WASHINGTON - House members had regulators on the defensive Thursday, arguing that the Basel II proposal would put U.S. banks at a disadvantage against foreign ones and suggesting that guidance to limit commercial real estate portfolios could spark a credit crunch.
Lawmakers on both sides of the aisle were uniformly critical of both proposals, but a House subcommittee hearing showed divisions among regulators on the commercial real estate plan. Office of Thrift Supervision Director John Reich broke with his colleagues by arguing that the proposed guidance could hurt community banks if left unchanged.
"I do have concerns that the degree of prescriptiveness that is in the current proposal may have some consequences that we don't necessarily want to see," Mr. Reich said. "I'm hopeful that we modify it to be clear about our intent and not to suffer unintended consequences."
That was music to the ears of lawmakers, who said the proposed guidance was already causing banks to stop making commercial real estate loans.
The proposed guidance, which regulators issued in January, defines excessive commercial real estate concentrations and says banks must hold more capital against them. The banking industry has said the plan is too broad and would cause them to cut back on traditional lending - a view that carried traction with lawmakers.
"The guidance issued by the banking agencies, if confirmed, would lead to the elimination of the small bank as a viable institution," said Rep. Sue Kelly, R-N.Y.
Rep. Jeb Hensarling, R-Tex., said he was concerned regulators were restricting commercial real estate when "a good case could be made that real estate helped the economy boom."
With the exception of Mr. Reich, the regulators strongly defended the proposed guidance, saying they are concerned because banks have been bulking up on commercial real estate loans during the past year. Under the proposed guidelines, a bank whose commercial real estate loans equaled 300% or more of its capital would be considered highly concentrated in commercial real estate. So would a bank whose loans for land, land development, and construction equaled 100% or more of capital.
Banks complain the thresholds constitute hard targets by the regulators, but Comptroller of the Currency John Dugan and Federal Reserve Board Gov. Susan Bies said examiners were being flexible in their application.
Ms. Bies said those levels are "intended as a beginning of more conversation."
Mr. Dugan said, "The basic message of the proposed guidance is not, 'Cut back on commercial real estate loans.' Instead it is this: 'You can have concentrations in commercial real estate loans, but only if you have appropriate risk management and capital to address the increased risk.' "
The regulators also stressed that the proposed guidelines were not the same as a rule, and that they would be treated differently by examiners.
But Rep. Barney Frank of Massachusetts, the lead Democrat on the House Financial Services Committee, rejected that defense. "The very fact that you single something out has a great impact," he said. "I'm therefore worried."
Rep. Frank also objected because regulators treated multifamily loans as posing a higher credit risk. He argued that the classification could cause banks to offer fewer loans of that type.
Mr. Reich - who signed a letter from regulators this year defending the proposed guidelines - said he "would plead guilty to signing a letter I didn't necessarily agree with everything in it."
"That is very odd behavior," Rep. Frank said.
Mr. Reich said he agreed that multifamily loans should be treated differently from many other types of commercial real estate loans.
The tone was not much better as lawmakers questioned the regulators about the implementation of Basel II, which is scheduled to go into effect in the United States in 2009.
The debate quickly focused on whether the proposal, designed to align a bank's capital requirements with its risk, would actually put American banks in a competitive disadvantage against foreign banks.
In Europe, regulators are implementing a version of Basel II that barely differs from the international text negotiated by the Basel Committee. Banks there can choose to follow one of three standards ranging in complexity from the simplest "standardized" approach to the most complicated "advanced approach."
Though European regulators have indicated their strong hope that the largest banks will implement the advanced approach, the American banking agencies have not given banks a choice - forcing banks to follow the advanced approach.
But the advanced approach in the United States will be different from what will be followed in Europe or other countries following Basel II. American regulators have tacked on additional requirements to the advanced approach, including floors under which capital levels cannot drop.
Critics contend that the additional requirements would force American banks to hold more capital than their European counterparts, and that doing so would eat into their profits and put them at a competitive disadvantage.
"If there are higher requirements for our banks, won't that disadvantage us?" asked Rep. Spencer Bachus, R-Ala., the chairman of the House Financial Services financial institutions subcommittee.
Ms. Bies said that the American proposal has strengthened areas regulators identified as weaknesses. But she said that the United States was so far ahead of other countries in developing its Basel II procedures that she expects foreign regulators to follow suit and beef up their standards.
"Other countries have acknowledged that they have not done anything at the national level to implement change," Ms. Bies said.
Rep. Bachus continued to press the issue, asking Ms. Bies if American banks would be disadvantaged if foreign banks did not make the adjustments she predicts.
"Well, it could," she said.
Speaking to reporters later Thursday afternoon, Ms. Bies did not specify the countries where she expects capital requirements to strengthen or when such a move would happen.
James M. Garnett Jr., the head of risk architecture for Citigroup Inc., testifying on behalf of the Financial Services Roundtable, also said the Basel II capital standards raise compliance cost issues and would present a competitive disadvantage for American institutions.
"Inconsistencies between … [the international text] and the U.S. version are not appropriately risk-sensitive" and present a "disadvantage for American institutions," Mr. Garnett said.
He suggested a "harmonization" of the accord with the international text.
"Choice assures a competitive marketplace, both domestically and internationally," he said.
Lawmakers continued to express skepticism about the entire Basel II process.
"I'm not confident that the present proposal is well designed," said Rep. Carolyn Maloney, D-N.Y.
