The Federal Reserve Board is poised to start testing within a month a plan that would let banks set their own capital requirements for trading and derivatives operations.
The so-called precommitment-of-capital approach to trading risk management is not expected to immediately replace internationally accepted regulations. But bankers are hopeful the test will show banking regulators the benefits of self-regulation.
Acceptance of the precommitment approach "could lead to a more comprehensive and less costly regulatory framework," said Gay Evans, the London-based chairman of the International Swaps and Derivatives Association.
In mothballs since the end of a comment period in October, the precommitment approach resurfaced this month after Fed Governor Janet Yellen said there was "enthusiasm" for the method within the central bank.
The precommitment approach must compete with some other regulatory proposals, however. For instance, the Basel Committee on Banking Supervision adopted a program in January that would require institutions to establish capital levels based upon market simulations. These simulations, called "backtesting," would attempt to show how actual trading performance would have been affected if the market had behaved differently.
Because a test of the precommitment approach and follow-up comment period may raise concern among Basel committee members that U.S. regulators are unilaterally adopting the approach, the Fed is expected to move carefully on the project.
To avoid such conflicts, the comment period following a test probably would be delayed until after the Basel capital guidelines are finalized, one Fed official said. Nonetheless, he said the agency appears ready to get a trial off the ground sometime in May.
Mark Brickell, a managing director at J.P. Morgan Securities, said a test is needed to understand the benefits and potential problems of such an approach.
In particular, the test could give regulators ideas on how to measure profit and loss in trading and derivatives, and how best to discipline institutions that exceed the risk levels they set for themselves with the committed capital.
The precommitment approach has the backing of the Bankers Roundtable and the International Swaps and Deriatives Association, among other banking organizations, which have argued that the precommitment approach was more workable than the program mandated by the Basel committee.