WASHINGTON — Financial companies that have large credit card operations could be hit the hardest by Basel II, and one — Capital One Financial Corp. — is already bowing out of the troubled international capital regime before it is even finalized.
Government data released at a congressional hearing in May showed two unnamed companies would have substantial increases in capital requirements because of Basel II. Two sources familiar with the study said they were the $55.6 billion-asset Capital One and MBNA Corp. — with increases of around 30% and 50% respectively.
MBNA, which is slightly larger at $61.4 billion of assets, probably will be required to adopt Basel II because it has $18.1 billion of foreign assets. Under the current proposal by U.S. regulators, a banking company with more than $10 billion of foreign assets would have to participate.
Capital One has just $5.6 billion of foreign assets, according to its most recent annual report. Neither company meets another key Basel II criterion — $250 billion of domestic assets.
Thomas Wren, MBNA’s treasurer, downplayed the potential for a competitive disadvantage, saying the Wilmington, Del., company already has capital levels much higher than regulatory requirements.
“From MBNA’s perspective, we are well situated to absorb any changes resulting from Basel II,” Mr. Wren said. “We do not have to issue any capital to position ourselves for Basel II. However, we think it requires too much capital.”
Basel II could end up hurting banks that adopt Basel II by requiring them to hold more capital than smaller competitors, Mr. Wren said.
“We feel strongly that banks investing the significant resources needed to adopt Basel II should not be penalized from a capital perspective when compared to banks using the Basel I accord,” he said.
Capital One had been expected to participate, but that was before a recent federal study showed credit card banks’ capital requirements would skyrocket under the risk-based plan, while those at more diversified companies would plummet.
A spokeswoman for Capital One told American Banker that the McLean, Va., company would not opt into Basel II as currently proposed.
“We will continue to monitor the Basel II requirements as they develop and will reevaluate our plans accordingly,” the spokeswoman said in an e-mail. “In the interim, we expect our capital levels will remain above the current regulatory requirements to be considered ‘well-capitalized’ and would provide for a comfortable transition” if the company changes its mind.
The Basel II impact study, known as QIS-4, showed that capital for 10 non-card portfolio types would drop considerably. For example, requirements for home equity would drop 74%, and those for residential mortgage portfolios would drop 66%.
Citigroup Inc., which has a massive credit card portfolio, is required to adopt Basel II because of its overall size. But Citi’s other business lines could help it absorb the hit.
Buying Hibernia Corp. could help soften Basel II’s impact on Capital One and might change its thinking in the future (the $5.3 billion deal was announced March 6 and is expected to close in the third quarter). Hibernia, of New Orleans, is more diversified and is continuing to add retail branches.
“Capital One and Hibernia are at opposite ends of the risk-weight spectrum,” said Bert Ely, an independent analyst from Alexandria, Va. “When you put these on your balance sheet, they have a neutralizing effect” on capital requirements.
Balvinder Sangha, a partner at Ernst & Young LLP’s financial services and economics practice, gave another reason banks might balk at opting in - regulators have not said which credit card portfolios might require more capital than others.
For example, subprime credit card portfolios are expected to require more capital than prime portfolios. This would be in line with other Basel II requirements, which attempt to align capital levels closer with risk. But regulators have not said exactly what the differences would be.
“If I am a [credit card] bank that does prime, subprime, or anything else, I don’t have the rules very well articulated,” Mr. Sangha said.
Regulators are still pondering substantive changes to the existing capital requirements for non-Basel II banks. Given the amount of changes that need to be made, some expect there will still be competitive issues when Basel II is scheduled to begin in 2008.
“With a capital number that is greater than the Basel I requirement, in the margins, you might have some pricing differences,” said Hugh Kelley, head of KPMG LLP’s bank regulatory advisory practice.
But he said it could take a while to determine if a real advantage exists because so many people are questioning whether the risk information banks submitted for QIS-4 is accurate.
“It’s a work in progress with respect to the data,” he said.
One reason some bankers remain skeptical about QIS-4 is that the agencies said there might have been serious errors in risk and loss data that banks submitted.
In April banking and thrift regulators decided to halt the Basel II process and reevaluate both bank preparations and regulatory capital formulas. The agencies, which include the Federal Reserve Board and Office of the Comptroller of the Currency, are considering whether banks need to build up their loss and risk data or whether regulators need to fine-tune the formulas from which banks calculate capital requirements.
“The impact to banks with significant credit card portfolios is one aspect of that analysis,” said Kevin Bailey, the OCC’s deputy comptroller for capital and regulatory policy. “Any discussion of the outcome of this analysis is inappropriate at this time.”
A proposal is scheduled for later this year, but it could be pushed back.
U.S. financial services regulators have been working on new rules since 1998 to make capital levels more risk-sensitive. QIS-4 showed capital levels would fall at most banks, as 13 of the 26 banks participating in the study had capital levels drop 26% or more.
The Fed is expected to publish a separate study this year on how Basel II’s treatment of credit cards would affect competitiveness between banks that use the new rules and banks that do not. Officials at the central bank have said that if they discover a major competitiveness issue, they will make changes to Basel II.
There are two major reasons regulatory capital levels at credit card banks would rise because of Basel II. First, a new requirement would make banks hold capital against the $2 trillion of unused credit card lines.
Second, banks have to factor in a variable that measures the likelihood of a group of credit card borrowers defaulting at once. This percentage, called the asset-value correlation, is set at 4%. Bankers want this lowered to 2% or 3%, closer to their own internal capital levels. Previously the variable was set on a curve between 11% and 2%. Most banks qualified for the lower number.
“Even though the difference between 3% and 4% seems small, it really is significant,” said Pam Martin, director of regulatory relations for the Risk Management Association in Philadelphia. She said it could cost banks billions of dollars in additional capital.
