WASHINGTON Federal Reserve Board Governor Laurence H. Meyer posed some critical questions Monday about new capital standards being developed by international regulators, and he urged bankers to weigh in.
Now is the time to comment and to influence the results, he said at a conference sponsored by the Institute of International Bankers. Dont miss the chance.
The Basel Committee on Banking Supervisions proposed capital accord, released Jan. 16, is intended to replace the 1988 standard under which internationally active banks around the world operate. It applies to all U.S. banks. Comments are due May 31, and regulators are planning to phase in a final rule over three years.
Which banks should be subject to the new capital rule was Mr. Meyers first question. Noting its complexity, he said he favors applying it to a narrower range of banks: those that have made or can make the greatest advances in risk measurement and management, and those for whom the adequacy of the current standard is most in question.
Mr. Meyer said the new international standard does not address the most critical risk factor for smaller banks geographic and sectoral concentrations of credit risk. U.S. regulators are working on separate capital rules for community banks.
The 1988 standard has been criticized as a crude tool to measure the risks being taken by increasingly sophisticated financial institutions. Under the proposal, banks could use their internal rating systems to help set regulatory capital. The plan offers three options; as a banks internal systems improved, its role in setting its capital would expand.
Mr. Meyer said he expects that to remain competitive, most large banks will want to use the most advanced option to achieve the largest possible reductions in regulatory capital. But most banks are not ready to make that leap. I suspect few banks would or should get a clean sign-off from their supervisor today, he said.
Besides, if many banks opt for the so-called advanced internal ratings-based approach, they would pose a problem for the regulators who must validate internal methodologies and monitor compliance. There is, therefore, a practical limit to the number of institutions that we and I would argue, other countries can effectively supervise under the internal ratings-based approaches, Mr. Meyer said.
The bar will be set high for banks wishing to use internal systems. U.S. regulators intend to establish very high standards both for those banks permitted to participate in the internal ratings-based approaches and for ourselves, as overseers of the credibility and integrity of the process, he said.
Still, Mr. Meyer made it clear that international regulators must accept the possibility that some banks will have lower capital requirements under the new standards. Better risk management should lead to lower capital requirements, he said.
Attempts to plug this gap with a capital charge against other risks, such as operational risk, would be counterproductive, he said.
The danger is that an arbitrary or ad hoc approach to capital for operating risk could deny banks the full benefits that would otherwise be available under the advanced approach, Mr. Meyer said. It is also likely to discourage banks from investing the resources necessary to better measure operating risk.