WASHINGTON - Considering the friction Basel II has generated and a recent technical glitch, bank and thrift regulators needed a moral victory.
They got it last week.
Their proposal to help banks and thrifts measure capital levels for everything from credit cards to mortgages elicited only a few substantive complaints from major banking companies in comment letters due Jan. 25.
Instead, 14 companies and trade groups - including Washington Mutual Inc., J.P. Morgan Chase & Co., and the Risk Management Association - agreed with regulators on most of the fundamentals and offered only minor corrections.
Retail credit risk is an area many Basel II observers are watching carefully. Banks with big mortgage and credit card portfolios have a lot to gain or lose depending on how regulators implement the international capital standards when they take effect in 2008.
Proposals to prescribe capital requirements for commercial or operational risk have met far more resistance. Industry officials interpreted the proposed retail credit guidelines as a sign that they are finally getting their points across.
"It shows the agencies have been listening to the industry," said Pam Martin, the RMA's director of regulatory affairs.
International regulators agreed on a framework for the new, risk-focused Basel II standards in June, and now the Federal Reserve Board, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency, and Office of Thrift Supervision are drafting a regulation on how to comply with them in the United States.
The retail credit proposal, issued in October, applies to credit card, mortgage, automobile, and personal loans as well as some small-business loans. The final version is expected to be included in the U.S. implementing regulation, which is scheduled to be proposed this summer.
Some Basel II critics, of which there are still many, groaned when a major flaw was discovered in a critical formula for calculating capital in the retail credit proposal. The error would have led banks to underestimate their capital needs by 50%. Regulators corrected the formula, but many bankers had feared that if such mistakes could go unnoticed for so long, more problems could be lurking in the fine print.
But this did not turn out to be the case, according to industry comment letters.
For example, Richard Gossage, Royal Bank of Scotland's director of group risk management, wrote that he agreed with more than 40 of the 58 parts of the proposal - a high batting average by Basel II standards.
Mr. Gossage endorsed the call for banks to collect more data to use in fine-tuning risk management practices, have models validated by regulators, and have internal risk management processes to monitor retail lending practices.
Others agreed that the regulators were on target.
"In many ways the proposal reflects the concerns expressed by the industry during development," wrote Russell Playford, Wachovia Corp.'s executive vice president of credit risk management, and Gary Wilhite, the Charlotte company's senior vice president of credit risk management.
In response to input from bankers last year, regulators adjusted the model they had planned to use to measure capital for credit cards and other revolving lines. The new model is more risk-sensitive and in some cases could lower capital requirements.
Still, many of the letters complained that the retail credit guidelines were too "prescriptive" and did not give bankers enough flexibility to incorporate their own models.
Unlike operational risk, bankers cannot rely on internal models to calculate retail capital. They have to identify variables - called the probability of default, loss given default, and exposure at default - then incorporate those numbers into their capital calculation.
Though regulators frequently point out that guidelines illustrate best practices and do not create standards, bankers tend to be wary of the distinction.
"The 58 retail standards, if viewed as requirements, would create unnecessary implementation costs and burdens with only minor, if any, improvements in the soundness of our capital allocation process," wrote Michael J. Cavanagh, JPMorgan Chase's chief financial officer.
Malcolm D. Griggs, Fifth Third Bancorp's chief risk officer, said complying with the Basel II standards will require the Cincinnati company to spend another $50 million on new information systems and data storage, among other things.
Several other longstanding Basel II issues have to be resolved.
John F. Robinson, Washington Mutual's executive vice president of corporate risk management, said the Seattle thrift company will not be able to benefit as much from Basel II because regulators refuse to scrap the 5% capital level banks need to be considered "well capitalized."
"This excess capital charge may prevent banks from engaging in low-risk activities," Mr. Robinson wrote.
Most of the other comments on the retail guidance were narrower, including one many banks made about whether loans classified as nonaccrual should be considered defaults (if so, banks would have to hold more capital).
But regulators probably will not think they have totally won over bankers after seven years of fights on the new capital rules.
Only about 10 of the nation's largest banks and thrifts will be required to adopt Basel II, and another 10 are expected to do so voluntarily. Regulators have said they plan to update the capital requirements for other banks and thrifts, but it is unclear if they will be using models as complex as those in the retail guidance or if new ones will be developed.
