Bies promotes Basel II buy-in for US banks

Despite considerable recent criticism concerning the value of Basel II for US banks, particularly from a number of senior banking officials including Sarbanes-Oxley legislator Paul Sarbanes, Susan Schmidt Bies remains upbeat that Basel II will contribute significantly to enhancing the safety and soundness of the US banking system.

Speaking at the Standard & Poor's North American Financial Institutions Conference in New York, Federal Reserve Governor Bies was keen to emphasise the value of the new Accord, saying that the Basel II framework, particularly the advanced approaches for credit and operational risk, is "much more risk-sensitive than Basel I".

Opposition to the proposed legislation in the US has been increasing since the outcome of the fourth Quantitative Impact Study (QIS4) was published earlier this year. The results showed a much greater than expected reduction in regulatory capital requirements under Basel II prompting William Isaac, Chairman of the Secura Group and former Chairman of the Federal Deposit Insurance Corporation to say he believed Basel II could cause "enormous harm to the US banking system". Senator Paul Sarbanes was also deeply sceptical about the value of the new Accord, questioning why it was needed for US banks which he said were not over capitalised and suggesting that Congress could ditch Basel II altogether.

Governor Bies however has sought to allay concerns that Basel II will pose a threat to the US banking system either for larger banks who would be the only institutions to implement Basel II or for smaller banks who fear they will be competitively disadvantaged due to an imbalance in capital ratios. "It is our intention to gather as much information as possible about the impact of the suggested regulatory capital proposals on these markets, and make any necessary adjustments", Bies said. "The agencies naturally understand that institutions not likely to adopt Basel II are among those most wary of the potential competitive effects; in drafting the ANPR for revising Basel I, the agencies have taken these concerns into account."

Governor Bies cited improved risk-sensitivity and the capture and management of operational risks under Basel II as particular reasons that large US banks should be implementing the new Accord. On Basel I, Bies said "the categories of risk used to determine capital are very broad and are intended to capture the 'average' risk levels across the banking system for that generic exposure. Basel I, which has primarily a balance-sheet focus and simple methodology for including off balance-sheet exposures, may be appropriate for most banking organisations. But Basel I is not adequate for the largest, most complex organisations, which have significant, complicated exposures off the books that need to be considered more explicitly in determining minimum regulatory capital. Among these are operational risks, which in some recent instances have been the source of substantial losses far exceeding credit- or market-related ones."

"The Basel II framework, particularly the advanced approaches for credit and operational risk that we are proposing in the United States, is structured to be much more risk-sensitive than its predecessor. For example, all commercial loans are not lumped into one risk bucket but are differentiated according to certain risk inputs provided by institutions' internal systems. On the operational risk side, the application of Basel II in the United States is intended to create better identification of those risk exposures and have them appropriately supported by regulatory capital."