This month federal banking agencies issued an advance notice of proposed rulemaking that seeks comment on various modifications to the existing capital rules for the vast majority of U.S. banks.
Basel IA was designed, largely in response to competitive concerns raised during the Basel II process, to provide capital benefits to non-Basel II banks. However, the framework proposed under Basel IA is meant to be much simpler to apply than Basel II. Basel IA is being presented as a uniform, prescriptive approach to measuring capital that will be easy for banks to implement using their existing systems and processes.
Initial review of the proposal, however, raises the question: Does it sacrifice meaningful capital reform at the altar of simplicity?
The stated goal is to encourage efficient capital allocation and reduce competitive inequalities. Several shortcomings may keep the rules from achieving this goal, including the following:
Although large corporate borrowers sometimes have agency ratings, the vast majority of corporate borrowers - the core of the industry's middle market - do not obtain such ratings today. As a result, Basel IA may offer little practical capital benefit for commercial lenders.
How does this dovetail with increasingly frequent regulatory pronouncements on the importance of risk management, and is this really creating the right incentives?For example, Basel IA would add a 350% risk-weight bucket for high-risk loans. That would penalize all banks equally, generally without regard to their different risk and collateral management practices, for lending to high-risk credits.
This shift could have significant effects on banks' incentive and ability to lend to meet a variety of credit needs, particularly into low-income urban areas. Careful scrutiny of the impact of this "capital penalty" is clearly warranted.
During a 90-day comment period, banks and representatives of their industry (including trade associations) have a chance to assist in charting the course of the capital rules that will apply to them. The notice encourages banks to be expansive and creative in considering the impact on them of the proposed risk-based capital rules and in proposing changes to the suggested framework.
Banks should thoughtfully consider whether Basel IA works for them in the specific context of their lending and risk management practices and growth strategies.
The European implementation of Basel II will include a standardized (prescriptive) approach as well as foundation and advanced (internal-ratings-based) approaches tailored to the relative sophistication, effort, and risk management of different banks.
In this country, only the most advanced approach is currently scheduled to be available, and there will be significant differences between that approach and the simple one offered by Basel IA.
No one is asserting that all U.S. banks should be subject to the extremely costly and burdensome sophisticated systems and processes demanded of the largest U.S. banks under the most advanced approach of Basel II. Still, it is a fair question to ask whether Basel IA should take at least some guidance from the more complex but more risk-sensitive multilevel Basel II approach.
Now is the best (and perhaps only) chance for banks to weigh in on the rulemaking and possibly alter its course.
