Just browsing through the latest edition of the Global Risk Regulator and I came across a discussion on a speech given by Martin Gruenberg of the FDIC on Basel II. It does not say much that Sheila Bair has not said before – but he does try to answer some of the critisism that has been directed at the FDIC for its attitude on this.

Regular readers of this blog will be familiar with my attitude towards the FDIC’s position – but if you need a summary, I think it is at best misguided. For a full discussion, look at the category.

I was, to say the least, disappointed with the weakness of some of his points, but this one was a real howler:

The dollar amount of excess capital that would be available to foreign banks as a result of Basel II is expected to be substantially less than the current market capitalization of any of the largest U.S. banks, thereby limiting the possibility that Basel II capital reductions will induce foreign acquisitions of U.S. banks.

From my reading of this he is saying that because you will not be able to fund a purchase in its entirety of a US bank from any reduction in regulatory capital it is less likely to happen. If I have read this correctly it is arrant nonsense. All you need is to get some advantage from the regulatory capital reduction – not fund it entirely. The next point was worse:

Finally, foreign acquirers of U.S. banking organizations would gain no immediate regulatory capital benefit for the newly formed banking subsidiary in the United States since the subsidiary would remain subject to U.S. capital and prompt corrective action rules, including the leverage ratio. This would reduce, if not eliminate, acquisitions with an economic purpose of capital arbitrage.

Ummm – ever heard of home / host? There would be an immediate capital benefit where the US bank has foreign operations (i.e. all those going Advanced) as the home regulator would no longer be one imposing the highly questionable (I will run out of weasel words soon) US regulations.

The observation he has made that more capital does not mean lower profits is right – but the linkage he uses is weak. As he notes elsewhere, defaults are at low levels – so this has led to increased profitability. Does that mean that all that additional capital was needed or even useful? I fail to see the link.

The rest of the speech is similarly disappointing. The FDIC is continuing to try to justify using a risk-insensitive approach to banking capital; to use Basel II as a stick to beat the US banks to both improve risk management and to hold unjustifiably high capital levels; and to generally use double-speak around risk-sensitivity.

Simple message, FDIC. Basel II is meant to give more risk-sensitive capital outcomes. If the banks modify their behaviour to reduce risks is this not a good outcome? Slavish adherence to a capital number that was not in the first place based on any real science beyond “hmmm – it looks right” is not a good substitute for a truly risk b

ased approach.