it creates a system biased toward larger financial institutions,” Sen. Shelby said. “There are a lot of things we don’t know about this.”
A later panel that included two former Federal Deposit Insurance Corp. chairmen, two professors, and a state regulator echoed the lawmakers.
“It’s not the time to be fooling around with lower capital ratios — it’s just not,” said former FDIC Chairman William M. Isaac, who is now the chairman of Secura Group in Falls Church, Va.
Mr. Isaac’s criticisms were endorsed by L. William Seidman, another former FDIC chairman, who is now a CNBC commentator. George Kaufman, a finance professor at Loyola University in Chicago; Daniel Tarullo, a professor at Georgetown University Law Center; and Katherine G. Wyatt, the head of financial services research at the New York State Banking Department, also said Basel II was misguided.
Mr. Kaufman said Basel II was “on the verge of causing major mischief” by reducing capital ratios.
Still, he said the effort to craft the accord had proved worthwhile, because it forced banks and their regulators to carefully scrutinize the increasingly complex risks institutions are taking.
“It is the process, not the end result, that will provide the major benefits,” Mr. Kaufman said.
Mr. Isaac said the rules in the proposed agreement were too complex for assessing the risk of various assets. “I don’t know of a single professional bank supervisor who is enthusiastic about Basel II.”
That comment was in direct contrast to what the committee heard earlier from Comptroller of the Currency John Dugan.
“We think, our supervisors think … that it is absolutely critical that we have a sophisticated risk management system,” Mr. Dugan said.
He said his agency’s examiners support the more detailed risk assessment program outlined in Basel II, because it is intended to tackle the highly sophisticated investments increasingly found in the portfolios of the largest banks.
Ms. Bies faced the sharpest questions from Sen. Sarbanes. In response, she said the study last spring was based on insufficient data and did not reflect the impact Basel II would ultimately have on key capital ratios. She said the accord is a proactive effort to improve the industry’s safety and soundness.
“Basel II should enhance risk management at the institutions that adopt it,” Ms. Bies said.
Regulators have already taken steps to slow that process down. Though they said last year that Basel II should be fully implemented by 2010, regulators announced a new timeline last month.
Beginning in 2008, 20 U.S. banks are expected to be in compliance with both the existing capital standard and Basel II. In 2009, if regulators are satisfied that the new standard is working well, participating banks would be allowed to use it, but regulatory capital levels could drop only 5% that year.
Capital could dip another 5% in 2010 and an additional 5% in 2011, if regulators remain comfortable with the process.
But that did not appear to quell lawmakers’ criticism.
Sen. Sarbanes said the Fed had a “vested interest” in completing the rule, which it took the lead domestically in crafting, and he warned that it cannot continue on its current path.
“If we just keep moving along without solving these problems, I think one day, all of a sudden, things might come to a stop,” he said. “Then your problems … will be much more severe than they are now.”
Unlike international diplomatic treaties, Basel II does not require ratification by the Senate. Still, members of Congress could slow its approval or implementation by raising public awareness of the issue, threatening to tamper with other initiatives important to regulators, or even passing legislation.
After the hearing an industry source expressed concern that certain members of Congress seem intent on scuttling the accord. The source sharply criticized others in the industry for failing to present a clear message to the Hill on Basel II.
“There has been a persistent underestimation of the role that Congress plays in a regulatory process like this,” the source said. “There’s got to be an affirmative, positive reason why this should happen, and nobody has done a really good job to make that case.”
