WASHINGTON U.S. and foreign regulators are poised to unveil Tuesday their latest plan to reform the 13-year-old Basel Accord, marking the last leg in a long journey toward new international capital rules.
Industry officials are expected to have until May 31 to comment on the proposal, which builds on a consultative paper released by the Basel Committee on Banking Supervision in June 1999. Federal Reserve Bank of New York president William J. McDonough, the committees chairman, has said that he hopes to issue a final rule this fall.
Officials involved in developing the revised proposal have said that it will allow many banks to use their internal systems to set, or help set, their regulatory capital. That is a change from the previous proposal and has broad industry support.
A key aspect of the revised proposal will be a greater reliance on banks internal risk-rating systems to set regulatory capital levels for credit risk, said Lawrence R. Uhlick, executive director and general counsel of the Institute for International Bankers.
But industry observers are eager to see how the committee deals with several related issues, such as whether banks that use collateral, derivatives, or other risk-mitigation techniques may hold less capital.
Collateral and derivatives were given virtually no consideration in the June 1999 paper, said Carl L. Tannenbaum, chief economist at ABN Amro/LaSalle Bank in Chicago. He also noted that the committee will require regulators to approve a banks internal systems before allowing them to be used to set capital. How high is the hurdle going to be? he asked.
Industry observers are also concerned about statements by committee members who have said they plan to create an additional capital charge to cover operational risk, which encompasses everything from losses caused by back-office failures to damage from natural disasters. Skeptics are worried that regulators, fearful the revised standards will lower capital requirements and be politically unpopular, could adjust operational risk charges to make up the difference.
It will also be extremely important to see what approach the Basel Committee takes in terms of a capital charge for operational risk, Mr. Uhlick said.
The Basel Committees first stab at remaking capital rules was a consultative paper that recommended basing capital on three pillars: minimum capital standards supplemented by supervisory review, and market discipline.
Under the previous plan, all but the most sophisticated banks would have been subject to a standardized approach to setting minimum capital standards. The method proposed would have tied the capital requirement to a borrowers debt rating, as determined by an independent ratings agency, such as Standard & Poors or Moodys.
Corporate loans, for instance, would be slotted into three risk categories, or buckets: loans to borrowers with a credit rating of between AAA and AA- would require 1.6% capital, those rated between A+ and B- would require 8%, and those below B- would require 12%.
In comment letters, bankers attacked the proposal, saying it was not much of an improvement over the original accord.
A typical comment came from the risk management consultant John Mingo of Mingo & Co., who helped draft the response submitted by the Risk Management Association. There are still too few buckets and the buckets are arbitrary, he said. Banks set economic capital in a continuum from 0% to 30%. With [the proposal] it is still the case that for any given asset, the regulatory capital is going to be significantly different from the economic capital, said Mr. Mingo, a former senior adviser in the Federal Reserve Boards research and statistics section.
Many of the banks responding urged the committee to explore wider use of internal systems.
Banks see a benefit to using internal systems, because they would allow them to tailor their capital to their specific assets. The standardized system, they argue, forces different kinds of institutions into a one-size-fits-all template, resulting in inaccurate assessments of minimum capital and encouraging arbitrage.
Successfully determining the capital required to back a specific loan or pool of loans requires two pieces of information: the probability that the loan will go into default, and the amount of money the bank is likely to lose in the event of default. Both involve complex calculations and models, but the second element, commonly known as loss-given-default, is the more difficult to measure.
In a speech last September, Mr. McDonough revealed that many more banks than the committee had expected were likely to try to qualify to use their internal ratings systems. The committee, he said, is trying to reward banks that really invest in these areas. To that end it had developed a tiered system that would allow banks different levels of autonomy in setting capital, depending on their sophistication, he said.
Banks able to calculate both the probability of default and the loss-given-default of their borrowers would be allowed to set their own regulatory capital. The systems would have to be approved by regulators and, in order to allow investors to judge the safety and soundness of specific institutions, their underlying methods would have to be disclosed to the public.
Banks able to calculate only the probability of default would be allowed to use that calculation as part of their capital-setting regimen, but would be required to supplement it with loss-given-default estimates supplied by regulators.
The standardized approach, which many bankers hope to see revised to include more risk categories, will remain an option for institutions that do not qualify to use internal systems.
Meanwhile, U.S. regulators are working on a simplified capital framework for small banks. This framework would let noncomplex institutions operate under simpler risk-based capital standards.
Under an interagency proposal issued in October, banks that have less than $5 billion of assets and a simple, low-risk balance sheet would qualify. These banks would primarily hold nonvolatile assets and liabilities and make minimal use of derivatives. About 90% of U.S. banks would qualify.
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