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One event I missed posting on at the time was the final agreement of all of the US regulators on the way that Basel II will be implemented in the US that happened 10 days ago. After some seriously silly obstinate argument from the FDIC, I was please to note at the time that the Fed largely got its way in the end, and now those rules have now been given final agreement.

To those of us watching from the outside this has been a painful process. I can only imagine how difficult it must have been for the US banks. The end result was close to the right one – the one I suggested a full year ago. In this, at least, the delay was worthwhile. Going with the FDIC’s original position would have been close to suicide for the whole US banking system – and a long, slow suicide it would have been.

Randall Kroszner’s speech on the matter is worth a read. The way he delicately steps around the blithering idiocy errors of the FDIC and the local bank lobbyists is almost artful.

One bit irks me, though – at the bottom of page 5 of the speech he is seeming to say that the US regulators will be coming up with a “standardised”  method of implementing Basel II. Amazing – I wonder what paras 50 to 210 of the New Accord are?

Anyway, if you are interested in my opinion on the whole process read the category. Reading in reverse order is probably best. I think some of my best posts have been in there.

In most of the rest of the world the process has been fairly sedate – well, as sedate as a nearly complete change to the bank regulatory framework can ever be. What am I going to talk about in this way again while we wait for Basel III?

In what looks like a (near) total victory for the US Federal Reserve, agreement has been reached between the various US regulators on the final implementation of Basel II in the US.

The elements of the deal:

  1. The risk insensitive capital floors (flaws) have been dropped, replaced with a gradual (5%p.a.) maximum drop in capital over the first 3 years;
  2. Basel IA has disappeared as an option;
  3. Basel II Standardised becomes an option for US banks; and
  4. Basel II Advanced will be implemented “and should be technically consistent in most respects with international approaches”

All I can say about this is: Excellent. Amongst many others, I have long been a critic of the stupid questionable US approaches. I am very glad the Fed held their line and, apart from a fig leaf of a review at the end of year 2, they have been vindicated.

Well done.

For those looking for an up-to-the minute summary of why Basel II is needed I would advise a look at this speech by Randall Krosner of the US Fed. Like most of the speeches by members of the Fed, he appears to understand the reasons for Basel II and why, in a global sense, it is important – unlike the lack of understanding displayed by other US regulators.

As a side note – it is interesting that the BIS PR department choose to publish the speeches of Fed employees and not those of the FDIC. Curious.

I would disagree with him on the need for Basel IA though – as I have said before, if a small credit union in Australia can implement Basel II Standardised I see no reason why a US S&L cannot.

Short speech that Nout Wellink of the Netherlands Central Bank will be making later today in Paris has just popped up on the BIS website. It makes a few good points around how the risk management practices being improved through Basel II will improve the resilience of financial institutions and the system generally. Might not be worth a full read, unless you like that sort of thing but a few points bear repeating.

Nout was clear on the importance of the Pillar III disclosures – “Pillar 3 will become more important because of increasing intermediation of risk through the capital markets.” In the context of the draft Pillar III disclosures that APRA released in the new APS 330 I can only repeat what I said at the time – they are inadequate. Banks and other ADIs going standardised and seeking cheaper funding would be well advised to make fuller disclosure than required.

The US regulators (hello – that is you FDIC) –

A regulatory framework based on a simple risk weight scheme has become less and less effective in assessing an appropriate level of regulatory capital against these new, complex risk exposures.

To extend the point beyond Nout’s – the old ways of calculating risk exposures do not work. Trying to impose them in this context is simply wrong.  Financial institutions need to be able to fail. Trying to make sure they cannot, as the FDIC seems to be trying to do is merely a recipe for the whole sector to become a moribund wasteland of zombies, too afraid to do anything new. Not an attractive prospect.

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 based approach.

An excellent post over at Ops Risk and Compliance regarding the US implementation. It makes many of the points I have previously made – and goes a bit further.

After quantative [sic] impact studies, advanced notices of proposed rulemaking, numerous consultation documents, incalculable titbits of contradictory information from a menagerie of regulators (some of whom apparently think Basel II: The New Accord is a movie – sequel to the 1988 worldwide smash hit original) we finally have an NPR out there that everyone has agreed on.

And in the same spirit of cooperation, compromise and conciliation with which the regulators thrashed out this NPR, the responders have answered in a similar spirit of agreement. That is, they all agree its pretty crap.

Little more to be said, really. Like the bit about the movie title.

For those of us that maintain a strong interest in the theory of bank regulation (sad, I know) a speech by Ben Bernanke provides a very interesting read. (Thanks to Bank Law Professor for another great link).

In this speech, he runs through what amounts to a history of bank regulation in the USA to illustrate his various points, on what he terms “command and control” bank regulation, deposit insurance and the moral hazard inherent in it, minimum capital requirements and Basel II. A real tour de force.

I was disappointed, though, that he did not mention one major possibility for the regulation of major banking markets. Read the rest of this entry »

Just a quick update to let you know I am still around. The last week has been very busy, with a quick trip to Melbourne for an update on AASB 139 (on which more in a subsequent post), an article in production for Business Islamica magazine and the close of one (Advanced) Basel II project and the proper start of an other (Standardised) one.

I have also decided to (temporarily) discontinue the series on the Basel II projects in the Australian banks. With APRA currently going through the approval processes for most of these projects it was just getting too sensitive. Some of the pronouncements from APRA on these projects have been questionable at best, so I think it best to discontinue these for the moment.

Also increasing worrying is the situation in the US. The Fed is now saying the 30 June target date for the release of the rules is looking aggressive – meaning they may either be rushed or incomplete and therefore subject to later alteration. Madness.

As always, we remain open to suggestions for future posts, so please suggest away.

Thanks to the Banking Law Prof Blog for pointing to this press release from the FDIC about a sub-prime lender in the US getting a “cease and desist” consent order from the FDIC. In Australia these would be termed an “EU” – an enforceable undertaking.

If I can use this example to illustrate how the three Basel II pillar would actually work in practice I think it would be a useful exercise. Read the rest of this entry »

Today’s GRR (Global Risk Regulator) really highlights the differences between two speeches, the first, given by Sheila Bair of the FDIC and the second, by the (now retiring) Susan Schimdt Bies of the Federal Reserve.

Both of the speeches, and particularly that of Bair, merely reinforce my view that the FDIC has got it drastically wrong and that the Fed actually understand what they are talking about. It is a real pity that it is Bies that is retiring.

Read the rest of this entry »

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