*EPF112 12/16/2002
Banks, Regulators Take Major Step Toward International Accord
(Banking industry likely to be reshaped, a U.S. bank regulator says) (1410)

By Andrzej Zwaniecki
Washington File Staff Writer

Washington -- Banks and bank regulators are taking a major step toward an international accord likely to reshape the banking industry around the world in the long run, an official with the Office of the Comptroller of the Currency (OCC) says.

Talks on a new banking accord intended to ensure that banks retain sufficient capital to survive difficult times without constraining their competitive posture are entering a new phase, said Tanya Smith, a senior international adviser at the OCC, a banking supervisory body in the Treasury Department.

The Basel Committee on Banking Supervision, which is crafting the new accord, is expected to receive by a December 20 deadline responses from major banks to its survey -- Quantitative Impact Survey (QIS) -- on proposed new and updated rules. QIS was designed to assess the effect of changes in the existing rules on individual banks' capital requirements, according to a July 10 Basel committee statement.

"It is going to tell us quite a bit about where we stand with these rules, how they are meeting our goals and whether things need to be changed," Smith said in a December 9 interview with the Washington File. "It will be a key part of our future negotiations."

Basel II, as the proposed accord is known, contains new and revised rules for credit risk and new rules for operational risk. The new accord also adds two elements -- supervisory review intended to ensure that the level of a bank's capital is sufficient given the level of its risks, and market discipline that aims to provide investors with enough information to understand a bank's risk profile.

Smith said that modification of the existing rules was needed to reflect changes in the banking industry since the first Basel accord was agreed on in 1988. The major reason for developing a new accord, she said, is to make a charge for credit risk -- the amount of capital banks must carry to cover risks of default on loans -- more "risk-sensitive," and in this way catch up with advances that banks have made in collecting data and managing risks.

The new rules would allow "far greater" differentiation in calculating appropriate capital levels, or "charges," depending on an individual bank's ability to collect internal data and manage risks, Smith said.

Basel II also would introduce a new type of capital charge for operational risk, which is defined by the committee as "direct or indirect loss resulting from inadequate or failed internal processes, people and systems, or from external events" and covers a wide range of events ranging from fraud to computer failure.

Basel II talks, which started four years ago, have progressed slowly because bringing varied national banking, supervisory and accounting systems onto a common platform is a tremendous task, Smith said. Differences stemming from national priorities and considerations are still being worked out, she added. The OCC indicated, for example, that it would prefer a more flexible approach to operational risk than the one proposed in the earlier versions of Basel II, Smith said. Although there was some resistance by the committee comprising experts from 13 developed countries, that flexibility has now been introduced, she added, in what is known as the advanced measurement approaches (AMA), one of the three proposed methods regarding operational risk. In addition, Smith said, in response to concerns from some committee members and the industry, the committee agreed to eliminate a proposed "floor" or minimal capital requirement on operational risk in conjunction with AMA.

German bank regulators insisted that requiring banks to set aside more capital against riskier loans would stifle a flow of credit to middle-size and small companies that are vital for the German economy, according to news reports. To address these concerns the committee said it would allow for lower capital charges for loans to small businesses and let national supervisors exempt loans to smaller enterprises from a requirement that a loan's maturity will be used in calculating the required capital levels.

But the committee recognized that the gap between banking systems in the developed world and developing countries would not be easy to bridge. For emerging markets and less developed countries, adopting the new rules would be a major challenge, Smith said. Not only would it require a tremendous amount of work, but it also would be "extremely" expensive, especially if those countries decide to adhere to more advanced approaches to risk, she said. Additionally, Smith said, it would require them to have supervisory capacity and external rating agencies that many of them currently lack.

"Basel II will change supervisory work fundamentally and will be resource intensive," she said. "Even in the U.S., we are looking very closely to see if we have resources necessary to carry it out."

The committee said that some countries that only recently adopted the 1988 rules "may need more time beyond 2006 to implement the new framework."

Where differences between national systems cannot be smoothed, "you will see some allowance for national discretion," Smith said.

She said the accord would allow countries to preserve a measure of distinctiveness by providing a menu of implementation options from which they could choose the one most appropriate for their systems. The United States and the European Union, for example, may use different approaches to arrive at the capital charge for operational risk, Smith said.

Because under the new rules banks would have to set aside more capital against some types of loans than others, they reportedly could be encouraged to cut the price of lower-capital-charge lending and shed higher-capital-charge lending entirely.

But Smith said such an outcome was not entirely certain.

"There may be areas where a particular bank is costed out of doing business simply because it requires too much capital," Smith said. "However, another bank may find that business line more advantageous."

It also is too early to tell how exactly the new accord would transform the banking industry, Smith added, because the negotiations are still going on, and some proposals, including those related to a more advanced approach to credit risk, retail and commercial real estate loans and securitization, are not yet complete.

So the accord's impact on different lines of banking business will be not clear, she said, until the proposed rules in key areas are finished.

Nevertheless, Smith said, the possibility of more consolidation occurring in the banking industry as a result of Basel II is "not unrealistic at all." Large banks using the advanced internal rating-based (IRB) approach to credit risk are likely to incur smaller capital charges, and consequently costs, than smaller ones using the standardized approach, she said. IRB would allow banks with sophisticated risk management systems to input data into formulas to calculate the necessary level of capital.

"But implementing the IRB approach does not automatically yield a smaller capital charge," Smith cautioned. "The capital savings also would depend on a type of business you have."

The banks with lower levels of required capital could offer loans at lower prices than their competitors could afford and this advantage could, ultimately, give them an incentive to buy out some of their rivals, according to private experts cited by news reports.

But, again, "Basel II is still very much work in progress," Smith said, and results of QIS might still change the way the committee approaches different issues, and that, in turn, would change the future competitive environment.

Following is a calendar of projected developments in the Basel II process:

-- December 20, 2002: QIS findings are due.
-- May 1, 2003: the third consultative paper or a final draft of the Basel II accord is expected to be released by the Basel committee, followed by three months of consultations.
-- June, 2003: U.S. agencies plan to issue a notice of proposed rulemaking reflecting how the United States plans to implement the new accord.
-- Fourth quarter, 2003: a final version of the new accord is expected.
-- 2004-2006: Banks and supervisors are expected to adapt and develop necessary systems and processes to implement the new accord.
-- end of 2006 (effectively 2007): the Basel II accord is expected to take effect.

The Basel Committee statements and press releases can be found on Bank for International Settlements web site at http://www.bis.org/bcbs/index.htm

(The Washington File is a product of the Office of International Information Programs, U.S. Department of State. Web site: http://usinfo.state.gov)

Return to Public File Main Page

Return to Public Table of Contents