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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:
- 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;
- Basel IA has disappeared as an option;
- Basel II Standardised becomes an option for US banks; and
- 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 »
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.
The more I read about the resignation of Susan Schmidt Bies from the board of the Fed the more convinced I am that the reason behind her leaving is a total disenchantment with the whole Basel II process in the US.
The reason given (”to spend more time with her family”) is the usual one given when you cannot say why you are really leaving. It is just such a cliché as to not be credible. The lack of follow up releases is indicative. Read the rest of this entry »
Prompted by this piece over at the Banking Law Professor’s Blog, the situation in regards the US Basel II implementation is getting a little clearer.
What is clear to me now is that the US regulators are trying to achieve two, contradictory, objectives. They are:
- Implement Basel II in the US; and
- Not disadvantage the banks that cannot achieve “Advanced” accreditation.
Problem is, you cannot do both. The result is the confusing muddle you now see in the US.
An interesting speech released yesterday from the Deputy Governor of the Central Bank of Sri Lanka on the way that Basel II is being implemented in Sri Lanka makes a few interesting points - and allows some commentary on events a long way away from Sri Lanka.
- The release of Basel II seems to be having its desired effect on both regulators and regulated around the world. The risk management practices of the banks and the regulators are improving and the tiered approach (allowing three routes to compliance) is actually prompting some true thinking on what needs to be done;
- Banks the world over are making the mistake, however, of allowing the regulators to dictate risk management practices. Basel II is a great improvement on Basel I, but it is not best practice. Each bank should work out for itself what suits them best, which should be better than the methods the regulator uses for strict Basel II compliance. For example, the use of the regulatory caps and floors on the factors should not be encouraged for internal capital allocation; and
- This speech reinforces my point below - the US approach of simply ignoring the existence of the simpler approaches is just plain ludicrous. If all of the banks in Sri Lanka can comply with Basel II (no insult intended to Sri Lanka, but the US banks can generally be considered to have better information on their risks) then why can’t the US?
Ranee Jayamaha can be commended for understanding the Accord - my guess would be that this has been assisted by the Financial Stability Institute - if so, well done on their part. It is a great pity the same cannot be said of the US regulators.
Just a quick update on the happenings in the US on the Accord. I missed the update while on holiday (vacation for US readers). The NPRs (Notice of Proposed Rulemaking) were released on December 26 (was this straight after Christmas for a reason?) on the implementation / invention / re-implementation (respectively) of these sets of rules. At least the muddle seems to have stopped or at least been swept under the carpet. The deadline for comment on the Basel II NPR has been extended to March 26 to coincide with those for the Basel IA / I NPR.
The staggering thing, though, is the errors that are in the thought process behind the whole process the Basel IA / I NPR itself. Even on a chartiable view, the background statements justifying the differing rules in the US are somewhere on (if not over) the border between simply being wrong and outright lies.
It would be funny if it were not so serious. The (so-called) Basel IA rules either may, or might not, be released for public comment on December 5. The FDIC is ready to initial them, but the other regulators probably will not be. This means the full Basel II rules will remain open for public comment throught the period when most other places on the planet have actually started implementing them (OK - only the standardised parts that are being ignored in the US, but you get the idea).
Surely this means the target implementation date will also be set back - banks the size of the 20 largest in the US, those implementing the accord, must have a target to shoot at and, at the moment they only have a fuzzy idea of it, and one that could change anyway. The lack of discussion between the regulators and the regulated, the late rule making, the uncertainly if they are even going to be allowed to reap the benefits of the improved risk sensitivity - what next?
If the US regulators just really thought about it, the full set of rules they should implement are here, with associated commentary here. It would be a great improvement.
Today’s Bobguide reminds me why I subscribe to it. Normally it is just a list of corporate advertisements - but today’s was a real pearler. As regular readers here will remember, I maintain an interest in overseas Basel II implementation - in particular the US, where it has been just plain barmy at times.
The discussion at the AEI looks like about one of the first “full and frank” discussions between the regulators and the regulated in this process, as the comment from Gary Wilhite (Wachovia) shows. As noted in the Bobsguide piece, this was an important piece of the discussion.
…the CCO of one of America’s largest banks [Wachovia] read through the list of collaborative working groups established between the EU regulators and the institutions they supervise to work though the details of Basel II implementation. He then noted quite sadly that no such cooperative effort exists between US bank regulators and the institutions which they oversee.
Any wonder why the rest of us are just shaking our heads? If they are not talking there is no chance of getting it right.
In what should be my last post on the US implementation until the final determination of what the heck they are doing is made, I thought a quick look around the (so-called) Basel IA framework is might be useful - and show why several banks want to use this approach rather than the advanced approach of the Basel II framework.
Firstly, as stated in another post, Basel IA is not a BCBS output, and should not, therefore, be called “Basel” in any case - you cannot blame the BCBS for it. What it is, on the other hand, is an attempt by the big 4 US regulators to get a more risk sensitive framework for US banks without requiring them to adopt even the simplest of the Basel II methodologies. The end result, as contained within the relevant ANPR is an attempt to create some middle ground between Basel I and Basel II standardised - improve the risk sensitivity of the credit risk calculations without doing anything substantive on the operational risk side or the other risks.
First of all: an apology. There seems to be a lot of posts recently on the US implementation of Basel II (or Basel IA or Basel I). This is largely because in Australia we have a few things going well - the regulator is progressing well on implementation, the banks know what the rules are and either are very busy putting them in to practice or have done so and are now refining then and the market is well informed.
This is not the case in the US. Even the basic rules are not yet clear, as a speech by Ben Bernanke has made clear. The US has consistently proposed (to the combined, at best, polite comment and, at worst, outright derision of fellow regulators) that Basel II needed another layer of conservatism - a layer that is not risk sensitive.
Bernanke’s speech has now thrown that, as well as whether their “Basel IA” rules up in the air. Essentially, he is saying that the US regulators will now review whether those additional rules make sense (note to the Fed, they do not) and therefore whether they should drop them.
The so called “Basel IA” rules are also under re-consideration for at least the smallest banks. Apparently, they may be too complex for the very smallest to implement, so they should be allowed to remain under Basel I.
The ”Basel IA” (I use inverted commas as they are a US formulation, not a Basel Committee formulation) are essentially dumbed-down Basel II standardised rules. In Australia, even the smallest ADI is using Basel II (the standardised approach). I cannot see why an Australian ADI can do it and a US one cannot.
Maybe we are getting some sense from the US regulators, at long last - but it comes too late and is going to introduce more uncertainty into the US implementation. The sooner they can get this sorted oout, the better. About 3 years ago would have been right.
[UPDATE]Looks like Sheila Bair at the FDIC is fighting back - at the ABA convention in Phoenix yesterday she is reported to have said that the leverage ratio “would ensure a minimum cushion of capital for safety-and-soundness throughout the global banking system”.
Looks like we are in for a nice little stoush. Arguments in bank regulation - always good fun. Lets see who wins.[/UPDATE]
[UPDATE 2]Ben Bernanke fights back! This just gets better. On the linked speech, look at the 6th and 7th paragraph on the section on bank capital (the section is on page 2, with those paras on page 3). Bernanke’s focus is on what is “…likely to add to implementation costs and home-host issues…” rather than Bair’s emphasis on “…safety-and-soundness…”.
I would like to be a fly on the wall when they next meet.[/UPDATE2]
As I suspected may happen and discussed in an earlier post, the US regulators have bowed to pressure from the banks and are to investigate allowing the standardised approach to be used for Basel II compliance.
Unless there is some form of regulatory arbitrage going on, I am mystified as to why this approach would attract any of the top 20 US banks - the only ones applying Basel II in the US. If these banks are not able to comply with what are reasonably modern risk standards (if not cutting edge any more) while operating in the most data-rich environment (and where privacy is probably the least protected) and banks elsewhere can comply I really wonder about their risk management abilities.
That really only leaves a regulatory arbitrage play - where the banks are shopping around for a system that allows them the best (i.e. lowest) regulatory capital outcome. Frankly, if the standardised method leaves them with a lower capital outcome than FIRB or Advanced, I really worry about their lending policies.
I, for one, look forward to the results of the investigation.
The implementation in the US just seems to get more confusing. Currently, the 20 or so banks that the Fed judge to be internationally active will have to apply the Basel II advanced methods. Everyone else will have to apply a modified version of the current, Basel I standards - this modification is termed Basel IA in the US. Clear enough - if not consistent with the rest of the planet.
A fair enough, too, in a way. The whole Basel framework is only meant to apply to internationally active banks. If a bank is not internationally active, then there is no need, within the accord, to apply Basel at all.
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