WASHINGTON — In the wake of the credit crisis, Federal Deposit Insurance Corp. Chairman Sheila Bair signaled Tuesday that she might push for the Basel II capital rule to be rewritten to let the largest banks use the standardized approach.
Regulators and the industry haggled for years over whether large banks should have the option to choose between Basel II's less cumbersome standardized approach and the more complicated advanced approach. The issue was seemingly settled last July when regulators agreed to issue a final rule that required the 12 largest domestic banks to use only the advanced approach, which relies on institutions to judge their risks internally and determine capital requirements accordingly.
Since then, however, the credit crisis has shown that many banks did not adequately gauge their risk, prompting Ms. Bair to argue that Basel II may need retooling.
"I'm not sure we've got it right," she said during an FDIC board meeting Tuesday. "I do not think we do. … If we have to go back and change the rule, then we have to change the rule."
At issue is which method would yield the most accurate capital reserving for banking system stability. The standardized approach relies more on credit rating agency judgments. As part of last summer's agreement, regulators scrapped Basel IA, which would have created a risk-based capital framework for smaller banks. In its place, the agencies agreed to issue a proposal this year on the standardized approach and include a question about whether the option should be open to larger banks. Ms. Bair said the proposal is under review by the Office of Management and Budget and, once this is complete, her agency would take a notational vote on the plan rather than wait until the next board meeting.
A copy of the proposal was not made public Tuesday, but from its characterization by FDIC officials, it appears to resemble Basel IA. A notable exception is a question calling for ideas on alternatives to using credit ratings to determine capital levels.
Credit rating agencies have come under heavy fire in recent months as highly rated assets have produced losses. Karen Shaw Petrou, the managing director of Federal Financial Analytics Inc., said she expects tougher requirements on assets that get easier capital treatment because of a credit rating.
The stricter standards may ultimately narrow the differences between the standardized and advanced approaches, she said.
Once rules are adopted, "depending on how those are done, the incentive for using the standardized approach over the advanced approach will diminish," she said. "It's going to depend on how the standardized approach moves away from the credit rating agencies."
Ultimately, the proposal would let smaller banks decide whether to use the standardized approach or remain under the Basel I rule.
Ms. Bair was always wary of the advanced approach, but it became clear Tuesday that her concern had grown in light of the market turmoil. She may face opposition, however.
Comptroller of the Currency John Dugan, who sits on the FDIC board, reminded the agency that the largest banks must use the advanced approach under the version of Basel II that took effect April 1. "It in no way changes the final rule that is applicable now to core banks and requires them to adopt … the advanced approach," he said.
"I do think it's a very relevant question," Ms. Bair responded.
