Basel II critical, says US Federal Reserve

The US Federal Reserve, one of the US's four national regulators, came out strongly in support of Basel II in a July 12th presentation by Randall S Kroszner, Member of the Board of Governors at the Federal Reserve, to the New York Bankers Association Annual Washington Visit to Washington DC on 12 July 2007.

Kroszner commented that the existing Basel I rules were flawed for large, complex US banks: its simple risk-bucketing approach creates perverse incentives for risk-taking – for example regulatory capital being the same for all unsecured corporate loans and bonds regardless of actual risk, all unsecured consumer credit card exposures being treated the same, and no differentiation in mortgages – with the result that banks were shedding low-risk exposures and acquiring relatively high-risk exposures within each of these asset classes.

"Implementation of Basel II in the United States is necessary in order to ensure the safe and sound operation of our banking industry and the stability of our financial system", Kroszner said. "Basel II would promote continued improvements in bank risk management practices and would maintain capital levels in the U.S. banking system that are appropriate and risk-sensitive."

A key recommendation was that Basel II implementation in the United States should proceed in a manner consistent with implementation in other countries. Krozner accepted that Basel II needed to accommodate robust US supervisory practices, but said that it was an international framework and should only retain differences where the regulatory benefits exceed the implementation burden and costs.

The US Senate Banking Committee has urged federal banking regulators to finalise the Basel II rules. In a 17th July letter to the heads of the Federal Reserve, Office of the Comptroller of the Currency, Federal Deposit Insurance Corp and Office of Thrift Supervision, signed by two of the top Democrats and Republicans, they said that "We both believe strongly that the decisions you take in the next few days will have a significant impact on both the safety and soundness and the competitiveness of the U.S. financial system."

However, the regulatory four agencies will struggle to reach agreement in time to meet the January 1st 2008 parallel run US implementation date promised for Basel II.