WASHINGTON - Bankers hoping for significant changes to the Basel II capital proposal were disappointed Tuesday when the Federal Deposit Insurance Corp. approved a plan that closely tracked one the Federal Reserve Board released in March.
The latest version includes two changes, but it maintains floors under capital levels that bankers have criticized as so conservative that they would give foreign banks a competitive advantage.
One of the changes seeks comment on whether banks should be allowed to use a simplified version of Basel II. Four large companies, including Citigroup Inc. and JPMorgan Chase & Co., had requested the change, arguing that foreign regulators were offering competitors in Europe the option of using either the "advanced" or "standardized" approach.
But though the regulators put the question to the public, they did not seem united behind the idea.
On one side was Comptroller of the Currency John Dugan, who strongly hinted at an FDIC board meeting Tuesday that he still favors requiring banks to adopt the so-called advanced internal ratings based approach. Joining him was Fed Chairman Ben Bernanke, who reiterated Tuesday that he opposes offering banks the option of using less sophisticated approaches.
FDIC Chairman Sheila Bair and Office of Thrift Supervision Director John Reich, however, sounded a lot more interested in the standardized approach.
"I am attracted to the simplicity of the standardized approach and the fact that, unlike the advanced approaches, it provides a floor for each exposure," Ms. Bair said.
All four regulators will get a chance to expand on their positions Sept. 14 when they testify before the House Financial Services Committee on the beleaguered proposal. Work began on Basel II in 1998, and it has been subject to numerous delays as a result of agency infighting and congressional criticism. The current schedule envisions a three-year implementation beginning in 2009. The proposal itself now numbers 501 pages.
The second change from the plan the Fed released in March clarifies that debt issued by government-sponsored enterprises should not be considered less risky because of any implied government guarantee. Yet that change may be more symbolic than substantive, because the amount of capital that banks would be required to hold behind GSE debt would not change.
At the FDIC meeting Tuesday, not one of its five board members even mentioned the GSE debt change.
Though large banks at least persuaded the agencies to seek comment on allowing them to use the standardized approach, they still face stringent floors on how much their regulatory capital could fall under Basel II.
Under the proposal, a bank's regulatory capital could fall 5% in the first year of implementation and 5% a year for the next two years. A second safeguard would prevent the industry's aggregate amount of regulatory capital from falling more than 10%.
Bankers have argued that, with these floors, Basel II is all stick and no carrot. Banks will pour a lot of money into building the systems needed to comply with Basel II, the argument goes, yet they will get no reward in the form of lower capital.
That actually was the idea behind Basel II when it was conceived - better managed banks could get by with less capital. But when regulators tested the likely impact and discovered some banks' regulatory capital levels would plummet, critics argued successfully that floors preventing such reductions must be added.
What no one was talking about then, however, was the competitive impact of keeping capital levels high at U.S. banks.
Domestic banks are now trying to change that, asking the agencies and Congress to let them use the standardized approach, which at least would be easier, and less expensive, to follow.
In addition to the FDIC, the Office of the Comptroller of the Currency and the OTS have signed off on the plan, which will be open for public input until early January.
For all the tension that has surrounded Basel II, the FDIC meeting was remarkably calm. Some board members did not even question the agency's staff about the proposal.
Thomas J. Curry, an FDIC director, seemed the most reluctant to approve the proposed rule.
"I will likely vote for this, primarily because the proposal contains the specific safeguards advocated by the FDIC, which provide for the controlled implementation of these risk-based capital regulations," he said.
Mr. Curry sided with Ms. Bair and Mr. Reich on whether banks should get the option of using the standardized approach.
"I'm particularly pleased that we will also be seeking comments on whether core institutions should be permitted to use this simpler standardized approach," Mr. Curry said.
Though Tuesday's votes moved Basel II closer to a final rule, the agencies are not expected to adopt a final rule before late February, when the Government Accountability Office is scheduled to issue a report on Basel II.
Only the eight to 10 largest banks would have to follow Basel II. Regulators are working on a plan to update Basel I for all other banks. This initiative is known as Basel IA.
"We are by no means at the end of the process," Mr. Reich said Tuesday. "We're not even at the starting gate."
