WASHINGTON - The forthcoming Basel II capital rules are supposed to set a uniform standard for banks operating internationally, but there is a nagging question: How consistent will enforcement be among European, Asian, and North American regulators?
"Everybody already knows that North American and U.K. regulators are tougher" than their counterparts elsewhere, said Pam Martin, the director of regulatory relations at RMA-the Risk Management Association. "The hope would be that Basel II lifts regulatory standards in other countries."
Andrew Wilson, a partner at Accenture in New York, said, "One of the big concerns is that banks are going to have to deal with two different regulators and potentially be caught in the middle with different capital requirements."
The shorthand term for this debate is the "home-host issue." Officially, the Basel Committee on Banking Supervision permits host-country regulators to have the final say. In other words, the Federal Reserve Board could require a German bank operating in the United States to boost its capital.
But even though agencies like the Fed can require higher capital, foreign banks hope they never do.
"We think there's an absolutely compelling case, especially when it's a branch, for deference to the home country on the capital computation," said Lawrence R. Uhlick, the executive director of the Institute of International Bankers. "The great potential problem is host countries really overplaying their role and getting into all kinds of second-guessing."
To address conflicts that arise among countries, the Basel Committee in late 2001 set up the Accord Implementation Group.
Joseph Dewhirst, the corporate treasurer at Bank of America Corp., singled out the question of "home" versus "host" regulators last week in testimony before a House Financial Services subcommittee.
Though he applauded the regulators' goal of cross-border cooperation, Mr. Dewhirst said, "We are quite concerned regarding their implementation in practice."
The Basel II project is entering its final stretch. After six years of work, the committee signed off on the final framework Saturday. Now regulators in each country will write implementing rules, but experts estimate there are close to 85 provisions open to interpretation.
A U.S. proposal is expected in mid-2005 with a final rule a year later. Banks here will be expected to be ready to test-drive the rule by early 2007. Full implementation is expected by January 2008.
From the start, there will be differences in implementation. For one thing, U.S. regulators plan to apply Basel II only to banks with at least $250 billion of assets or $10 billion of foreign receivables. The agencies figure that includes eight banks, which they refuse to name. Another dozen or so banks are expected to voluntarily adopt Basel II.
These 20-odd banks will be required to use the most advanced method of assessing the capital needed to guard against credit and operational risks. In other countries, banks will be able to use any of three methods.
That leads to an obvious question: Will U.S. regulators force a foreign bank operating here to use the advanced approach, or will U.S. banks be competing with foreign rivals holding less capital?
In a December speech, Fed Vice Chairman Roger W. Ferguson Jr. said the fact that foreign banks will able to use less sophisticated methods could "create genuine operational complexities if these banks plan to use one of the other Basel II options in their home or in third countries."
Four of the 20 largest banks operating here are foreign-owned - Deutsche Bank AG; ABN Amro Holding NV; HSBC Holdings PLC; and Royal Bank of Scotland Group PLC, which owns Citizens Financial Group Inc.
Another issue regarding international implementation has to do with operational risks such as human error, fraud, and natural disasters. The first international capital accord, drafted in 1988, did not require banks to hold capital against operational risks, and critics claim they are hard to quantify on a subsidiary level.
"Operational risk is generally measured on a consolidated basis, often by business line," Mr. Ferguson said in December. "That diversification benefits exist on a consolidated basis suggests that operational risk estimated from the bottom up - by, say, legal entity - would not only be more difficult but might well add up to more than the total from the top down."
But he said this concern could be hard to balance with the "understandable focus" of domestic regulators on making sure banks in their jurisdiction have enough capital. Still, how the issue will be resolved depends on how regulators interpret Basel II, and major differences might not be revealed for more than a year.
"Once we find out how the rules are applied in each nation, then we can start to see the differences, and then we'll know how big of a problem this is going to be," said Rob Strand, a senior economist at the American Bankers Association.
Several people watching Basel II said that except for the broad guidance set out by the Basel Committee, the home-host issue would usually be settled on a case-by-case basis and just presents another challenge to supervisors looking for common ground.
"To be fair to the regulators, the whole Basel II process has required a lot of give and take," said Andrew Kuritzkes, a managing director at Marsh & McLennan Cos.' Mercer Oliver Wyman. "If they've gotten this far, the remaining home and host issue is much smaller than others that needed much more compromise."
Separately Tuesday, the Fed released a study of six large, internationally active banks and found that their operational loss figures were very similar.
