WASHINGTON - A top U.S. regulator on Thursday called the international effort to rewrite bank capital rules overly complex, dangerously rigid, and open to international regulatory arbitrage.
Comptroller of the Currency John D. Hawke Jr., an outspoken critic of the new rules, appears to be making some headway with his fellow regulators - even the Federal Reserve. On Thursday, he announced U.S. regulators have agreed on a plan to make the operational risk component of the new rules less burdensome.
But Mr. Hawke still questions whether the Basel Committee on Banking Supervision's plan - in the works now since 1998 and not scheduled to be implemented until 2006 - will ever become reality.
"All the criticism and delay have cast a cloud over the Basel process, causing some to speculate whether the Committee will be able to produce a generally acceptable product," he said.
On operational risk, Mr. Hawke said U.S. regulators will offer a compromise on the Basel Committee's controversial plan. This piece of the proposal has drawn harsh criticism, both because operational risk is difficult to quantify and because the proposal would determine a bank's capital requirement by applying a pre-set formula to a single indicator, such as gross profits.
While saying he personally would eliminate an explicit capital charge for operational risk and leave the capital level to the discretion of bank examiners, Mr. Hawke said the U.S regulators would try to persuade their counterparts to dump the current plan for a capital "floor" that would set operational risk capital at 12% or more of total capital.
Instead, capital to cover operational risks would be set using a bank's internal risk management system, much the way capital to cover credit risk would be set.
In an interview following his remarks, Mr. Hawke said the regulators wanted "to inject a little bit more of a discretionary element … so that we can look to banks' own internal assessments of the quality of their internal control mechanisms and build on that as a basis for assigning operational risk capital charges."
The Basel Committee defines operational risk as "direct or indirect loss resulting from inadequate or failed internal processes, people and systems, or from external events."
Mr. Hawke said U.S. regulators have not yet raised the proposal with their counterparts, but they hope to get it added to the third version of Basel's proposal, which is due out next year. It had been expected in early 2003, but on Thursday Mr. Hawke extended that time frame to the first half of next year.
During his prepared remarks, which were delivered at a conference sponsored by RMA-the Risk Management Association, Mr. Hawke said that one of the biggest problems with the proposed accord is its complexity. The committee's most recent proposal, a "consultative paper" released in January 2001, was 500 pages long but was still incomplete, as a number of sections were still being written.
"I believe that the sheer size of the capital proposal has been an obstacle to clear understanding and meaningful commentary," Mr. Hawke said.
Richard K. McCrea, a senior vice president and the chief credit policy officer at Sun Trust Banks Inc., called the speech "a very realistic and balanced assessment of where we are in Basel."
According to Mr. McCrea, Mr. Hawke "understands as much as anyone the balance that has to be struck on these issues."
RMA has been demanding that regulators abandon their plans to issue detailed, prescriptive rules.
"The danger of taking a regulatory system and imposing it on our banks while the state of the art is still evolving has been our point all long," said Pam Martin, a spokeswoman for the trade group of lending and risk management professionals. "You are going to create this huge, sophisticated, complicated system, and as soon as you create it, it is going to be out of date."
Mr. Hawke got the message; he said a highly structured approach to assessing capital could stifle innovation in a still-developing field.
"The last thing we want to do is to force the industry to invest in systems that will soon be incompatible with future market-driven developments," he said.
As regulators craft the next proposal, they "should strive to set forth a reasonably concise set of black-letter rules that lay out the structure of the new accord in readily understandable form, with such elaborating detail as is absolutely necessary confined to supplements or annexes," Mr. Hawke said.
He also warned that a system of detailed, prescriptive rules could place U.S. banks at a disadvantage in the international market. U.S. regulators will enforce whatever rules are finalized, but their counterparts in other countries may not, he said. "I submit that U.S. banks are more likely to be subjected to more vigorous enforcement, and less likely to be the beneficiaries of permissive exceptions, than banks in countries whose supervisory practices fall at the other end of the spectrum."
The Basel Committee's proposal is an attempt to improve banks' risk management by allowing the institutions with the most advanced risk management systems to carry less capital than their less sophisticated counterparts. The proposed rule is an update of the 1988 Basel Capital Accord that the world's biggest institutions must follow.
Before regulators issue their final proposal next year, they plan to road-test it this fall. Regulators "will ask banks to apply the Basel proposals hypothetically in their institutions, as a work in progress, and to calculate for the committee the capital charges that would result," Mr. Hawke said.
However, U.S. regulators have been reviewing the practices of some large banks and found that "the current state of the art doesn't yet meet the standard proposed by the Basel Committee," he said.
Noting that some non-U.S. regulators on the Basel Committee have claimed that their countries' institutions are prepared to adopt the tough standards, Mr. Hawke said: "I have some difficulty concluding that these judgments are based on as exacting an inquiry as we have been making."
The Basel Committee is chaired William J. McDonough, the Federal Reserve Bank of New York president who is widely admired for his tenacity on this tough project, but having such a stake in the plan's success has forced the Fed into the role of champion and left the OCC to play the critic.
Within days of the latest proposal's release in January 2001, Senior Deputy Comptroller Jonathan L. Fiechter suggested that the committee had gone overboard in its efforts to make the accord highly risk-sensitive.
"Are [banks] comfortable with the balance we reached in the proposal, or would they rather have something that is a little less risk-sensitive and a little easier to follow?" he asked.
