When the Basel Committee on Banking Supervision rolled out its third proposal for rewriting international bank capital rules last week, the bulk of the attention - like the bulk of the document itself - was on its methods of calculating regulatory capital requirements.
But Basel II, as the proposed accord is known, is made up of three "pillars." In addition to capital requirements, it mandates supervisory review of internationally active banks (Pillar 2) and specific public disclosures to encourage market discipline (Pillar 3).
Experts say that U.S. banks are already in compliance with most of the elements of the second pillar, but the disclosure requirements could present challenges, despite efforts by the plan's authors to soften Pillar 3.
In the United States, only about 20 of the largest banks are expected to have to comply with the new Basel rules, and they will be expected to adopt the highest of its three levels of risk management. Known as the "advanced internal ratings based" approach, the method requires that institutions develop complex systems to measure their own risk across various categories and use those measurements to determine how much regulatory capital they need.
The proposal is open for comment until July 31, with a final rule expected by yearend but not scheduled to go into effect until the beginning of 2007.
Pillar 2 is supposed to establish a close dialogue between regulators and banks. The proposal released last week included a few new elements. Advanced internal ratings banks will have to implement a "meaningfully conservative" stress test as part of the supervisory review so regulators can gauge the impact that shifts in the broader economy could have on their capital requirements.
Supervisors will also pay more attention to banks' securitization. They will have the authority to intervene in cases where banks have moved securitized assets off the books but implicitly promised to assume all or some of the risk of default.
U.S. banks may be justified in giving scant attention to Pillar 2. Regulators involved in drafting the proposal say that the main effect of the new supervisory review requirements, as now written, would be to bring supervision in many countries up to the U.S. standard.
Maged Fanous, an associate partner in the London office of the consulting firm Accenture, said Pillar 2 would have little impact on most large U.S. institutions and other G-10 countries.
Countries with the "most advanced financial services systems have got the discipline in place that supports a lot of the requirements of Pillar 2, and a lot of them are working on enhancing what they have got already," he said.
Kim Olson, a senior director and regulatory liaison with Fitch Inc. in New York, said: "I think the U.S. has operated this way for a long time - not with respect to capital solely, but with respect to risk management and measurement. That spirit of dialogue has been in place for a while. What this does is extend that around the globe."
Pillar 3, however, could be problematic for U.S. institutions.
Designed to create market discipline by improving the public disclosures banks make about their risk exposures, it asks banks not only to detail their risk management procedures, but to disclose quantitative data about those risks.
For instance, advanced internal ratings banks would have to assess the "probability of default" of their outstanding credits and disclose the percentage of credits that fall into each of five different grades of likely default.
Pam Martin, a spokeswoman for RMA-the Risk Management Association in Philadelphia, said her group is concerned that default probability estimates, arrived at independently by individual institutions, will not offer valid comparisons across institutions.
"All PDs aren't equal - it's how you get to them," she said. "Everyone agrees that Pillar 3 is very important and that it is very important to have more disclosure. It is a question of what really gives you an apples-to-apples comparison, and I am not sure that raw PD disclosure does that."
When it released last week's proposal, the Basel Committee noted that it had made substantial concessions to banks that had balked at disclosing what many regard as sensitive data about internal operations.
Mark Fogarty, a senior manager with the financial services practice of the accounting firm KPMG LLP, said regulators tried to be more accommodating. "They are still after a lot of the information they were after before, but they appear to be trying to make it easier for banks to comply," he said.
The committee relaxed requirements for the disclosure of historical loss data, giving banks until 2008 to comply. It also streamlined many of the other disclosure provisions and reduced the amount of data that must be released.
It also lifted a requirement that banks' Pillar 3 disclosures be independently audited.
However, the net burden for banks may not be noticeably lighter, because they will be expected to collect all the information even though regulators will not require that they disclose it.
"It means that there will probably be less information that they need to disclose," said Accenture's Mr. Fanous. "But probably it will be the same amount of work that is required."
Mr. Fogarty and others said that the committee also appears to be trying to strike a balance between strict requirements and flexibility that will let banks in different countries achieve roughly comparable disclosures.
"I think the general concept is that regulators don't want to become too prescriptive," he said.
Ms. Olson of Fitch agreed, noting that regulators want two things from disclosures: the ability to compare institutions against one another and the ability to understand a given institution's risk profile. But these often conflict: Though comparability might take more general disclosures, it takes meticulous information to get a true picture of an institution's risk profile.
It remains a struggle to find the right balance, but "Basel will go a long way toward helping people think about that," she said.
