This week regulators will ask bankers for help in improving risk-based capital requirements.
John G. Medlin, chairman of Wachovia Corp., and Frank V. Cahouet, president and CEO of Mellon Bank, are among the industry leaders slated to offer their views Friday at a Federal Financial Institutions Examination Council conference.
Regulators want to make capital rules more sensitive to the differences in the risk profiles of banks.
"We have a burdensome capital system that is not reflective of a time and technology that has moved along," Comptroller of the Currency Eugene A. Ludwig said in an interview Friday. "We have to be careful that the current system doesn't get so out of step with reality that we are really creating a danger."
Mr. Ludwig, who is also chairman of the exam council, noted that banks have developed internal computer models that can determine where capital is needed most.
"Compared to what all the large banks are doing now, the risk-based capital approach is quite unsophisticated," he said.
Indeed, bankers have been complaining for years that the existing rules penalize institutions that make conservative investments by requiring them to hold the same amount of capital as institutions with riskier assets. In addition, the rules do not recognize banks' constantly improving ability to manage risk, said Kevin M. Blakely, executive vice president for risk management at KeyCorp, Cleveland.
"There winds up being a very significant conflict with the level of capital that the risk-based rules impose and the level of capital that the bank feels is prudent," Mr. Blakely said. "The risk rules cause us to maintain more capital than we need to in a lot of areas."
The current risk-based capital rules require banks to hold 8% of most loans as reserves. Government-issued debt is exempt entirely, and banks must hold capital equivalent to 4% of home mortgages.
These ratios often require banks to back conservative loans and more risky ones with the same level of capital, Mr. Ludwig noted.
"All commercial loans are treated in one big lump, as are all housing loans," he said. "But haven't we moved to a level of sophistication where there are clearly different risk attributes within these classifications?"
To date, the agencies have not been especially successful in their attempts to rework risk-based capital rules.
For example, regulators have been trying to rewrite the capital rules for assets sold with recourse for nearly eight years. After four years of debate, the banking and thrift agencies in May 1994 issued an advanced notice of proposed rulemaking. It took another three years to issue a proposal, and even then the agencies only suggested several alternatives.
"Recourse is a perfect example of where banks have found ways to control and lessen risk, and how difficult it is to translate that into a rule," Mr. Strand said.
Regulators have been experimenting with several approaches for measuring banks' exposure to credit, interest rate, and market risk. In general, the agencies are trying to give bankers more control over their capital by letting them use their own systems to measure exposure to these risks and in turn set their own capital levels.
But risk-based capital minimums are unlikely to be eliminated.
Regulators privately are predicting that they will settle on a system that allows banks to rely primarily their own systems to estimate the majority of capital levels but still requires a specific risk weighting for certain assets.
"Using models is a good approach for many areas, but we don't think that there is a complete ability to predict some things, like the risk that a hurricane will come along and destroy a bank's collateral," said one senior agency official. "There will still be a need for us to set some risk-based capital levels."
