US Fed backs Basel II plan for smaller banks

ABS-CBN News

Posted at Jun 27 2008 01:48 AM | Updated as of Jun 27 2008 09:48 AM

Reuters

WASHINGTON - The majority of US banks would have the option to adopt alternative risk-based capital adequacy rules based on the Basel II agreement, under a proposal approved by the Federal Reserve Board on Thursday.

The long-awaited "standardized" capital rules would apply to almost 8,500 banks and are intended to be less complex and costly to implement than the "advanced" requirements for about a dozen of the largest, internationally-active US banks.

"It is important to give these institutions the option to calculate risk-based capital requirements using a more updated framework while being mindful of regulatory burden," Fed Chairman Ben Bernanke said at a Federal Reserve Board meeting.

"Recent market events remind us that institutions of all sizes need prudent risk measurement and management practices and levels of capital that are commensurate with the risks that they bear," he said.

The Federal Deposit Insurance Corporation approved the same interagency plan on Wednesday, saying it would help banks to more closely align their capital requirements with risk.

"The standardized approach proposal is expected to add greater risk sensitivity without creating excessive complexity and burden, and, thus, should minimize competitive inequities between large and small banks," said FDIC Chairman Sheila Bair in a statement.

Basel II aims to ensure banks worldwide meet similar requirements for matching reserves to the risks they face.

The standardized approach is optional and allows smaller banks that already carry capital well above regulatory minimums to avoid the compliance burden of the new framework.

The biggest US banks such as Bank of America, Citigroup Inc and JPMorgan Chase & Co are required to use the "advanced" version of Basel II rules issued last year. The big banks, which are trying to pick up the pieces from the housing market bust, face an October deadline to tell US regulators how they will implement the new rules.

But in proposing the standardized approach for smaller banks, banking regulators ask if the biggest banks should also get the option to use the simpler standardized approach.

Bair has spoken positively about that idea, saying the advanced approach would let the biggest banks cut their capital too much and relies too heavily on internal ratings systems.

"Given the turbulence in the credit markets, I take some comfort in the fixed risk weights established under the standardized approach as they provide supervisors with some control over unconstrained reductions in risk-based capital," Bair said in the statement.

Bair is responsible for the FDIC's $53 billion deposit insurance fund, which could be tapped if a big bank failed.

Lessons learned

Jason Cave, FDIC associate director for capital markets, says that in other countries, large banks have adopted the standardized approach.

Cave told reporters the standardized approach takes into account recent turmoil in the credit markets and the risks associated with subprime mortgages.

The approach aims to improve risk management for collateral and guarantees, and certain off-balance sheet exposures, such as liquidity commitments to asset-backed commercial paper programs. The proposal also establishes a more risk-sensitive approach for residential mortgages based largely on loan-to-value measures and requires a capital charge for operational risk.

But Cave said the standardized approach proposal could change as the international Basel committee addresses how to deal with continuing market developments. "Events can overtake us," he said.

One element that could change is part of the proposal expanding the use of external credit ratings to a broader range of exposures. The proposal asks "whether identified weaknesses in the credit rating process suggests the need to change or enhance any of the proposals."

Rating agencies such as Moody's, McGraw-Hill Cos' Standard & Poor's and Fimalac SA's Fitch Ratings have been blamed for contributing to the crisis by assigning top ratings to mortgage-backed securities that later deteriorated.

The standardized approach proposal will have a 90-day comment period after which regulators may make more changes.