It now appears the regulators are trying to rein in the monster that is the pages and pages of international capital rules. But the problem is their effort to simplify years of Basel Committee standards and separate regulations by domestic rulemaking agencies may just make matters worse.
For lack of a better title, this "simplification" effort is known as Basel IV. I know there is no document with that heading and regulators will deny that a Basel IV exists. But no other term can describe it. And the goals of this effort – as fragmented as it is – are laudable. Regulatory capital standards before and after the crisis have been impossibly complex. The international Basel Committee created Basel I, II and III, and U.S. regulators have multiplied the capital measures on their own.
The largest banks are required to monitor over a dozen regulatory capital dials. Added to this are less well defined but more demanding regulatory capital expectations with annual stress tests, such as the Comprehensive Capital Analysis and Review. The U.S. regulators have also created more stringent versions of Basel standards, such as the "capital conservation buffer" and a capital surcharge for "global systemically important banks." Community banks are not subject to this full array of capital standards, but their capital requirements are also far more complex than is necessary.
Which brings me back to Basel IV. Although the Basel Committee has recognized the need to rein in the complexity of so many different capital rules, the proposed solution is just more rules.
Over the past two years, the committee has issued more than a dozen new regulatory capital proposals in a bid to simplify. The proposals have been released in a piecemeal fashion, with each new proposal seemingly unrelated to the previous one. If the process were more streamlined, it would be easier for banks to comment publicly on the effort, including how the various different rules might be interconnected. It has been difficult for even the largest and most sophisticated banking organization to provide informed comment on the proposals. For community banks, which could potentially be impacted by some of the proposals, it is downright impossible.
But further complicating efforts is that the U.S. banking agencies have separately been discussing the simplification of regulatory capital standards domestically. They appear to be considering a path that differs from the Basel Committee. It is unclear from regulators' public statements whether they will continue to allow large banks to use internal modeling for calculating risk-based capital levels. For community banks, U.S. regulators have also been exploring how to simplify capital requirements.
Of course, all of this is very important, which is why it is unfortunate that, much like previous Basel projects, neither the public, Congress, nor industry have been effectively involved in the Basel deliberations.
The U.S. banking agencies should broaden the discussion, including the issuance of an "advance notice of proposed rulemaking" to bring greater transparency to the options being considered. Such an ANPR should include discussion of the problems to be addressed, the scope of potential changes, what is being considered for adoption domestically, and how potential changes would be applied and to which banks.
Issuing an ANPR when such fundamental changes are being considered would be consistent with past practices. During the development of the Basel II standards in 2003, regulators issued an ANPR that clearly outlined the scope and potential regulatory requirements, and asked for comments so the agencies could "seek appropriate modifications" at the international level. As a result of the Basel II ANPR, every bank knew whether the Basel process would affect them and could decide whether to participate in the comment process armed with that information. Moreover, consideration of all of the miscellaneous Basel pieces together would allow banks to provide more informed comments to the regulators.
Whatever options U.S. regulators are considering to simplify the standards, it is essential that they engage the public, the Congress and industry in the discussion. This would allow the public to weigh in on crucial questions that need to be debated, including whether agencies are striking the right balance between risk sensitivity and simplicity, whether simplification is being done in a capital-neutral manner, whether the U.S. approach is consistent with Basel, and how community banks will be affected. The federal banking agencies would do themselves – and all who must live with the results – a great service by encouraging the debate.
Hugh Carney is vice president of capital policy for the American Bankers Association.