Regulators are considering several changes to market risk rules that could reduce the amount of capital large trading banks hold.
Under review are the elimination of a minimum capital requirement for banks that use market risk models and modifications to the treatment of section 20 subsidiaries.
Regulators are working on both issues, although action is not expected for several months.
"I would fully expect as we get further into implementation of market risk that we will uncover new issues and new approaches," said Christine Cumming, senior vice president for bank supervision at the Federal Reserve Bank of New York.
The market risk rules, adopted in August, require large trading banks such as Citibank and Morgan Guaranty Trust Co. to use internal models to determine how much they could lose from a 10-day drop in the value of their securities portfolios.
The rules take effect Jan. 1 for institutions with trading assets and liabilities exceeding 10% of total assets, or $1 billion. Though only 15 banks are covered, they conduct 97% of securities trading by banks, according to the Fed.
Banks may comply with the rules before Jan. 1, and Bankers Trust New York Corp. has done so.
Regulators may drop a requirement that a bank's market risk capital total at least half of what would have been required under the old system. This requirement initially was intended to ensure banks would not manipulate their models to reduce their capital to unsafe levels. But regulators said they have become confident that the models work and believe the 50% requirement is unnecessary.
"This is under very active consideration right now," said Roger T. Cole, the Fed's deputy associate director for supervision and regulation. "We are considering permitting banks to use the results of their models and not have the floor."
The section 20 trouble surfaced during the last several months as large trading banks began modifying their systems to accommodate the new rules.
The rules require banks to look at capital requirements on a consolidated basis, which means the capital of the bank and the section 20 are considered together.
Because of quirks in accounting rules and securities regulations, the consolidation increases required capital reserves. That's because not every instrument traded by banks is subject to the market risk rules.
Repurchase agreements for everything except government securities require 8% reserves under credit risk rules. This is substantially higher than the amount of capital a model would require for these relatively risk- free instruments used to fund section 20 units.