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entitled 'Risk-Based Capital: New Basel II Rules Reduced Certain
Competitive Concerns, but Bank Regulators Should Address Remaining
Uncertainties' which was released on October 14, 2008.
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Report to the Subcommittee on Financial Institutions and Consumer
Credit, Committee on Financial Services, House of Representatives:
United States Government Accountability Office:
GAO:
September 2008:
Risk-Based Capital:
New Basel II Rules Reduced Certain Competitive Concerns, but Bank
Regulators Should Address Remaining Uncertainties:
GAO-08-953:
GAO Highlights:
Highlights of GAO-08-953, a report to the Subcommittee on Financial
Institutions and Consumer Credit, Committee on Financial Services,
House of Representatives.
Why GAO Did This Study:
Basel II, the new risk-based capital framework based on an
international accord, is being adopted by individual countries. It
includes standardized and advanced approaches to estimating capital
requirements. In the United States, bank regulators have finalized an
advanced approaches rule that will be required for some of the largest,
most internationally active banks (core banks) and proposed an optional
standardized approach rule for non-core banks that will also have the
option to remain on existing capital rules. In light of possible
competitive effects of the capital rules, GAO was asked to examine (1)
the markets in which banks compete, (2) how new capital rules address
U.S. banks’ competitive concerns, and (3) actions regulators are taking
to address competitive and other potential negative effects during
implementation. Among other things, GAO analyzed data on bank products
and services and the final and proposed capital rules; interviewed U.S.
and foreign bank regulators, officials from U.S. and foreign banks; and
computed capital requirements under varying capital rules.
What GAO Found:
Large and internationally active U.S.-based banks (core banks) that
will adopt the Basel II advanced approaches compete among themselves
and in some markets with U.S.-based non-core banks, investment firms,
and foreign-based banks. Non-core banks compete with core banks in
retail markets, but in wholesale markets core banks often compete with
investment firms and foreign-based banks. Because holding capital is
costly for banks, differences in regulatory capital requirements could
influence costs, prices, and profitability for banks competing under
different capital requirements.
The new U.S. capital rules addressed some earlier competitive concerns
of banks; however, other concerns remain. By better aligning the
advanced approaches rule with the international accord and proposing an
optional standardized approach rule, U.S. regulators reduced some
competitive concerns for both core and non-core banks. For example, the
U.S. wholesale definition of default for the advanced approaches is now
similar to the accord’s. Core banks continue to be concerned about the
leverage requirement (a simple capital to assets calculation), which
they believe places them at a competitive disadvantage relative to
firms not subject to a similar requirement. Foreign regulators have
been working with U.S. regulators to coordinate Basel II implementation
for U.S. banks with foreign operations. The proposed standardized
approach addresses some concerns non-core banks raised by providing a
more risk sensitive approach to calculating regulatory requirements.
But other factors likely will reduce differences in capital for banks
competing in the United States; for example, the leverage requirement
establishes a floor that may exceed the capital required under the
advanced and standardized approaches.
Many factors have affected the pace of Basel II implementation in the
United States and, while the gradual implementation is allowing
regulators to consider changes in the rules and reassess banks’ risk-
management systems, regulators have not yet taken action to address
areas of uncertainty that could have competitive implications. For
example, the final rule provides regulators with considerable
flexibility and leaves open questions such as which banks may be
exempted from the advanced approaches. Although the rule provides that
core banks can apply for exemptions and regulators should consider
these in light of some broad categories, such as asset size or
portfolio mix, the rule does not further define the criteria for
exemptions. Some industry participants we spoke with said that
uncertainties about the implementation of the advanced approaches have
been a problem for them. Moreover, regulators have not fully developed
plans for a required study of the impacts of Basel II before full
implementation. Lack of specificity in criteria, scope, methodology,
and timing will affect the quality and extent of information that
regulators will have to help assess competitive and other impacts,
determine whether there are any material deficiencies requiring future
changes in the rules, and determine whether to permit core banks to
fully implement Basel II.
What GAO Recommends:
GAO recommends that the U.S. bank regulators (1) clarify how they will
use regulatory flexibility built into the rules and (2) fully develop
plans, on a joint basis, for the required study of the impacts of Basel
II. The bank regulators generally agreed with our recommendations in a
joint response to this report.
To view the full product, including the scope and methodology, click on
[hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-953]. For more
information, contact Orice M. Williams at (202) 512-8678 or
williamso@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Core Banks Compete among Themselves and with Other Financial Entities
That Will Operate under Different Capital Regimes:
New U.S. Capital Rules Have Reduced Some Competitive Concerns about
Basel II:
Bank Regulators Have Taken Limited Actions to Address Additional
Competitive Effects of Basel II Implementation on U.S. Banking
Organizations:
Conclusions:
Recommendations:
Agency Comments and Our Evaluation:
Appendix I: Objectives, Scope, and Methodology:
Appendix II: Three Pillars of the Advanced Approaches:
Appendix III: Basel II Timeline:
Appendix IV: Comments from Federal Banking Regulators:
Appendix V: GAO Contact and Staff Acknowledgments:
Related GAO Products:
Tables:
Table 1: Percentage of Selected Assets of Core Banks in Certain Retail
and Wholesale Markets, December 31, 2007:
Table 2: Percentage of Total Assets in Selected Classes, by Bank
Holding Company Size, December 31, 2007:
Table 3: Significant Technical Differences between the U.S. NPR on
Advanced Approaches and the New Basel Accord, and the Treatment of
These Differences in the U.S. Final Rule on Advanced Approaches:
Figures:
Figure 1: The Three Pillars of Basel II:
Figure 2: Foreign Exposures of U.S.-based Core Banks, as of December
31, 2007:
Figure 3: Required Capital for Short-term Corporate Loans under the
Advanced Approach and Bank Holding Company Leverage Requirement, by
Probability of Default:
Figure 4: Risk Sensitivity of Proposed Standardized Approach vs.
Prudently Underwritten Residential Mortgages under Basel I, by LTV:
Figure 5: Required Capital for Externally Rated Corporate Loans under
Basel I, Proposed Standardized Approach, and Advanced Approach, by
Rating:
Figure 6: Required Capital for Externally-rated Corporate Loans under
the Advanced Approach and Depository Institution Leverage Requirement,
by Rating:
Figure 7: Computation of Wholesale and Retail Capital Requirements
under the Advanced Internal Ratings-based Approach for Credit Risk:
Abbreviations:
A-IRB: advanced internal ratings-based approach:
AMA: advanced measurement approaches:
CSE: consolidated supervised entity:
EAD: exposure at default:
FDIC: Federal Deposit Insurance Corporation:
FFIEC: Federal Financial Institutions Examination Council:
LTV: loan-to-value:
LGD: loss given default:
M: maturity of the exposure:
MRA: market risk amendment:
NPR: Notice of Proposed Rulemaking:
OCC: Office of the Comptroller of the Currency:
OMB: Office of Management and Budget:
OTS: Office of Thrift Supervision:
PCA: prompt corrective action:
PD: probability of default:
QIS-4: fourth quantitative impact study:
SEC: Securities and Exchange Commission:
SME: small-and medium-sized enterprise:
United States Government Accountability Office:
Washington, DC 20548:
September 12, 2008:
The Honorable Carolyn B. Maloney:
Chair:
The Honorable Judy Biggert:
Ranking Member:
Subcommittee on Financial Institutions and Consumer Credit:
Committee on Financial Services:
House of Representatives:
Ensuring that banks maintain adequate capital is essential to the
safety and soundness of the banking system.[Footnote 1] Basel II, the
newly revised risk-based capital framework, aims to better align
minimum capital requirements with enhanced risk-measurement techniques
and to encourage banks to develop a more disciplined approach to risk
management. Basel II rests on an international accord (the New Basel
Accord) adopted by the Basel Committee on Banking Supervision (Basel
Committee) in June 2004.[Footnote 2] The New Basel Accord includes a
standardized approach and advanced approaches, more complex approaches
that large, internationally active banks are encouraged to use. U.S.
federal banking regulators have been working to finalize capital rules
based on this accord. Since our February 2007 report on Basel II, U.S.
federal banking regulators have finalized the advanced approaches rules
that are required for some of the largest and most internationally
active banking organizations (core banks), which account for about half
of U.S. banking assets.[Footnote 3] Some other banks may choose to
comply with the advanced approaches rule as well. These rules lay out a
phased implementation schedule, which generally requires core banks to
have Basel II implementation plans approved by their boards of
directors by October 1, 2008. In addition, in July 2008, U.S. banking
regulators published for comment a proposed rule on the standardized
approach, a simpler version of the new regulatory capital framework
that could be adopted by banks that were not required to adopt the
advanced approaches (non-core banks).
Though the goal of Basel II was to improve the safety and soundness of
the banking system through better risk management and create a level
playing field for internationally active banks, the development of
Basel II has generated concerns among banks, banking regulators, and
other interested parties that potentially different capital
requirements and implementation costs for various categories of U.S.
and foreign banks could have competitive effects.[Footnote 4] These
concerns arose, in part, because U.S. banks that all have been
operating under the same risk-based capital rules--known as Basel I--
may be operating under different capital rules in the future--Basel II
advanced approaches, Basel II standardized approach, or Basel I. In
addition, because the New Basel Accord identified certain areas for
national discretion, the capital regimes being adopted in various
countries differ from that being implemented in the United States.
The risk-management systems for financial institutions and the
information systems on which they rest have been called into question
by the failure of some of these systems during the market turbulence
that began with subprime mortgages in 2007. While this turmoil is not
the focus of this report, it is an important factor that is leading
banking organizations and their regulators to reassess capital
requirements and other aspects of bank regulation and
supervision.[Footnote 5] These assessments could lead to changes in the
Basel II rules or could influence the implementation of those rules in
the United States. In addition, as a result of concerns about the
ability of U.S. financial institutions to compete with institutions
based in foreign countries, the U.S. Department of the Treasury has
proposed a restructuring of the complex U.S. regulatory
system.[Footnote 6] Various congressional committees have held hearings
that addressed this issue and in the past, we have recommended that the
U.S. regulatory system be restructured.[Footnote 7]
In light of concerns about possible competitive effects, you requested
that we review the competitive implications of Basel II for non-core
U.S. banks in comparison to core banks adopting the advanced approaches
and how differences in the implementation of Basel II in foreign
countries might affect the competitiveness of internationally active
banks operating in the United States. Specifically, this report
examines (1) the nature of the competitive environment in which U.S.
banking organizations operate, (2) the extent to which the new capital
rules address competitive concerns of U.S. banking organizations
internationally and domestically, and (3) actions regulators are taking
to address competitive and other potential negative effects of the new
capital rules during implementation.
To meet our objectives, we reviewed the New Basel Accord, the U.S.
proposed rules on the advanced approaches and standardized approach,
the U.S. final advanced approaches rule, supervisory guidance, and
related materials. In addition, we reviewed research related to the
impact of Basel II in the United States and the European Union. We
interviewed officials at the federal bank regulatory agencies
responsible for implementing Basel II, including examination and policy
staff. We also interviewed officials from all of the core banks and
other domestic and foreign banks with operations in the United States.
In addition, we interviewed officials from several foreign bank
regulatory agencies; domestic and foreign trade associations; credit
rating agencies; and several academics and consultants with banking
expertise. To describe the competitive environment in which U.S.
banking organizations operate, we analyzed various data sources on the
products and services that U.S. and foreign banking organizations offer
domestically and internationally. To assess the competitive impact of
the different capital rules on U.S. banks, we computed capital
requirements for certain products under the varying rules and reviewed
academic and other studies of the impact of regulatory capital on bank
behavior.
We conducted this performance audit from May 2007 to September 2008 in
accordance with generally accepted government auditing standards. Those
standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe that
the evidence obtained provides a reasonable basis for our findings and
conclusions based on our audit objectives. Appendix I discusses our
scope and methodology in further detail.
Results in Brief:
Core banks--large and internationally active U.S. banks that will be
required to adopt the advanced approaches for Basel II--compete with
other core banks and in some markets with non-core U.S.-based banks,
other financial institutions, and foreign-based banks. Core banks that
will adopt the advanced approaches have varying business models such
that some focus on domestic retail banking activities such as
residential mortgages, some focus on wholesale activities such as
lending to large corporate clients domestically and abroad, and others
are engaged in the full range of these activities. In retail markets
such as those for residential mortgages, core banks often compete with
smaller non-core banks that are not likely to adopt the advanced
approaches. In wholesale markets, core banks often compete with
investment firms. Core banks compete globally with investment firms and
also with foreign-based banks. In addition, banks that are subsidiaries
or branches of foreign-based banks are active in U.S. markets at both
the retail and wholesale levels. While Basel II likely will apply to
foreign-based banks in their home countries, the specifics of the rules
and their implementation in other countries will differ from those in
the United States, in part, because the New Basel Accord identified a
number of areas for national discretion. Because holding capital is
costly for banks, differences in regulatory capital requirements could
influence costs, prices, and profitability for banks competing under
different capital requirements.
U.S. regulators addressed some of the banking industry's competitive
concerns with the advanced approaches rule for core banks and the
proposal of an optional standardized approach rule for other banks.
However, some of the industry's competitive concerns about the U.S.
capital framework remain. In developing the rules, regulators analyzed
some competitive issues raised by banks. By adopting a final advanced
approaches rule that is closer to the New Basel Accord, U.S. regulators
reduced the differences between the U.S. rule as originally proposed
and the New Basel Accord that had the potential to lead to greater
implementation costs. For example, in the final advanced approaches
rule banks will use a single wholesale definition of default for both
their U.S. and foreign operations, thus reducing the cost of operating
in multiple countries. Nonetheless, core banks are concerned about
continuing to be subject to the leverage requirement, which they
believe could place them at a competitive disadvantage relative to
certain foreign-based banks and investment firms, which do not have a
similar requirement. In efforts to mitigate other differences, U.S.
regulators have been working with foreign regulators, bilaterally and
as members of international bodies, to coordinate Basel II
implementation for U.S.-based internationally active banks. The
proposed standardized approach rule issued by U.S. regulators in July
2008 addresses some concerns raised by non-core banks--those banks not
required to adopt the advanced approaches. These banks were concerned
that core banks would have a competitive advantage because they would
be able to hold less capital for some assets. The proposed standardized
approach would allow for additional risk-sensitivity-over Basel I with
respect to the capital treatment for certain assets, including
residential mortgages. Among other factors, the leverage requirement
may reduce differences in capital among banks competing in the United
States because it establishes a floor that may exceed capital required
under the advanced or standardized approaches for certain low-risk
assets.
Since we last reported on Basel II in February 2007, the regulators
have made significant progress by jointly issuing the advanced
approaches rule and a proposed rule for an optional standardized
approach. However, while the gradual implementation is allowing
regulators to consider changes in the rules and reassess banks' risk
management systems, regulators have not taken action to address some
areas of uncertainty that could have competitive implications or other
negative effects. For example, the regulatory flexibility that the
advanced approaches rule provides will help regulators deal with the
rule's unforeseen consequences, but leaves uncertainties such as which
banks will ultimately be exempted from using the advanced approaches.
While the regulators have stated that they may exempt some core banks
from using the advanced approaches, they have only provided broad
categories such as asset size and portfolio mix rather than specific
criteria for making these decisions. And, in the proposed standardized
approach rule, regulators have asked for comments on the question of
whether large and internationally active core banks should be able to
use the proposed standardized approach. These uncertainties may
continue to reflect the difficulties that resulted from the differing
perspectives the regulators brought to negotiations during the
development of Basel II. In addition, some industry participants we
spoke with said that uncertainty about the implementation of the
advanced approaches rule has been a problem for them. Finally,
regulators have undertaken some planning for a study of the impact of
the advanced approaches, but plans are not fully developed. The
advanced approaches rule called for a study of the rule's impact to
determine whether major changes in the rule needed to be made before
banks would be permitted to fully implement the new rule. However, the
regulators have not developed criteria by which to assess Basel II,
have not specified whether the scope of the study will go beyond core
banks to consider, for example, investment firms, or developed a
methodology to analyze opportunities for regulatory arbitrage. Lack of
development or specificity in criteria, scope, methodologies, and
timing will affect the quality and extent of information that
regulators will use to help assess competitive and other impacts,
determine whether there are any material deficiencies that require
changes in the rules, and determine whether core banks should fully
implement Basel II.
To further limit any potential negative effects and to reduce the
uncertainty about Basel II implementation, we are making two
recommendations to the heads of the Federal Deposit Insurance
Corporation (FDIC), Board of Governors of the Federal Reserve System
(Federal Reserve), Office of the Comptroller of the Currency (OCC), and
Office of Thrift Supervision (OTS). Specifically, where possible, these
regulators should reduce the uncertainty built into the Basel II rules
by better clarifying the use of certain regulatory flexibilities,
particularly with regard to how they will exercise exemptions from the
advanced approaches requirements and the extent to which core banks
will be allowed to adopt the standardized approach. In addition, to
improve understanding of potential competitive effects, we recommend
that the regulators fully develop plans, on a joint basis, for the
required study of the impacts of Basel II.
We requested comment on a draft of this report from the heads of the
Federal Reserve, FDIC, OCC, OTS, Securities and Exchange Commission
(SEC), and Department of the Treasury. We received written comments
from the Federal Reserve, FDIC, OCC, and OTS, who provided a joint
letter, which is reprinted in appendix IV. In their joint letter, the
banking regulators said that they were in general agreement with our
recommendations. Specifically, the regulators said that they will work
together to resolve, at the earliest possible time, the question posed
for comment in the proposed standardized approach rule regarding
whether and to what extent core banks should be able to use the
standardized approach. With regard to clarifying certain regulatory
flexibilities, the regulators said they will continue to make decisions
concerning the exemption of core banks from the advanced approaches
based on the specifics of a bank's request; they have already commenced
discussions to ensure a clear and consistent interpretation of these
provisions is conveyed to U.S. banks. In addition, regarding the need
to jointly plan the required study, the regulators said that they will
begin to prepare more formal plans for the study once they have a
firmer picture of banks implementation plans. The banking regulators
also provided technical comments, which we incorporated in the report
where appropriate. We did not receive comments from SEC or the
Department of the Treasury.
Background:
Basel II rests on the New Basel Accord, which established a more risk-
sensitive regulatory framework that was intended to be sufficiently
consistent internationally but that also took into account individual
countries' existing regulatory and accounting systems. The U.S. bank
regulators have been adapting the New Basel Accord for use by U.S.
banks.
The New Basel Accord:
The New Basel Accord sets forth minimum requirements, which regulators
may complement with additional capital requirements, such as a leverage
ratio. The New Basel Accord also identifies a number of areas for
national discretion, thus requiring regulators from different countries
to work together to understand how each country is implementing the New
Basel Accord and to ensure broad consistency in the application of the
regulatory framework across jurisdictions. The New Basel Accord
consists of three pillars: (1) minimum capital requirements, (2)
supervisory review of an institution's internal assessment process and
capital adequacy, and (3) effective use of disclosure to strengthen
market discipline as a complement to supervisory efforts.[Footnote 8]
As shown in figure 1, Pillar 1 establishes several approaches (of
increasing complexity) to measuring credit and operational
risks.[Footnote 9] The advanced approach for credit risk (also known as
the advanced internal ratings-based approach) uses risk parameters
determined by a bank's internal systems as inputs into a formula
developed by supervisors for calculating minimum regulatory capital. In
addition, banks with significant trading assets--assets banks use to
hedge risks or to speculate on price changes in markets for themselves
or their customers--must calculate capital requirements for market risk
under Pillar 1.[Footnote 10] Pillar 2 explicitly recognizes the role of
supervisory review, which includes assessments of capital adequacy
relative to a bank's overall risk profile and early supervisory
intervention that are already part of U.S. regulatory practices. Pillar
3 establishes disclosure requirements that aim to inform market
participants about banks' capital adequacy in a consistent framework
that enhances comparability. See appendix II for more information on
the three pillars of the advanced approaches.
Figure 1: The Three Pillars of Basel II:
This figure is a chart showing the three pillars of Base II: millennium
capital requirements, supervisory review, and market discipline (via
disclosure).
[See PDF for image]
Source: GAO.
[End of figure]
After extensive discussions and consultation that included issuing an
advanced notice of proposed rulemaking in 2003 and a Notice of Proposed
Rulemaking (NPR) in 2006, the U.S. banking regulators issued a final
rule on the advanced approaches that became effective on April 1,
2008.[Footnote 11] Under the rule, only certain banks--core banks--will
be required to adopt the advanced approaches for credit and operational
risk. Core banks are those with consolidated total assets (excluding
assets held by an insurance underwriting subsidiary of a bank holding
company) of $250 billion or more or with consolidated total on-balance
sheet foreign exposure of $10 billion or more. Publicly available
information shows that, as of July 2008, 12 banks met the rule's basic
criteria for being a core bank. A depository institution also is a core
bank if it is a subsidiary of another bank that uses the advanced
approaches. Under the rule, a core bank's primary federal regulator may
determine that application of the advanced approaches is not
appropriate in light of a core bank's asset size, level of complexity,
risk profile, or scope of operations. In addition, banks that are not
required to adopt the advanced approaches, but meet certain
qualifications, may voluntarily choose to comply with the advanced
approaches. Generally, core banks had or will have from April 2008
until April 2010 to begin the four phases that lead to the full
implementation of Basel II.[Footnote 12] As a result, core banks could
be ready for full implementation between April 2012 and April 2014. By
January 1, 2008, banks in the European Union, Canada, and Japan had
moved off of Basel I and begun implementing some version of the New
Basel Accord's advanced approaches or standardized approach for all of
their banks. Banks located in the European Union, Canada, and Japan
expect to have fully implemented Basel II sometime in 2010.
Non-core banks--those that do not meet the definition of a core bank--
will have the option of adopting the advanced approaches, a
standardized approach when finalized, or remaining on Basel I. The
proposed standardized approach rule, published in July 2008, provides
for a more risk-sensitive approach than Basel I by classifying banks'
assets into more risk categories and assessing different capital
requirements according to the riskiness of the category.[Footnote 13]
While Basel I has 5 risk categories, the proposed standardized approach
rule includes 16 categories. In contrast to the advanced approaches,
the standardized approach relies more on external risk assessments--
conducted by rating agencies--than on a bank's own assessments of a
certain product's or borrower's risk. The proposed U.S. standardized
approach generally is consistent with the standardized approach
outlined in the New Basel Accord, but diverges from the New Basel
Accord to incorporate more risk sensitive treatment, most notably in
the approaches for residential mortgages and equities held by banks.
Additional U.S. Capital Requirements:
The U.S. regulatory capital framework also includes minimum leverage
capital requirements. Banks, thrifts, and bank holding companies are
subject to minimum leverage standards, measured as a ratio of Tier 1
capital to total assets. The minimum leverage requirement is either 3
or 4 percent, depending on the type of institution and a regulatory
assessment of the strength of its management and controls.[Footnote 14]
Leverage ratios are a commonly used financial measure of risk. Greater
financial leverage, as measured by lower proportions of capital
relative to assets, increases the riskiness of a firm, all other things
being equal. If the leverage capital requirement is greater than the
risk-based level required then the leverage requirement would be the
binding overall minimum requirement on an institution. Depository
institutions also are subject to the Federal Deposit Insurance
Corporation Improvement Act of 1991, which created a new supervisory
framework known as prompt corrective action (PCA) that links
supervisory actions closely to these banks' capital ratios. PCA, which
applies only to depository institutions and not bank holding companies,
requires regulators to take increasingly stringent forms of corrective
action against banks as their leverage and risk-based capital ratios
decline.[Footnote 15] Under this rule, regulators also can require
banks to hold more than minimum levels of capital to engage in certain
activities. In addition, under the Bank Holding Company Act, the
Federal Reserve can require that bank holding companies hold additional
capital to engage in certain activities.
U.S. Regulators Responsible for Implementing Basel II:
In the United States, the four federal bank regulators oversee the
implementation of Basel II for banks and SEC oversees the
implementation of Basel capital rules for investment firms. The
financial institutions that will be involved in the implementation of
Basel II are organized as bank holding companies, thrift holding
companies, or consolidated supervised entities (CSE). At a consolidated
level the Federal Reserve supervises bank holding companies that are
subject to Basel capital requirements, OTS supervises thrift holding
companies that are not subject to Basel capital requirements, and SEC
supervises CSEs that voluntarily choose to be subject to consolidated
oversight including Basel capital reporting requirements.[Footnote 16]
Each of these types of holding companies has subsidiaries that are
depository institutions that could be required to adopt Basel II. Each
of these banking institutions is regulated by a primary federal
regulator according to the rules under which it is chartered.
* FDIC serves as the primary federal regulator of state chartered banks
that are not members of the Federal Reserve System (state nonmember
banks). It is also the deposit insurer for all banks and thrifts and
has backup supervisory authority for all banks it insures.
* The Federal Reserve serves as the primary federal regulator for state
chartered banks that are members of the Federal Reserve System (state
member banks).
* OCC serves as the primary federal regulator for national (i.e.,
federally chartered) banks. Many of the nation's largest banks are
federally chartered.
* OTS serves as the primary federal regulator for all federally insured
thrifts.
Under the dual federal and state banking system, state chartered banks
are supervised by state regulatory agencies in addition to a primary
federal regulator.
In 2004, SEC established a voluntary, alternative net capital rule for
broker-dealers whose ultimate holding company consents to groupwide
supervision by SEC as a CSE. This alternative net capital rule permits
the use of statistical models for regulatory capital purposes. At the
holding company level, CSEs are required to compute and report to SEC
capital adequacy measures consistent with the standards in the Basel
Accord, and SEC expects them to maintain certain capital ratios, though
they are not required to do so. According to SEC, all CSEs have
implemented Basel II. Primary U.S. broker-dealers affiliated with CSEs
are required to comply with a capital requirement that SEC says is not
identical to the Basel standards but makes use of statistical models in
its computation. Depository institutions within the CSEs are subject to
the same requirements as other banks of similar sizes and exposures
including risk-based capital requirements, the leverage ratio, and PCA;
however, there is no leverage requirement at the consolidated level for
CSEs.
Core Banks Compete among Themselves and with Other Financial Entities
That Will Operate under Different Capital Regimes:
Core banks face a range of competitors including non-core U.S. banks,
other financial institutions, and foreign-based banks. Core banks that
have varying business models--some focus on domestic retail banking
activities, some on wholesale activities, and others are engaged in the
full range of these activities--are overseen by a number of different
bank regulators. Banks of different sizes that are likely to be under
different capital regimes are more likely to compete with each other in
retail markets, where they offer products such as residential mortgages
to the same customers, than in wholesale markets. In certain wholesale
markets, core banks often compete with U.S. investment firms. U.S.-
based core banks also compete with foreign-based banks in foreign
markets and in U.S. markets where foreign-based banks are very active.
Since core banks compete with other financial institutions across
various product and geographic markets, differences in capital rules or
the implementation of those rules may have competitive effects by
influencing such things as the amount of capital institutions hold, how
banks price loans, and the cost of implementing capital regulations.
Core Banks Compete with Other Core and Non-core Banks:
Core banking organizations--those that meet the requirements in terms
of asset size and foreign exposure for mandatory adoption of the Basel
II advanced approaches--have adopted a variety of business models, but
all compete with some other core banks. Some of the core banks are
active in retail markets, some in wholesale markets, and some in the
full range of banking activities. As illustrated in table 1, which is
based on publicly available information, five core banking
organizations--including one that is foreign-based--have at least 25
percent of their assets in retail markets and one of these, the only
thrift that is a core banking organization (Washington Mutual Bank),
has more than 60 percent of its assets in retail markets, while a few
institutions have almost no activity in these markets. In addition, two
core banks that appear less active in retail markets--with about 15
percent of their assets in these markets--may still have a major
presence there because of their overall size. In wholesale markets,
table 1 shows that some banks are active in making commercial and
industrial loans while others hold a larger percentage of their assets
as trading assets--assets held to hedge risks or speculate on price
changes for the bank or its customers. However, the thrift institution
has very little activity in these markets. The three smaller U.S.-based
core banks, which are classified as core banks because they have large
foreign exposures, engage primarily in custodial activities where they
manage the funds of their clients. In this area they compete with the
largest U.S. banks that are also engaged in these activities.
Table 1: Percentage of Selected Assets of Core Banks in Certain Retail
and Wholesale Markets, December 31, 2007:
(Dollars in millions):
Institution: Top level parent based in the United States: Citigroup
Inc;
Total assets: Top level parent based in the United States: $2,187,631;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 11.1%;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 4.0%;
Trading assets: Top level parent based in the United States: 24.6%;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 9.4%;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 1.0%;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 8.8%.
Institution: Top level parent based in the United States: Bank of
America Corp;
Total assets: Top level parent based in the United States: 1,720,688;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 23.0;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 4.7;
Trading assets: Top level parent based in the United States: 11.7;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 10.3;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 6.0;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 13.9.
Institution: Top level parent based in the United States: JPMorgan
Chase & Co;
Total assets: Top level parent based in the United States: 1,562,147;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 11.0;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 4.9;
Trading assets: Top level parent based in the United States: 29.3;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 9.0;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 1.6;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 5.2.
Institution: Top level parent based in the United States: Wachovia
Corp;
Total assets: Top level parent based in the United States: 782,896;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 30.0;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 0.3;
Trading assets: Top level parent based in the United States: 7.1;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 10.5;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 9.9;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 14.6.
Institution: Top level parent based in the United States: Wells Fargo &
Co;
Total assets: Top level parent based in the United States: 575,442;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 30.1;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 3.4;
Trading assets: Top level parent based in the United States: 1.3;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 13.8;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 9.7;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 12.7.
Institution: Top level parent based in the United States: Washington
Mutual Bank[A];
Total assets: Top level parent based in the United States: 325,809;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 59.5;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 3.0;
Trading assets: Top level parent based in the United States: 0.8;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 1.0;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 13.5;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 10.6.
Institution: Top level parent based in the United States: Bank of New
York Mellon Corp;
Total assets: Top level parent based in the United States: 197,839;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 2.3;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 0;
Trading assets: Top level parent based in the United States: 3.3;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 3.4;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 1.3;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 24.5.
Institution: Top level parent based in the United States: State Street
Corp;
Total assets: Top level parent based in the United States: 142,937;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 0;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 0;
Trading assets: Top level parent based in the United States: 3.5;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 0.1;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 0;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 52.2.
Institution: Top level parent based in the United States: Northern
Trust Corp;
Total assets: Top level parent based in the United States: 67,611;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 13.6;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 0.0;
Trading assets: Top level parent based in the United States: 1.3;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 9.6;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 3.4;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 12.6.
Institution: Top level parent based in a foreign country: Taunus Corp.
(Germany);
Total assets: Top level parent based in the United States: 668,199;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 3.2;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 0.4;
Trading assets: Top level parent based in the United States: 30.1;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 1.4;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 1.2;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 0.5.
Institution: Top level parent based in a foreign country: HSBC North
America Holding Inc. (United Kingdom);
Total assets: Top level parent based in the United States: 487,755;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 24.6;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 10.5;
Trading assets: Top level parent based in the United States: 11.7;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 8.2;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 1.7;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 6.5.
Institution: Top level parent based in a foreign country: Barclays
Group US (United Kingdom);
Total assets: Top level parent based in the United States: 343,736;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 3.9;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 1.9;
Trading assets: Top level parent based in the United States: 15.1;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 0;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 3.3;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 0.2.
Source: GAO analysis of publicly available Federal Reserve and OTS
data.
[A] Data are for the federal savings bank rather than the consolidated
entity. The federal savings bank comprises 99.4 percent of the
consolidated entity's total assets.
[B] Securities available for sale or held to maturity include mortgage-
backed securities, asset-backed securities, and others.
[End of table]
Core banks are in some ways similar to non-core banks. For example,
banks of all sizes continue to participate in some activities
historically associated with banking-, such as taking deposits and
making loans. As table 2 shows, bank holding companies of different
sizes hold similar proportions of certain loans such as residential
mortgages and commercial and industrial loans.
Table 2: Percentage of Total Assets in Selected Classes, by Bank
Holding Company Size, December 31, 2007:
(Dollars in millions):
Size category by assets: Core bank holding companies;
Number of bank holding companies: 11;
Total assets: $8,736,881;
Certain retail products as percent of assets: Mortgages: 15.9%;
Certain retail products as percent of assets: Credit cards: 3.7%;
Certain wholesale products as percent of assets: 18.1%;
Certain wholesale products as percent of assets: Commercial &
industrial loans: 8.6%;
Certain wholesale products as percent of assets: Commercial real
estate: 3.6%;
Certain wholesale products as percent of assets: Securities held for
sale or until maturity[A]: 9.9%.
Size category by assets: Non-core bank holding companies;
Total assets: [Empty];
Certain retail products as percent of assets: Mortgages: [Empty];
Certain retail products as percent of assets: Credit cards: [Empty];
Certain wholesale products as percent of assets: [Empty];
Certain wholesale products as percent of assets: Commercial &
industrial loans: [Empty];
Certain wholesale products as percent of assets: Commercial real
estate: [Empty];
Certain wholesale products as percent of assets: Securities held for
sale or until maturity[A]: [Empty].
Size category by assets: Consolidated assets between $100 billion and
$250 billion;
Number of bank holding companies: 9;
Total assets: 1,402,048;
Certain retail products as percent of assets: Mortgages: 23.1;
Certain retail products as percent of assets: Credit cards: 2.4;
Certain wholesale products as percent of assets: 1.5;
Certain wholesale products as percent of assets: Commercial &
industrial loans: 14.1;
Certain wholesale products as percent of assets: Commercial real
estate: 15.4;
Certain wholesale products as percent of assets: Securities held for
sale or until maturity[A]: 13.8.
Size category by assets: Consolidated assets between $10 billion and
$100 billion;
Number of bank holding companies: 48;
Total assets: 1,431,394;
Certain retail products as percent of assets: Mortgages: 15.6;
Certain retail products as percent of assets: Credit cards: 0.5;
Certain wholesale products as percent of assets: 0.9;
Certain wholesale products as percent of assets: Commercial &
industrial loans: 15.0;
Certain wholesale products as percent of assets: Commercial real
estate: 25.3;
Certain wholesale products as percent of assets: Securities held for
sale or until maturity[A]: 18.3.
Size category by assets: Consolidated assets between $3 billion and $10
billion;
Number of bank holding companies: 100;
Total assets: 558,077;
Certain retail products as percent of assets: Mortgages: 16.7;
Certain retail products as percent of assets: Credit cards: 0.2;
Certain wholesale products as percent of assets: 0.4;
Certain wholesale products as percent of assets: Commercial &
industrial loans: 11.9;
Certain wholesale products as percent of assets: Commercial real
estate: 29.9;
Certain wholesale products as percent of assets: Securities held for
sale or until maturity[A]: 21.2.
Size category by assets: Consolidated assets between $1 billion and $3
billion;
Number of bank holding companies: 283;
Total assets: 468,831;
Certain retail products as percent of assets: Mortgages: 15.5;
Certain retail products as percent of assets: Credit cards: 0.3;
Certain wholesale products as percent of assets: 0.2;
Certain wholesale products as percent of assets: Commercial &
industrial loans: 10.5;
Certain wholesale products as percent of assets: Commercial real
estate: 39.6;
Certain wholesale products as percent of assets: Securities held for
sale or until maturity[A]: 17.4.
Size category by assets: Consolidated assets between $500 million and
$1 billion;
Number of bank holding companies: 465;
Total assets: 325,611;
Certain retail products as percent of assets: Mortgages: 17.2;
Certain retail products as percent of assets: Credit cards: 0.2;
Certain wholesale products as percent of assets: 0.1;
Certain wholesale products as percent of assets: Commercial &
industrial loans: 10.4;
Certain wholesale products as percent of assets: Commercial real
estate: 39.0;
Certain wholesale products as percent of assets: Securities held for
sale or until maturity[A]: 17.3.
Size category by assets: Consolidated assets less than $500 million;
Number of bank holding companies: 4,148;
Total assets: 649,948;
Certain retail products as percent of assets: Mortgages: 17.4;
Certain retail products as percent of assets: Credit cards: 0.1;
Certain wholesale products as percent of assets: 0.1;
Certain wholesale products as percent of assets: Commercial &
industrial loans: 2.9;
Certain wholesale products as percent of assets: Commercial real
estate: 32.4;
Certain wholesale products as percent of assets: Securities held for
sale or until maturity[A]: 19.6.
Source: GAO analysis of publicly available Federal Reserve data.
Note: Metropolitan Life Insurance Company is excluded from the table
because, while it is large enough to be a core bank, it is involved
primarily in insurance activities. For 4,103 of the smaller bank
holding companies, consolidated data is not reported to the Federal
Reserve. For those bank holding companies we grouped the banks in the
holding company and reported that data instead. Bank holding companies
that do not have to report asset distributions at the holding company
level generally do not engage in activities outside of their banks.
This table also does not include thrifts or thrift holding companies
that are active in banking markets especially in retail areas.
[A] Securities available for sale or held to maturity include mortgage-
backed securities, asset-backed securities, and others.
[End of table]
According to research conducted by Federal Reserve staff and other
experts, banks of different sizes compete with each other for retail
products such as residential mortgages.[Footnote 17] As illustrated in
table 2, bank holding companies in all size ranges hold a relatively
large percentage of their assets--from 15.5 to 23.1 percent--in
residential mortgages. Customers can obtain mortgages from banks across
the United States and generally can obtain pricing information from
brokers or directly through the Internet or financial publications. For
small thrifts, which make up a portion of the small non-core banking
institutions in the United States but are not included in table 2, the
proportion of mortgages is much higher.[Footnote 18] Unlike residential
mortgages, only a few banks, including several core banks, are active
in the credit card market, but some non-core banks are active in this
market as well; and all credit card issuers generally compete for the
same customers.[Footnote 19]
For wholesale products, the competitive landscape is more complex. As
table 2 illustrates, in some areas core banks differ substantially from
non-core banks and are thus not likely to compete with them in those
markets. For example, non-core banks hold a very small percentage of
their assets as trading assets, an area where some core banks are very
active, and core banks hold a relatively small proportion of their
assets in commercial real estate, an area where non-core banks are very
active. While table 2 shows that core and non-core banks are both
active in the commercial and industrial loan markets, the market for
loans from large banks may be quite different from those for smaller
banks. According to a bank official and other experts, larger banks do
not price commercial and industrial loans individually; instead, these
loans generally are part of a package of products and services offered
to major corporate clients. Financial market experts told us that often
these loans are discounted to establish a relationship with the
customer. Because smaller banks do not offer a full range of products
and services, they likely are not competing for the same customers as
larger banks. In addition, we and others have shown that smaller banks
tend to serve the needs of smaller businesses with which they can
establish a personal relationship.[Footnote 20] Because obtaining
credit information on small businesses is difficult, community banks
often have an advantage with these customers in that they may have
better information about small businesses in their local market than do
large national or internationally active banks. As a result, the
largest banks are unlikely to be competing with community banks in
these markets. At the same time, research conducted by Federal Reserve
staff has shown that large non-core banks may compete with core banks
for corporate customers.[Footnote 21]
In Some Markets, Core Banks Compete with Other U.S. Financial
Institutions:
Core banks are much more likely than smaller or regional non-core banks
to participate in activities often associated with investment banking.
For example, core banks are much more likely to hold trading assets
that typically are used to hedge risks or speculate on certain market
changes either for the banking organization or its customers (see table
2).
In addition, core banks are involved in international activities where
they often provide investment banking products and services in the
major capital markets around the world. In the United States and
abroad, U.S.-based core banks, especially Citigroup and JPMorgan Chase,
compete with the four major U.S. investment firms---Goldman Sachs,
Merrill Lynch, Morgan Stanley, and Lehman Brothers. The core banks also
are involved in custodial and asset management activities domestically
and internationally. In this capacity, core U.S.-based banks compete
with foreign-based banks, with investment firms, and with asset
management firms that do not own depository institutions and are not
subject to regulatory capital requirements.
U.S.-Based Banks Compete with Foreign-Based Banks in Foreign and U.S.
Markets:
Basel capital requirements were established, in large part, to limit
competitive advantages or disadvantages due to differences in capital
requirements across countries; however, the New Basel Accord allows for
certain areas of national discretion and this could create competitive
advantages or disadvantages for banks competing in various countries.
In addition, because a major part of Basel II involves direct
supervision of the risk management processes of individual banks,
further opportunities exist for differences across countries to develop
as the new rules are implemented.
While all but one of the core banks has some foreign exposure, some of
the nine U.S.-based core banks have foreign exposures that are large
relative to the size of the institution (see fig. 2). As noted above,
most of these banks are engaged in asset management and investment
banking activities globally. In addition, one of the banks is heavily
engaged in retail banking activities in a wide range of countries where
each country likely comprises a separate market. To the extent that
U.S.-based banking institutions that have subsidiaries in foreign
countries face more stringent capital requirements for the parent
institution at home, U.S.-based banks could be disadvantaged in foreign
markets.
Figure 2: Foreign Exposures of U.S.-based Core Banks, as of December
31, 2007:
This figure is a map with a chart showing foreign exposures of U.S.-
based core banks, as of December 31, 2007.
Citigroup: $971.4;
JP Morgan Chase & Co.: $486.4;
Bank of America Corp.: $125.2;
Wachovia Corp.: $72.3;
Bank of New York Mellon Corp.: $61.7;
Northern Trust Corp.: $27.5;
State Street Corp.: $19.8;
Wells Fargo & Co.: $9.4;
Washington Mutual Bank: $0.0.
Country (number of U.S.-based core banks operating subsidiaries):
United Kingdom: 7;
Ireland: 7;
Luxembourg: 6;
Germany: 5;
Netherlands: 5;
France: 3;
Italy: 3;
Belgium: 2.
[See PDF for image]
Source: GAO analysis of SEC Form 10-ka and information from Mergent
Online; Map Resources (map).
[End of figure]
Much of the competition between U.S.-and foreign-based banks takes
place in the United States, where foreign based-banks are very active
through their subsidiaries, branches, and offices. Foreign-based banks
account for about $2.8 trillion of the approximately $15 trillion of
U.S. banking assets and subsidiaries of those banks account for 11 of
the 50 largest U.S. bank holding companies. Further, as noted in table
1, three of the core banks in the United States are subsidiaries of
foreign-based banks. Two of these operate primarily in wholesale
markets, while the third, HSBC, is active in both retail and wholesale
banking markets in the United States. In addition, some large U.S. non-
core banks that are subsidiaries of foreign-based banks are likely to
adopt the advanced approaches in the United States.
The extent to which differences in capital requirements will affect
competition in the United States between U.S.-based and foreign-based
banks will depend, in part, on how the U.S. activities of the foreign-
based banks are organized. For capital purposes, although foreign-based
banks with U.S. subsidiaries will likely follow the Basel II rules in
their home countries, the U.S. subsidiaries are regulated as U.S. banks
within the United States and will follow U.S. rules. However, branches
of foreign banks are not required to meet the U.S. rules. As a result,
some foreign-based banks that have substantial U.S. operations, but
conduct their banking activities in the United States through branches,
will be following the Basel II rules in their home country rather than
in the United States.
Differences in Capital Requirements Have the Potential to Create
Competitive Disparities:
Because holding capital is costly for banks, differences in regulatory
capital requirements could influence costs, prices, and profitability
for banks competing under different capital frameworks. If regulatory
capital requirements increase the amount of capital banks hold relative
to what they would hold in the absence of regulation, then the
requirements would increase banks' costs and reduce their
profitability.[Footnote 22] Depending on the structure of markets,
these higher costs could be passed on to bank customers in the form of
higher prices--interest rates on loans or fees for services--or
absorbed as reduced lending and profits. For example, higher capital
costs driven by higher capital requirements could result in a
competitive disadvantage for banks that compete for similar customers
with banks subject to different capital rules. Conversely, lower
capital requirements that allow banks to reduce the capital they hold
for a particular asset could allow them to price those assets more
aggressively, thereby increasing market share or earning higher returns
at existing prices.
Bank officials with whom we spoke and some empirical evidence we
reviewed suggested that regulatory capital requirements are one of
several key factors banks consider in deciding how much capital to
hold. Other factors include management views on the amount of capital
the firm needs internally and market expectations.[Footnote 23] These
multiple and overlapping motivations for holding capital make it
difficult to isolate the impact of regulatory capital on the amount of
capital banks hold.[Footnote 24] Nevertheless, there is some evidence
that banks hold more than the minimum required capital--a buffer--in
part to reduce the risk of breaching that minimum requirement. For
example, one study of United Kingdom banks found that an increase in
required capital was followed by an increase in actual capital,
although the increase was only about half the size of the increase in
required capital.[Footnote 25] Thus, changes in minimum required
capital could cause banks to change the amount of capital they hold to
maintain a similar buffer of capital, consistent with the other goals
of the bank. The study also found that banks with small buffers reacted
more to a given change in individual capital requirements--and banks
with larger buffers reacted little, if at all--supporting the view that
the capital buffer is a form of insurance against falling below
regulatory minimums.
Differences in the implementation costs of capital requirements also
could have competitive effects. In principle, higher implementation
costs could lead to a one-time increase in costs or ongoing costs
associated with compliance. One-time costs would influence
profitability directly, while ongoing costs also could influence the
cost of lending for banks in the same way that higher capital costs
could influence pricing and profitability. Significant implementation
costs are likely to be easier to bear the larger the institution--the
costs of implementing regulation are on average higher (as measured by
cost per employee) for smaller firms.[Footnote 26]
The possible effects of differences in regulatory capital requirements
on implementation and capital costs also could influence incentives for
consolidation by making acquisitions more or less advantageous for
banks operating under different capital rules. Such advantages would
imply that those banks under a given capital regime might be able to
use the capital resources of banks under a different regime more
effectively, making it profitable for the former banks to acquire the
latter ones. Conversely, if implementation costs for a capital regime
imposed on larger banks were high, this might discourage some banks
from merging because they would become large enough to be required to
adopt a capital regime with high implementation costs.
New U.S. Capital Rules Have Reduced Some Competitive Concerns about
Basel II:
The new U.S. capital rules address some competitive concerns of banks;
however, other concerns remain. Regulators analyzed some competitive
issues raised by banks during the development of the Basel II rules in
the United States. In the final rule for the advanced approaches, the
regulators addressed concerns about differences between the NPR and the
New Basel Accord that could have led to greater implementation costs.
For example, in the final rule they harmonized the definition of
wholesale loan default with the accord, thus responding to banks'
concerns that differences in the definition of wholesale loan default
between the NPR and the accord could have led to increased costs of
operating in multiple countries. However, core banks remain concerned
that the leverage requirement will affect their ability to compete with
both foreign-and some U.S.-based competitors. The coordination between
U.S. and foreign regulators on implementation issues for core banks may
address some competitive concerns of internationally active core banks.
For non-core banks, the proposed standardized approach rule may address
some concerns--for example, that core banks could hold less capital for
similar assets. The proposed rule is more risk sensitive than Basel I,
providing non-core banks with the possibility of lower regulatory
capital minimums for certain assets or activities. Other factors, such
as the leverage requirement, may reduce differences in capital for
banks competing in the United States.
U.S. Regulators Recognized Some Competitive Concerns during the
Development of the Rules:
As a result of the potential for large banks to hold less capital under
Basel II, at least for certain assets, researchers, primarily at the
Federal Reserve, conducted studies of the potential impact of Basel II
on specific markets and on aspects of the rule, including the impact on
residential mortgages, credit cards, operational risk, and mergers and
acquisitions. These studies were limited by the availability of data
and by a lack of information on the impact regulatory capital has on
bank behavior. Nonetheless, the studies identified that there could be
competitive impacts in the residential mortgage market and helped to
lead to the development of alternatives to Basel I for non-core banks.
OCC and OTS provided the Office of Management and Budget (OMB) with
regulatory impact analyses that included examination of the impact of
the rules on domestic competition.[Footnote 27] In addressing
competitive issues in this analysis, OCC relied primarily on the
studies conducted at the Federal Reserve. In its regulatory impact
analysis, OTS incorporated OCC's analysis adding appropriate material
specifically related to the thrift industry. For example, OTS noted
that because thrifts have high concentrations of assets in residential
mortgages, the leverage requirement would be more likely to impose
greater capital requirements on these firms than would the Basel II
requirements and, as a result, would have a negative impact on the
ability of thrifts to compete with other banking organizations. OTS
also pointed out that interest rate risk for those mortgage-related
assets that a bank is planning to hold rather than trade is
particularly important to thrifts. However, the adequacy of capital
held for these risks is being assessed in Pillar 2 rather than in
Pillar 1, where the risks associated with changes in interest rates on
mortgage related assets that are being actively traded are assessed.
Since there is more regulatory flexibility in Pillar 2 than in Pillar
1, OTS expressed concern that thrifts could be disadvantaged if
different regulatory agencies did not implement Pillar 2 consistently.
The regulators did less analysis regarding the international
competitive impact of the new rules. At the time that the capital rules
were being developed, OMB provided little guidance on analyzing the
international impact of U.S. rules and the agencies did not discuss
international competition issues in their analyses. Alternatively,
European Union guidance for regulatory impact analyses includes a more
detailed evaluation of impacts on international trade and investment,
and OMB is considering including more explicit guidance on the analysis
of the impact on international trade and investment in the United
States.[Footnote 28] During the development of Basel II, U.S. banks
raised concerns about being disadvantaged internationally by certain
aspects of the U.S. rules.
U.S. Final Rule on the Advanced Approaches Addresses Some Competitive
Concerns Raised by Banks, but the Leverage Ratio Continues to Be a
Concern:
Although regulators have harmonized some aspects of the advanced
approaches final rule with the New Basel Accord, concerns remain about
remaining differences in the final rule and other issues such as the
leverage requirement that could have competitive effects. The final
rule removed an important technical difference in the definition of
default for wholesale products that existed between the U.S. NPR and
the New Basel Accord. However, other differences were retained, such as
the U.S. implementation schedule and the amount by which regulatory
capital could decrease during a bank's transition to the final rule.
Core banks are specifically concerned that the leverage requirement
will have negative effects on their ability to compete with CSEs and
foreign-based banks.
Final Rule Eliminated Some Technical Differences That Raised Concerns
about Competitive Effects, but Other Differences Remain:
U.S. banking regulators harmonized certain aspects of the U.S. final
rule on the advanced approaches with the New Basel Accord, reducing
some concerns of core banks. For example, one of the major concerns of
U.S. core banks was that the proposed rule included a different
definition of default for wholesale products, which could lead to
increased implementation costs through the need to maintain separate
systems for data in the United States and in those foreign countries
where U.S. core banks were required to adopt Basel II. The definition
of default for wholesale products in the final rule now closely
resembles the New Basel Accord's definitions for these types of
products, thus limiting the potential for higher implementation costs
for core banks. Other technical differences that have been diminished
for core banks include how core banks have to estimate their losses
after a borrower has defaulted on a loan. Table 3 outlines several key
technical differences between the earlier proposed U.S. rules and the
New Basel Accord and highlights where U.S. regulators diminished or
retained differences in the final rule.
Table 3: Significant Technical Differences between the U.S. NPR on
Advanced Approaches and the New Basel Accord, and the Treatment of
These Differences in the U.S. Final Rule on Advanced Approaches:
Significant technical differences: Wholesale definition of default;
U.S. NPR on the Advanced Approaches: Based on whether:
* the bank places any exposure to the borrower on non-accrual status,;
* the bank incurs full or partial charge offs on any exposure to the
borrower, or;
* the bank incurs a credit-related loss of 5 percent or more on the
sale of any exposure to the borrower or transfer of any exposure to the
borrower to the held-for-sale, available-for-sale, trading account, or
other reporting category;
New Basel Accord: Based on whether:
* the bank considers a borrower unlikely to pay in full without
recourse to bank actions, or;
* a borrower's payment on principal or interest is more than 90 days
past due;
* Includes non-accrual status and material credit-related loss on sale
as elements indicating unlikeliness to pay. However, the accord does
not specify the threshold of 5 percent for credit-related losses upon
sale or transfer, and other countries' definitions do not generally
include non-accrual status;
U.S. Final Rule on Advanced Approaches: Based on whether:
* the bank considers that the borrower is unlikely to pay its credit
obligations to the bank in full, without recourse by the bank to
actions such as realizing collateral (if held), or;
* the borrower is past due more than 90 days on any material credit
obligation to the bank;
* Includes nonaccrual and material credit-related loss on sale as
elements indicating unlikeliness to pay.
Significant technical differences: Retail definition of default;
U.S. NPR on the Advanced Approaches: Occurs when an exposure reaches
120 or 180 days past due, depending on exposure type, or when the bank
incurs a full or partial charge off or write-down on principal for
credit- related reasons;
New Basel Accord: Occurs when an exposure reaches a past due threshold
between 90 and 180 days, set by the national supervisor, or when the
bank considers a borrower unlikely to pay in full without recourse to
bank actions;
U.S. Final Rule on Advanced Approaches: * Occurs when an exposure
reaches 120 or 180 days past due, depending on exposure type, or when
the bank incurs a full or partial charge-off or write-down on principal
for credit-related reasons;
* Banks can adopt the definition of default of host countries for
foreign subsidiaries subject to prior approval of their primary federal
supervisor.
Significant technical differences: Small-and medium-sized enterprise
(SME) lending;
U.S. NPR on the Advanced Approaches: Does not include an adjustment
that would result in a lower capital requirement for loans to SMEs
compared to other business loans under the framework;
New Basel Accord: Includes such an adjustment;
U.S. Final Rule on Advanced Approaches: Does not include an adjustment
that would result in a lower capital requirement or loans to SMEs
compared to other business loans.
Significant technical differences: Loss given default (LGD);
U.S. NPR on the Advanced Approaches: * A bank may use its own LGD
estimates upon obtaining supervisory approval, which is based in part
on whether the estimates are reliable and sufficiently reflective of
economic downturn conditions;
* A bank that does not qualify to use its own internal LGD estimates
must instead compute LGD using a supervisory formula that some bank
officials have described as overly conservative;
New Basel Accord: * Requires banks to estimate losses from default that
would occur during economic downturn conditions, which may result in
higher regulatory required capital for some exposures under the
framework;
* Does not identify an explicit supervisory formula for estimating LGD
when a bank's internal LGD estimates do not meet minimum requirements;
* Instead, if a bank is unable to estimate LGD for any material
portfolio, it would not qualify for the A-IRB approach;
U.S. Final Rule on Advanced Approaches: Bank's LGD estimate must be
reliable and sufficiently reflective of economic downturn data and
should have rigorous and well-documented policies and procedures for
(1) identifying economic downturn conditions for each exposure
subcategory, (2) identifying changes in material adverse relationships
between the relevant drivers of default rates and loss rates given
default, and (3) incorporating identified relationships into LGD
estimates.
Source: GAO.
[End of table]
One technical difference that remains between the U.S. final rule on
advanced approaches and the New Basel Accord is the treatment of SME
loans. U.S. regulators believe that an adjustment to lower the capital
charge for such business loans is not substantiated by sufficient
empirical evidence. In other words, this suggests that, all other
things equal, SME loans have risks comparable to those posed by larger
corporate loans. U.S. regulators also noted that the SME treatment in
the Accord might give rise to a domestic competitive inequity between
core banks and banks subject to other regulatory capital rules, such as
Basel I. Officials at one rating agency with whom we spoke said that a
lower capital requirement for SME loans in the New Basel Accord was not
reflective of the risk for these exposures, and the rating agency did
not treat these loans differently from other business loans in their
own assessments of capital adequacy. In addition, several experts with
whom we spoke noted that this difference in capital requirements for
SME loans would likely not have any immediate or major impact on
competition between U.S. and foreign banks.
In addition to the technical differences discussed above, the final
rule addressed one concern related to a prudential safeguard U.S.
regulators introduced in the 2006 NPR, but some core banks remain
concerned about the implementation schedule. The NPR contained a
benchmark--a 10 percent reduction in aggregate minimum capital among
core banks--that would have been viewed as a material reduction in
capital requirements that warranted modification in the rule. Core
banks had commented that this safeguard could affect them negatively
because of the uncertainty surrounding its application. In the final
rule, U.S. regulators eliminated the benchmark. However, retention of
the implementation schedule proposed in the 2006 NPR continues to raise
concerns for some core banks because it will lead to a longer
transition period in the United States than in other countries and
delay any possible capital reductions. European banks and most Canadian
banks on the advanced approaches most likely will exit their
transitional periods by January 2010. In contrast, U.S. core banks
cannot exit their transitional periods before April 2012 and could do
so in 2014 or later. Furthermore, European banks will be able to reduce
capital to 90 percent of Basel I requirements in 2008 and to 80 percent
of Basel I requirements in 2009 while Canadian banks will be able to
apply for approval to reduce their capital by similar amounts under the
same timeframes. Under the final rule, U.S. core banks will have three
distinct transitional periods during which required risk-based capital
may be reduced to only 95 percent, 90 percent, and 85 percent of Basel
I requirements respectively.[Footnote 29] The different implementation
schedules and maximum capital reductions may provide foreign
competitors of U.S. core banks an earlier opportunity to make use of
any decreases in capital costs associated with lower required capital
for certain assets or activities. Therefore, by making the transition
to Basel II lengthier for U.S. core banks, foreign competitors may be
able to take better advantage of strategic opportunities, such as a
mergers or acquisitions. Though several core bank officials with whom
we spoke remained concerned about the time difference, officials at one
core bank explained that the current market environment may limit the
competitive implications of that difference.
Several core bank officials with whom we spoke mentioned that they
would have wanted to have the option to select the standardized
approach with some officials suggesting that the lack of a choice may
lead to higher implementation costs. In the United States, the final
rule requires all core banks to adopt the advanced approaches for both
credit and operational risk, but affords opportunities for the primary
federal supervisor to exercise some flexibility when applying the final
rule to core banks. The advanced approaches rule specifically allows
for the exemption of subsidiary depository institutions from
implementing the advanced approaches, and, under the reservation of
authority, the primary federal regulator can require a different risk
weighted asset amount for one or more credit risk exposures, or for
operational risk, if the regulators determine that the requirement
under the advanced approaches is not commensurate with risk. However,
some U.S. regulatory officials with whom we spoke noted the potential
risk of a piecemeal approach and emphasized that they do not want banks
to apply the advanced approach for credit risk to their least risky
portfolios and to apply Basel I or the proposed standardized approach
for their riskier portfolios.
In contrast, some foreign banks have not been explicitly required to
adopt the advanced approaches for credit and operational risk. For
example, Canadian regulators told us that they have an expectation for
their domestic banks with significant global operations to move to the
advanced approach for credit risk and that there is no such expectation
for domestic banks to use the advanced approach for operational risk.
Furthermore, all other banks in Canada can decide to adopt the advanced
approaches with the condition that the bank must adopt the advanced
approach for credit risk before adopting the advanced approach for
operational risk. In addition, regulatory officials from the United
Kingdom told us that all banks were required to adopt the standardized
approach in 2007, but some banks applied for a waiver to allow them to
adopt the advanced approaches for determining capital requirements for
credit risk or for operational risk. Moreover, officials from one
European bank told us that they entered their first transitional year
in their country with approximately three-quarters of their portfolios
on the advanced approach for credit risk.
Retention of Leverage Requirement Has Raised Concerns of Core Banks
about Competitive Effects:
Officials from some of the core banks with whom we spoke expressed
concerns that they may be at a competitive disadvantage due to the
retention of the U.S. leverage requirement, which applies to all
depository institutions and U.S.-based bank holding companies. Foreign
banks based in other industrialized countries are generally not subject
to a leverage requirement.[Footnote 30] Some U.S.-based core banks are
concerned about the impact of the leverage requirement for bank holding
companies on their operations abroad. That is, in meeting the leverage
requirement, a U.S. bank holding company must include the assets of its
foreign operations, potentially increasing the amount of required
regulatory capital in comparison with the regulatory capital
requirements for foreign-based bank holding companies. For example, the
additional capital needed to meet the leverage requirement may exceed
the additional capital required under the advanced approaches for
certain corporate loans that are estimated by banks to be relatively
low-risk, as demonstrated in figure 3. Most core bank officials with
whom we spoke also said that by maintaining the leverage requirement,
U.S. regulators were preserving a regulatory capital requirement that
was not aligned with the improved risk-management practices promulgated
by the final rule on the advanced approaches. Officials from one trade
association said that because the leverage requirement does not require
additional capital as risk increases, banks may have an incentive to
increase their return on equity by holding assets with higher risk and
return, but no additional capital required by the leverage requirement.
In contrast, regulatory officials have stated that risk-based and
leverage requirements serve complementary functions in which the
leverage requirement can be seen as offsetting potential weaknesses or
supplementing the risk-based capital requirements.
Figure 3: Required Capital for Short-term Corporate Loans under the
Advanced Approach and Bank Holding Company Leverage Requirement, by
Probability of Default:
This figure is a line and bar combination graph showing required
capital for short-term corporate loans under the advances approach and
bank holding company leverage requirement, by probability of default.
The X represents the annual probability of default, and the Y axis
represents the required capital (percentage).
Annual probability of default: 0.05%;
Advanced approach: 0.76%.
Annual probability of default: 0.15%;
Advanced approach: 1.67%.
Annual probability of default: 0.25%;
Advanced approach: 2.34%.
Annual probability of default: 0.35%;
Advanced approach: 2.87%.
Annual probability of default: 0.45%;
Advanced approach: 3.32%.
Annual probability of default: 0.55%;
Advanced approach: 3.70%.
Annual probability of default: 0.65%;
Advanced approach: 4.04%.
Annual probability of default: 0.75%;
Advanced approach: 4.33%.
Annual probability of default: 0.85%;
Advanced approach: 4.59%.
Annual probability of default: 0.95%;
Advanced approach: 4.83%.
Annual probability of default: 1.05%;
Advanced approach: 5.05%.
Annual probability of default: 1.15%;
Advanced approach: 5.24%.
Annual probability of default: 1.25%;
Advanced approach: 5.42%.
Annual probability of default: 1.35%;
Advanced approach: 5.59%.
Annual probability of default: 1.45%;
Advanced approach: 5.75%.
Annual probability of default: 1.55%;
Advanced approach: 5.89%.
Annual probability of default: 1.65%;
Advanced approach: 6.03%.
Annual probability of default: 1.75%;
Advanced approach: 6.16%.
Annual probability of default: 1.85%;
Advanced approach: 6.28%.
Annual probability of default: 1.95%;
Advanced approach: 6.40%.
Annual probability of default: 2.05%;
Advanced approach: 6.51%.
[See PDF for image]
Source: GAO analysis of the advanced approaches rule. Federal Reserve
regulation, and data from the QIS-4 summary.
Note: Estimates of the capital required under the advanced approaches
in the figure assume an LGD of 35.8 percent (adjusted for downturn
conditions using the supervisory formula from the advanced approaches
NPR, based on mean LGD for corporate, bank, and sovereign exposures
from the fourth quantitative impact study (QIS-4 ) of 30.2 percent),
and a maturity of 1 year. The leverage requirement of 3 percent for
bank holding companies subject to the market risk amendment is measured
in tier 1 capital, while the Basel II credit risk requirement is
measured in total capital. The estimates of required capital under the
advanced approach do not include any increase in the operational risk
capital requirement that could come from holding additional assets.
[End of figure]
In terms of potential competitive effects domestically, some core bank
officials with whom we spoke expressed concerns that certain financial
firms, primarily the CSEs, offer similar wholesale products but lack
similar regulatory capital requirements, while other core bank
officials were no longer concerned. As noted previously, CSEs are
required to compute and report to SEC capital adequacy measures
consistent with the standards in the New Basel Accord, and SEC expects
them to maintain certain capital ratios, though they are not required
to do so. SEC has said that it will make modifications in light of the
final rule adopted by U.S. bank regulators and subsequent
interpretations. In addition, bank holding companies are subject to a
leverage requirement, but CSEs do not have a similar requirement. For
example, in December 2007, the leverage ratio for core bank holding
companies ranged from about 4.0 percent to about 6.8 percent and for
CSEs ranged from about 3 percent to 3.8 percent.
International Coordination among Regulators Has Contributed to Reducing
Competitive Concerns for Core Banks:
U.S. regulators and their foreign counterparts are coordinating in ways
that contribute to reducing the potential for adverse competitive
effects on U.S. banks operating abroad. These efforts aim to resolve
some issues that develop between regulators in a bank's home country
and those in other countries where the bank operates, usually referred
to as home-host issues. Handling home-host issues is an essential
element of the New Basel Accord framework because it allows for
national discretion in a number of areas.[Footnote 31] Several foreign
regulators with whom we spoke discussed how well U.S. regulators have
been able to collaborate with their foreign counterparts on a variety
of supervisory issues. Specific to Basel II implementation, U.S.
regulators have been able to provide needed information to foreign bank
supervisors that could limit the compliance costs of subsidiaries of
U.S. banks operating abroad. For example, OCC examiners explained to us
how they assisted a foreign regulator in better understanding some of
the information a core bank was using in estimating credit risk for a
certain loan portfolio. In another instance of collaboration, foreign
regulators explained to us that they waived the requirement for a core
bank to adopt the advanced approaches for its foreign-owned subsidiary
until the core bank adopted the advanced approaches in the United
States.
Over the years, the U.S. regulators have entered into various
information-sharing agreements that facilitate cooperation with their
foreign counterparts. These agreements are intended to expedite the
meeting of requests posed by foreign regulators for supervisory
information from U.S. regulators. As of July 2008, OCC and Federal
Reserve officials explained that they had some form of an information-
sharing agreement with 25 and 16 foreign jurisdictions respectively.
Likewise, FDIC and OTS officials both described good working
relationships with their foreign counterparts as they related to U.S.
banks with international operations that they supervise.
U.S. regulators have been and continue to be active members in the
Basel Committee and its various subcommittees, including the Accord
Implementation Group. In addition, U.S. regulators participate in
colleges of supervisors and other international bodies, such as the
Joint Forum.[Footnote 32] Participation in such entities further
provides U.S. regulators information on how U.S. banks may be treated
by foreign regulators, thus allowing for more dialogue among regulators
to preemptively address any home-host issues. The Accord Implementation
Group's purpose is to exchange views on approaches to implementation of
Basel II, and thereby to promote consistency in the application of the
New Basel Accord. Colleges of supervisors are meetings at which
regulators from various countries discuss supervisory matters that
relate to a specific bank that has global operations. Officials from
the Federal Reserve stated that the colleges are more often better for
sharing information among regulators than for addressing a specific
regulatory issue. Though regulators from various countries are sharing
information, several core banks expressed concerns to us that their
foreign regulators have been implementing Basel II differently.
Proposed Standardized Approach May Reduce Competitive Concerns of Non-
core Banks, as May Other Factors:
As discussed earlier, because non-core banks compete with core banks in
some markets, non-core banks were concerned that core banks would be
able to hold less capital than non-core banks were holding under Basel
I for the same assets. Part of this concern came from the April 2005
results of the fourth quantitative impact study (QIS-4), which
estimated that Basel II could result in material reductions in
aggregate minimum required risk-based capital among potential core
banks.[Footnote 33] By holding less capital for certain products, such
as residential mortgages, core banks might charge less for these
products than non-core banks. Two studies of the potential impact of
Basel II on the market for residential mortgages have disagreed as to
the magnitude of any competitive impact--one suggested a potentially
significant shift in income from mortgages toward banks on the advanced
approaches, while the other argued that any competitive impact was
unlikely.[Footnote 34] In addition, U.S. regulators have recognized
that some banks were concerned about core banks being required to hold
less capital overall, thus making it advantageous to acquire non-core
banks. The proposed standardized approach rule should address some of
the competitive concerns non-core banks expressed in the early 2000s,
while several other factors, including the leverage requirement, also
may reduce differences in capital between core and non-core banks.
Proposed Standardized Approach Provides a More Risk-sensitive Option
for Non-core Banks:
U.S. regulators have proposed the standardized approach in part to
mitigate potential competitive differences between core and non-core
banks.[Footnote 35] The U.S. version of the standardized approach
features more risk-sensitive capital requirements than Basel I. In
particular, it adds risk sensitivity for mortgages based on their loan-
to-value (LTV) ratios and has lower capital requirements than Basel I
for some lower-risk (lower LTV) mortgages (see fig. 4).
Figure 4: Risk Sensitivity of Proposed Standardized Approach vs.
Prudently Underwritten Residential Mortgages under Basel I, by LTV:
This figure is a combination bar graph showing risk sensitivity of
proposed standardized approach vs. prudently underwritten residential
mortgages under Basel I, by LTV. One bar shows Base I, and the other
shows Proposed U.S. standardized approach.
Loan-to-value (LTV) ratio: LTV<60;
Base I: 4;
Proposed U.S. standardized approach: 1.60.
Loan-to-value (LTV) ratio: 6095;
Base I: 4;
Proposed U.S. standardized approach: 12.
[See PDF for image]
Source: GAO analysis of the standardized proposal.
Note: Estimates of required capital under the standardized approach in
the figure do not include any increase in the operational risk capital
requirement that could come from holding additional assets. Mortgage
loans that are not prudently underwritten would receive a 100 percent
risk weight under Basel I. Banks must demonstrate that mortgage loans
with a LTV that exceeds 90 percent are prudently underwritten to
receive the 50 percent Basel I risk weight.
[End of figure]
The proposed standardized approach rule is also similar to the
standardized approach under the New Basel Accord in that, like the
accord, it features increased risk sensitivity for some externally
rated exposures, including corporate loans. This is in contrast to the
single risk weight for corporate credits and most mortgages in Basel I.
Figure 5 demonstrates that the minimum required capital under the
standardized approach for the credit risk associated with externally-
rated corporate loans will be much more similar to that required under
the advanced approaches than that required under Basel I. In addition,
the standardized approach expands incentives for better risk management
in that it allows banks to reduce capital in light of certain
additional practices that could reduce risk, such as the use of
collateral or third-party guarantees, and explicitly requires banks to
set aside capital for operational risk. The added risk sensitivity of
the standardized approach proposal should reduce some differences in
risk-based capital requirements, as compared with the advanced
approaches, for adopting banks.
Figure 5: Required Capital for Externally Rated Corporate Loans under
Basel I, Proposed Standardized Approach, and Advanced Approach, by
Rating:
This figure is a combination bar graph showing required capital for
externally rated corporate loans under Base I, Proposed Standardized
Approach, and Advances Approach by rating. The X axis represents the
rating, and the Y axis represents the required capital (percentage).
Moody's rating: AAA;
Base I: 8;
Standardized approach: 1.6;
Advanced Approach: 1.13.
Moody's rating: Aa;
Base I: 8;
Standardized approach: 1.6;
Advanced Approach: 1.13.
Moody's rating: A;
Base I: 8;
Standardized approach: 4;
Advanced Approach: 1.13.
Moody's rating: Baa;
Base I: 8;
Standardized approach: 8;
Advanced Approach: 3.1.
Moody's rating: Ba;
Base I: 8;
Standardized approach: 8;
Advanced Approach: 7.07.
Moody's rating: B;
Base I: 8;
Standardized approach: 12;
Advanced Approach: 10.67.
Moody's rating: C;
Base I: 8;
Standardized approach: 12;
Advanced Approach: 16.32.
[See PDF for image]
Source: GAO analysis of the advances approaches rule, standardized
proposal. and data from Moody's Investors Service ant the QIS-4
summary.
Note: Estimates required capital under the advanced approaches in the
figure assume LGDs of 28.0 percent, 35.8 percent, and 44.2 percent for
low, medium, and high estimates, respectively (adjusted for downturn
conditions using the supervisory formula from the advanced approaches
NPR, based on 25th percentile, median, and 75th percentile LGDs for
corporate, bank, and sovereign exposures from QIS-4 of 21.7 percent,
30.2 percent and 39.4 percent, respectively), and a maturity of 3
years. Default probabilities, from Moody's, are 0.03 percent for AAA,
Aa, and A (the lower bound in the advanced approaches rule), 0.18
percent for Baa, 1.21 percent for Ba, 5.24 percent for B, and 19.48
percent for C. We include a range of estimates for the advanced
approach for credit risk because it allows for greater granularity of
risk assessments than the standardized approach and because banks may
use a variety of methodologies and different underlying data for
estimating risk parameters. The estimates of required capital under the
advanced and standardized approaches do not include any increase in the
operational risk capital requirement that could come from holding
additional assets.
[End of figure]
Once the standardized approach rule becomes final, non-core banks will
have the option of choosing it or the advanced approaches, or remaining
on Basel I. Presumably, non-core banks will take into consideration a
wide range of issues when deciding what regulatory capital framework to
adopt, including potential competitive effects. For example, a growing
non-core regional bank that competes principally with core banks in
wholesale and retail lending may find it beneficial to adopt the
advanced approaches in order to model and receive lower risk-based
capital requirements for certain lower-risk credits. Similarly, a
smaller non-core bank that found itself increasingly competing with
regional banks might opt for the additional risk-sensitivity of the
standardized approach. However, one trade association representing some
of the smallest non-core banks with whom we spoke said the standardized
approach may not fully address the competitive concerns of these banks
because the capital relief associated with holding some lower risk
assets might be offset by additional capital required for operational
risk. Officials at one large non-core bank told us that the bank was
considering all of its options carefully and noted that there were a
large number of factors to consider in deciding which risk-based
capital rule to adopt.
Other Factors, Such as the Leverage Requirement, May Reduce Competitive
Effects of Multiple U.S. Capital Rules:
While the leverage requirement, particularly for bank holding
companies, remains a competitive concern for core banks, the leverage
requirements that all depository institutions must meet may limit
competitive differences resulting from banks in the United States
operating under multiple risk-based capital rules. Because these
banking institutions must meet both risk-based and leverage
requirements, the leverage requirement may be the effective or binding
requirement for lower-risk assets held on the balance sheet, or more
generally for banks with a relatively low-risk portfolio. The
additional capital needed to meet the leverage requirement likely will
exceed both the additional advanced and standardized approaches risk-
based capital requirements for certain lower-risk assets held on
balance sheets, such as low LTV mortgages and highly rated corporate
credits.[Footnote 36] Figure 6 compares the capital required by the
advanced approaches with the capital required by the leverage
requirement for certain externally rated corporate loans.
Figure 6: Required Capital for Externally-rated Corporate Loans under
the Advanced Approach and Depository Institution Leverage Requirement,
by Rating:
This figure is a line and bar graph showing required capital for
externally-rated corporate loans under the advanced approach and
depository institution leverage requirement, by rating. The X axis
represents Moody's rating, and the Y axis represents the required
capital (percentage).
Moody's rating: AAA;
Higher requirement: 1.13;
Required capital (percentage): 1.13.
Moody's rating: Aa;
Higher requirement: 1.13;
Required capital (percentage): 1.13.
Moody's rating: A;
Higher requirement: 1.13;
Required capital (percentage): 1.13.
Moody's rating: Baa;
Higher requirement: 3.1;
Required capital (percentage): 3.1.
Moody's rating: Ba;
Higher requirement: 7.07;
Required capital (percentage): 7.07.
Moody's rating: B;
Higher requirement: 10.67;
Required capital (percentage): 10.67.
Moody's rating: C;
Higher requirement: 16.32;
Required capital (percentage): 16.32.
[See PDF for image]
Source: GAO analysis of the advances approaches rule, and data from
Moody's Investors Service and the QIS-4 summary.
Note: Estimates of required capital under the advanced approaches in
figure 6 assume a LGD of 35.8 percent (adjusted for downturn conditions
using the supervisory formula from the advanced approaches NPR, based
on median LGD for corporate, bank, and sovereign exposures from QIS-4
of 30.2 percent), and a maturity of 3 years. Default probabilities,
from Moody's, are 0.03 percent for AAA, Aa, and A (the lower bound in
the advanced approaches rule); 0.18 percent for Baa; 1.21 percent for
Ba; 5.24 percent for B; and 19.48 percent for C. The leverage
requirement of 4 percent for depository institutions is measured in
tier 1 capital, while the Basel II credit risk requirement is measured
in total capital. The estimates of required capital under the advanced
approach do not include any increase in the operational risk capital
requirement that could come from holding additional assets.
[End of figure]
Because U.S. banks hold capital for a number of reasons and are
generally expected to hold more than the minimum amount of capital
required, banks under different risk-based capital rules may
nevertheless hold similar capital for similar assets and activities--
and therefore have similar capital costs--despite differences in
minimum required capital. As already discussed, banks hold capital
based on management views on the amount of capital the bank needs
internally and market expectations, in addition to regulatory
requirements. Furthermore, regulators generally expect banks to hold
capital above these minimum requirements, commensurate with their risk
exposure. For example, as part of Pillar 2, banks and regulators will
assess risks not covered or not adequately quantified by Pillar 1
minimum requirements.
Another factor that may reduce competitive effects resulting from
differences in risk-based capital requirements is the ability of banks
to originate loans and subsequently securitize and sell them to other
entities. Differences in required capital for credit risk across
multiple risk-based regimes would likely have a competitive impact only
to the extent that banks retain the credits they originate on their
balance sheets or retain a significant portion of the credit risk off
their balance sheets. Banks may securitize residential mortgages and
other types of loans into other marketable investments in order to
raise further funds to originate additional loans. This is also known
as an originate-to-distribute model where revenues are derived from the
sale of assets rather than an ongoing stream of interest payments.
However, the recent turmoil in the credit markets has reduced the
volume of some securitizations and highlighted weaknesses in
underwriting standards associated with the originate-to-distribute
model. As a result, incentives for securitization could be influenced
by changes in capital requirements and the market environment.
Potential Impact of New Rules on Mergers and Acquisitions Is Uncertain:
The potential impact of the new regulatory capital rules on incentives
for mergers and acquisitions remains uncertain because it is not clear
how much capital requirements and other regulatory costs will change
under the new capital rules. As noted earlier, differences in
regulatory capital requirements could influence incentives for
consolidation by making acquisitions more or less advantageous for
banks operating under different capital rules, such as the multiple
risk-based capital rules being introduced in the United States.
However, several industry participants with whom we spoke said that
mergers and acquisitions generally were driven by strategic concerns
such as gaining access to a new market rather than capital concerns. In
addition to the new capital rules, changes in credit markets may be
affecting the benefits and costs of certain mergers. For example, one
regional bank told us that the costs of implementing the advanced
approaches is high especially for smaller banks and that the benefits
of the advanced approaches were less certain in the current financial
climate where credit quality has deteriorated. As a result, some
industry participants said that regional banks may be forgoing mergers
with each other to avoid being classified as core banks that would have
to adopt the advanced approaches.
Bank Regulators Have Taken Limited Actions to Address Additional
Competitive Effects of Basel II Implementation on U.S. Banking
Organizations:
Many factors have affected the pace of Basel II implementation in the
United States, and while the gradual implementation is allowing
regulators to consider changes in the rules and reassess banks' risk-
management systems, regulators have not yet addressed some areas of
uncertainty that could have competitive implications. The final rule
provides regulators with considerable flexibility and leaves open
questions about which banks will be exempted from the advanced
approaches. Without such clarification, core banks may expend greater
resources to prepare for implementation than otherwise would be
necessary. In addition, opportunities for regulatory arbitrage exist if
regulators use different standards for exemptions. Regulators also have
not fully developed plans for a required study of the impacts of Basel
II implementation. Lack of development or specificity in criteria,
scope, methodology, and timing will affect the quality and extent of
information that regulators would use to help address competitive and
other effects and make future changes in the rules.
A Number of Factors Have Affected the Pace of Basel II Implementation,
Including Market Turmoil:
The financial market turmoil that began in the subprime housing market
in 2007 accounts, in part, for banks' delaying implementation of the
Basel II advanced approaches. In part, because the economy had been
experiencing benign conditions, in 2005, U.S. regulators had estimated
in QIS-4--a study of the potential impact of Basel II as then proposed-
-that minimum capital requirements for credit risk would fall once
Basel II was fully implemented. And, according to the head of one of
the regulatory agencies, many were impatient with a gradual approach to
implementing Basel II at that time. Now that credit markets are
experiencing turmoil, some bank officials and regulators told us that
banks will implement Basel II more slowly.
As a result of the current financial turmoil, regulators have been
considering modifications in the advanced approaches to Basel II and
are assessing banks' risk management systems. The Basel Committee has
been reviewing certain aspects of the capital framework including the
treatment of securitizations, greater specification of scenario testing
in Pillar 2, and the treatment of credit risk charges for trading
assets.[Footnote 37] The Basel Committee is also considering principles
for sound risk management and supervision related to liquidity risk and
issued a consultative document on this issue in June 2008.[Footnote 38]
U.S. regulators have noted that the gradual implementation of Basel II
in the United States is allowing them to better understand how the
rules might need to be adapted or implemented in the changed financial
climate. Regulators have also been speaking to bankers in a number of
forums on the need to improve risk management practices in relation to
Basel II.
Gradual implementation is also built into the advanced approaches. (See
app. III for an illustration of the timeline for the development and
implementation of the advanced approaches.) As noted earlier, the
advanced approaches rule took effect on April 1, 2008. Core banks
generally must adopt an implementation plan approved by the bank's
board of directors by October 1, 2008, but do not actually have to
begin the four intermediate phases that lead to full implementation of
Basel II until April 1, 2010. If banks begin then and each of the four
intermediate phases takes a year, they would then be ready to fully
adopt Basel II by April 1, 2014. At the time the rule took effect,
banks could start their parallel run, the first of the four
intermediate phases, at the beginning of any quarter ranging from the
second quarter of 2008 to the second quarter of 2010.
The 2007 decision to offer non-core banks an option to adopt the
standardized approach also has affected the pace of implementation in
the United States. As a result of comments received on NPRs related to
Basel II in 2006, U.S. regulators decided to offer non-core U.S.
banking institutions the option of a standardized approach. Regulators
issued the NPR in July 2008 but are uncertain as to when they will
issue a final rule. In addition, the new NPR again asks the question of
whether core banks should be permitted to adopt the standardized
approach rather than advanced approaches creating uncertainties that
will be discussed later.
Some Uncertainties about Basel II Implementation Remain to Be
Addressed:
A primary goal of federal bank regulators is to promote the safety and
soundness of the banking institutions they oversee. To fulfill this
obligation, bank regulators must have the authority and flexibility to
take actions to achieve this objective. The Federal Reserve and OCC
have taken a number of steps to help ensure that Basel II is
implemented consistently across the banking organizations they
supervise and regulators have issued some joint statements and guidance
to address some of the remaining uncertainty for banks. Nonetheless,
the flexibility afforded by the rule for the advanced approaches could
lead to inconsistent application of the rules, which could, in turn,
produce competitive differences among the banks or provide
opportunities for regulatory arbitrage.
The Final Rule for the Advanced Approaches Allows Regulators to
Exercise Some Regulatory Flexibility:
A certain amount of flexibility for primary bank supervisors and
related uncertainty for banks is necessary for maintaining the safety
and soundness of the banking system. Under the final rule for the
advanced approaches, regulators can respond to new or unforeseen
situations that pose risks to safety and soundness without having to
first change the rule. The rule reserves the authority of primary
federal bank regulators to require that banks hold an amount of capital
greater than the minimums dictated by the rule. This authority is being
maintained both in the application of Pillar 1, where regulators can
require that a bank calculate required capital in ways that recognize
the individual situation of that institution and in Pillar 2, which by
its very nature promotes supervision that uniquely addresses the
situations of specific banks, while following general principles. For
example, under the advanced approaches, regulators can generally allow
U.S.-based banks with foreign subsidiaries to use a different retail
definition of default for subsidiaries in foreign countries unless the
primary supervisor determines that the banking organization is using
the differences in the definitions of default to engage in regulatory
arbitrage.
Given the provisions for primary federal regulators to exercise their
judgment during the implementation of Basel II, the Federal Reserve and
OCC, which oversee all but one of the banks that meet the asset size
and foreign exposure criteria for core banks, have taken a number of
steps to help ensure that Basel II is implemented consistently within
and across the banking organizations they supervise. As we have noted
in a previous report, the Federal Reserve has been aware that its
decentralized structure could lead to inconsistent supervisory
treatment of large banks it oversees and had developed some procedures
to limit these differences.[Footnote 39] These procedures include
having a management group, which consists of officials from the Federal
Reserve Board of Governors and Federal Reserve District Banks, provide
additional review of supervisory plans and findings for large, complex
banks. They have been relying on this process to help ensure
consistency in the application of Basel II. OCC also has been taking
actions to help ensure that examiners will implement Basel II in an
equitable manner across the banks it supervises. Heretofore, the OCC
examination process permitted lead examiners to provide information to
banks without obtaining specific input from headquarters staff;
however, OCC has been requiring that information about Basel II be
raised to higher levels and that some of the same personnel be involved
in Basel-related examinations across banks. These two agencies also
have taken a number of actions to ensure consistent application of
Basel II across the agencies. For example, Federal Reserve and OCC
examiners have conducted joint examinations to look at how banks are
implementing some processes related to the advanced approaches.
The other two primary bank regulators--OTS and FDIC--which oversee
fewer core banks, have also participated in activities related to
ensuring consistency in the implementation of Basel II. OTS is the
primary regulator for the only thrift that meets the definition of a
core bank on its own and is thus interested in ensuring that its
processes for that bank are consistent with those of the other
regulators overseeing similar institutions. OTS and FDIC oversee a
number of depository institutions that have been identified as core
banks because they are subsidiaries of U.S.-based banks that meet the
asset size and foreign exposure criteria for core banks, and FDIC also
oversees subsidiaries of foreign-based banks that may adopt the
advanced approaches. Officials at both agencies said that they are
active in Basel Committee activities and that they played a role in the
Federal Reserve and OCC's joint examination of credit risk. In
addition, according to some of the regulators, all four primary
regulators have participated in joint examinations of operational risk
across some of the core banks.
Regulators Have Taken Some Actions to Reduce Uncertainty but Have Not
Clarified Which Banks They Will Exempt from the Advanced Approaches:
Regulators have taken actions to reduce uncertainty by jointly
providing some clarifying information about certain aspects of the
capital rules. For example, during the development of the advanced
approaches rule the regulators issued proposed guidance and interagency
statements that helped to clarify certain aspects of the rules and,
beginning in July 2008, updated some of these to reflect the final
rule. They updated the interagency statement on the qualification
process that had first been issued in 2005, following the Basel
Committee's issuance of the New Basel Accord. They also issued updated
supervisory guidance for Pillar 2 that had been proposed initially in
February 2007 to provide banks with more detail on the NPR for the
advanced approaches. Regulators and examiners at one agency said that,
in their view, it is not necessary to update the guidance on Pillar 1
that had been issued under the NPR because of the time and care that
went into crafting the extensive and detailed preamble that accompanied
the advanced approaches rule. Nonetheless, officials at many of the
core banks with whom we spoke said that the lack of additional or
updated guidance, including the standards by which examiners will judge
the banks' compliance, had been a problem for them. Regulators may
provide additional joint information to banks and examiners based on
the questions they have received from banks since the advanced
approaches rule was issued. Regulators told us they are considering
providing this information in a question and answer format on their Web
sites. In addition, each of the regulators will be providing separate
guidance for its examiners to determine whether the banks they oversee
are complying with the rule.
Regulators said they do not intend to issue any joint guidance for the
proposed standardized approach rule while it is out for comment or when
a final rule is issued beyond information provided in a preamble.
However, to ensure that non-core banks are not disadvantaged by core
banks moving onto the advanced approaches, regulators have said they
are planning to issue the standardized approach rule before core banks
move into the first transitional period for the advanced approaches.
Timely issuance of the final rule and any clarifying information will
help to ensure that non-core banks have adequate information on which
to base decisions about which capital regime--advanced approaches,
standardized approach, or Basel I--will be best for them.
While some flexibility is necessary and regulators have taken some
steps to ensure greater consistency in the implementation of the rules,
there are actions the regulators could take to further reduce banks'
uncertainty about Basel II without necessarily jeopardizing the safety
and soundness of the banking system. One area where uncertainty could
be reduced is in clarifying which core banking institutions would be
exempt from the application of the advanced approaches rule. The rule
allows for exempting any core bank---a bank that meets the size or
foreign exposure criteria for core banks or a depository institution
that is a core bank because it is a subsidiary of a core bank that
meets those criteria. Although the rule outlines a mechanism for
certain banks to be exempted and provides some broad factors regulators
will use in making these determinations (asset size, level of
complexity, risk profile, or scope of operation), the regulators have
not been specific in the current rule about whether they will grant
these exemptions and under what circumstances. The regulators have said
that they will not grant many exemptions and did not specify these
exemptions because they believe it is important for them to retain
supervisory flexibility as they move forward with implementation of the
final rule. As such, they said each decision is to be made on a case-
by-case basis.
Throughout the development of the rules, regulators had introduced
uncertainty about the extent to which foreign-based banks with
subsidiaries that are U.S. bank holding companies will be subject to
the advanced rules in the United States and the current rule continues
to provide the Federal Reserve, the regulator of bank holding
companies, considerable flexibility in making these decisions. The
Federal Reserve has not answered the question of which specific bank
holding companies that are subsidiaries of foreign-based banks and
qualify as U.S. core banks---they have assets of $250 billion or
greater--will be exempted from using the advanced approaches in the
United States. When the advanced approaches NPR was issued in 2006,
some foreign-based institutions with large bank holding companies in
the United States but relatively small depository institutions were
surprised to find that they would be treated as core banks in the
United States. The final rule acknowledged the concerns of those
institutions and noted that the Federal Reserve may exempt them, but it
does not make it clear that they will be exempt. Because the Federal
Reserve, the regulator of bank holding companies, has not issued more
specific criteria or guidance for reviewing requests for exemptions,
these banks (at least one bank has requested an exemption) may have to
devote resources to complying with the U.S. final rule until they
receive an answer on whether they will be exempted. On the other hand,
while only one banking organization is affected, the rule specifically
exempts bank holding companies with significant insurance underwriting
operations that otherwise would meet the requirements to be a core
bank.
Similarly, the rule states that regulators will consider the same
factors--asset size, level of complexity, risk profile, and scope of
operations--in making a determination as to whether depository
institutions that are subsidiaries of U.S. core banks can be exempted.
As a result, institutions have little guidance concerning the
likelihood that some of their depository institutions will be exempt
and will need to prepare for a full implementation of the advanced
approaches in each entity until they receive a response from their
regulator on whether they will be exempted. Moreover, because the
factors are so broad, if different regulators use different specific
criteria to exempt entities, they may set up the potential for
regulatory arbitrage. For example, a U.S. banking organization could
hold higher-risk assets in subsidiary banks that are exempt and remain
on Basel I and could hold lower-risk assets in subsidiary banks that
are not exempt from the advanced approaches. And banks that do not
currently have a structure that would allow them to reduce capital in
this way could change their structure accordingly by acquiring or
changing bank charters. The overall result could be lower capital held
in the bank or resources being devoted to reducing capital that do not
properly align capital with risk. However, officials from the Federal
Reserve noted that regardless of the structure of the bank, at the
holding company level, all material bank assets would be consolidated
and subject to the advanced approaches rule.
This continuing uncertainty could make it difficult for banking
organizations to pursue the most cost-effective route to complying with
Basel II and could create more risk for the banks at a time when risks
are already high because of the turmoil in financial markets. For
example, some industry participants told us that those parts of Basel
II that do not improve risk management divert resources that banks
otherwise would use to better manage risk. In addition, resources
devoted to circumventing certain aspects of the rule through regulatory
arbitrage will divert the attention of bank officials from improving
banks' risk-management systems.
Finally, the uncertainty over which banking institutions ultimately
will have to adopt the advanced approaches continues because the
advanced approaches rule says all core banks will be required to adopt
detailed implementation plans for the complex advanced approaches by
October 1, 2008, and the proposed standardized approach rule, which
will not be finalized by that time, contains a question about whether
and to what extent core banks should be allowed to use the simpler
proposed standardized approach. The advanced approaches rule generally
requires core banks to comply with the advanced approaches and adopt an
implementation plan no later than October 1, 2008. Under this rule, the
Federal Reserve can exempt bank holding companies from meeting the
requirements of the final rule for the advanced approaches and primary
federal regulators can exempt depository institutions that meet the
definition of a core bank from the advanced approaches requirements.
Given the authority of the primary federal regulator, once the
standardized approach rule is finalized, those regulators would be able
to require that exempt banking organizations adopt that approach.
However, the proposed standardized approach rule, which will not be
finalized by the time the core banks must adopt their implementation
plans, asks whether core banks should be allowed to use the
standardized approach instead of the advanced approaches.
In the press release accompanying the proposed standardized approach
rule, the FDIC Chairman stated, "Given the turbulence in the credit
markets, I take some comfort with the fixed risk weights established
under the standardized approach as they provide supervisors with some
control over unconstrained reductions in risk-based capital." However,
the interagency statement on U.S. implementation of the advanced
approaches issued in July 2008, stressed the existing timelines for the
advanced approaches. The continued discussion on whether core banks
should be exempt from the advanced approaches and permitted to adopt
the standardized approach indicates that the primary federal regulators
continue to have questions about whether the advanced approaches are
the best risk-based capital requirements for core banks. Thus, it is
difficult to tell whether the regulators have found a solution to
difficulties that resulted from the differing perspectives they brought
to negotiations during the development of the advanced approaches. We
recommended in our February 2007 report on Basel II that regulators
take actions to jointly specify the criteria they will use to judge the
attainment of their goals for Basel II implementation and for
determining its effectiveness for regulatory capital-setting purposes.
We noted that without clarification on the criteria to evaluate or make
changes in the Basel II rules, the implementation will continue to
generate questions about the adequacy of the framework.
Plans for Studying the Competitive Impacts of the Final Rules Have Not
Been Fully Developed:
The regulators have not fully developed plans for an interagency study
that is to assess implementation and provide the information to form
the basis for allowing banks to fully transition to Basel II. Partly in
response to recommendations we made in 2007, the final rule says that
the regulators will issue annual reports during the transitional period
and conduct a study of the advanced approaches after the second
transitional period. According to the rule, the annual reports are to
provide timely and relevant information on the implementation of the
advanced approaches. The interagency study is to be conducted to
determine if there are material deficiencies in the advanced approaches
and whether banks will be permitted to fully transition to Basel II. In
its regulatory impact analysis, OCC said that the regulators will
consider any egregious competitive effects associated with
implementation of Basel II, whether domestic or international in
context, to be a material deficiency.
Among the items the rule specifies that the study will cover, several
are important first steps in studying the competitive effects of the
rule. These include:
* the level of minimum required regulatory capital under U.S. advanced
approaches compared to the capital required by other international and
domestic regulatory capital standards;
* comparisons among peer core banks of minimum regulatory capital
requirements;
* the processes banks use to develop and assess risk parameters and
advanced systems, and supervisory assessments of their accuracy and
reliability; and:
* changes in portfolio composition or business mix.[Footnote 40]
Some of these steps are similar to the calculations the regulators
performed as part of QIS-4. The advantage of the future study over QIS-
4 is that it will be based on actual data provided by banks whose risk
management and data systems have been reviewed by regulators as part of
the approval process for banks to enter the first two transitional
periods. In addition, one regulator noted that the study will also
benefit from the stresses of the recent market turmoil. This study
should allow the regulators to determine the extent to which total
regulatory capital changes in the short run, the specific behavior in
which banks engage to comply with some aspects of the rule, and how the
rule affects the capital of different banks.
However, plans for the study do not address a number of factors
including the establishment of shared overall goals and criteria for
Basel II that will help delineate the study's scope, methodology, and
timing. For example, while OCC in its impact study said that the
evaluation of competitive impacts will be an important part of the
study, the rule does not specify how this will be measured and the
scope and methodology of the study are not clearly designed to achieve
this objective. Because regulators design the study to evaluate Basel
II in light of clearly specified overall objectives or criteria for
Basel II, it will be difficult to jointly determine the extent to which
the rules need to be modified or whether implementation of Basel II
should proceed. If some regulators object to the full implementation of
Basel II while others do not, the rule specifies that a regulator can
permit the banking organizations for which it is the primary federal
regulator to move forward with the advanced approaches if it first
provides a public report explaining its reasoning. However, such an
outcome would not provide confidence in the current regulatory system
and could allow for regulatory arbitrage.
Further, the scope of the study has not been well defined. While the
study contemplates calculations of capital using the standardized
approach, Basel I, and other international rules as well as the actual
data on the banks following the advanced approaches, regulators have
not said that they plan to collect comparable data on financial
entities not adopting these approaches--specifically, those banking
institutions that will adopt the standardized approach or remain on
Basel I. In addition, the regulators have not explicitly included the
CSEs in the study. The effectiveness of the study will be limited if
the CSEs are not included because information on a major segment of
competitors of core banks that has had significant experience with some
aspects of the advanced approaches will have been excluded. The
agreement signed on July 7, 2008, between the Federal Reserve and SEC
regarding coordination and information sharing in areas of common
regulatory interest should facilitate the inclusion of the CSEs in any
study of the advanced approaches. Finally, the regulators have
conducted little research on international differences that could have
competitive effects in the past, and the study's design does not
explicitly include research on international differences that could
have competitive effects. However, since U.S. regulators participate in
the Capital Monitoring Group, Accord Implementation Group, and other
similar groups, they will have some perspective on Basel II
implementation in the other countries in that group including some
European Union countries and Canada that they will be able to use for
this purpose. OCC officials explained that the Capital Monitoring Group
will collect and analyze information on the implementation of Basel II
in other countries and suggested that this information will inform the
U.S. study. In addition, some U.S. regulators noted that the study
outlined in the rule will not preclude them from looking at a broad
range of data.
The methodology the study will use to evaluate competitive impacts
initially is not fully developed, although from a methodological
perspective Basel II affords an opportunity to consider the impacts of
regulatory capital on bank behaviors and among groups of banks adopting
different requirements at different times. While the measurements and
comparisons envisioned for the study are a necessary first step for
evaluating competitive impacts among the core banks and between the
core banks and other groups, they do not take full advantage of the
opportunities to better understand the impact of regulatory capital on
a range of bank behavior. Because banks in the United States and around
the world are adopting a range of capital requirements at different
times, Basel II affords a unique opportunity to consider whether event
studies could contribute to a better understanding of the impact of
regulatory capital on a variety of bank behaviors. While regulators at
OCC noted that with banks on different capital regimes, academics and
other researchers, including those at the regulatory agencies, will
have data available to study the impact of regulatory capital on bank
behavior, they said that they had not thoroughly considered the use of
event studies as part of the study planned by the regulators. Because
regulators have not clearly specified how they will evaluate the
competitive impacts of Basel II, there is an increased likelihood that
the kinds of data needed to complete an effective study will not be
available.
In addition, the advanced approaches rule does not specify a
methodology for the study to analyze the extent to which the new rules
provide opportunities for regulatory arbitrage that could limit the
effectiveness of the rules in promoting improved risk management
throughout the banking system. Several industry participants noted that
having multiple capital requirements with different levels of risk
sensitivity provides incentives for core banks to hold less risky
assets and leave more risky assets in banks using the standardized
approach or Basel I. Higher risk-based capital requirements for high-
risk assets at core banks may increase their cost of holding these
assets. Greater costs would reduce the supply of credit for these types
of loans, and thus returns would increase. As a result, banks with less
risk-sensitive capital requirements under Basel I or the standardized
approach might find some higher risk credits more attractive at these
higher rates of return. (As illustrated earlier in fig. 2, there may be
different amounts of capital required for the same asset across the
different risk-based rules.) Officials at one regulatory agency said
that all of the regulators were aware of this potential outcome and
planned to look at changes in the portfolios of core banks in the
study. Further, for non-core banks, regulators at another agency said
they would become aware of non-core banks increasing their holdings of
high-risk assets through their normal oversight duties. However, the
advanced approaches rule does not specify how the study would more
fully explore this potentially important outcome of the new rules. If
this arbitrage took place, the rules could require less capital overall
in the banking system and would leave banks with the least well-
developed risk management systems with the riskiest assets, thus
exposing the U.S. banking system to greater systemic risk.
Finally, the timing of the study is unclear. The rule specifies that
the study will be published after the second transitional period, but
core banks could begin the four intermediate phases required for full
implementation in 2008, 2009, or 2010 and different banks (as well as
different types of banks) could enter the second transitional period in
different years. The phased implementation produces uncertainty about
timing and could throw into question how many banks will be included in
the study, and whether the results of the study will provide relevant
information for all of the banks. For example, if the banks in the
second transitional period in 2011 are primarily retail banks, the
results are not likely to be applicable for the custodial banks, or
vice versa. As a result of this and other factors discussed, the use of
the study for taking actions that would improve risk management or
reduce competitive concerns may be limited.
Some regulators told us that they have not yet focused on plans for the
study, in part, because it is early in the Basel II implementation
process and they and the banks they supervise have been dealing with
the financial turmoil. In addition, some regulators said that the
language and factors laid out in the final rule should be viewed as a
starting point, and officials at one regulatory agency said that the
study will benefit from the data that will be available from the
financial turmoil in the world's credit markets.
Conclusions:
A global effort is underway to implement the New Basel Accord, which
aims to improve the risk-management practices of banks, in part, by
aligning the capital banks hold more closely with the risks they face.
Capital's role becomes more important in periods of economic
uncertainty because banks rely on capital to weather unexpected losses.
Although the impact of regulatory capital on a bank's ability to
compete is not always obvious because banks often hold more than their
minimum required capital, regulatory capital is one of many factors
that affects competition. And, the adoption of Basel II in the United
States has raised concerns about competitive effects it could have on
banks of varying sizes and in various locations. In addition,
regulators have made clear that in light of the current market turmoil
further revisions will be made in Basel II.
Uncertainty about how to implement Basel II, to whom the rules will
apply, and the effects the rules will have may lead banks to devote
resources to information gathering and implementation that could
otherwise be dedicated to improving risk management or other purposes.
In our 2007 report, we noted that the rulemaking process for Basel II
could benefit from increased transparency to respond to broader
questions and concerns about transitioning to Basel II in the United
States. The regulators referred to the recommendation in the advanced
approaches rule and, with that rule and the proposed standardized
approach rule, they have provided greater clarity about some aspects of
Basel II. We recognize that the time table for Basel II implementation
in the United States has slowed since we issued our earlier report and
that both the regulators and the banks have been dealing with the
market turmoil that began in mid-2007. This gradual implementation is
allowing bank regulators to reassess banks' risk-management systems and
consider changes in the rules before any banks begin their Basel II
implementation. As part of this preparation period, regulators have
taken and are planning some actions to reduce uncertainty, but could
take further actions to address remaining uncertainties about the
implementation of the rules and facilitate banks' planning and
preparation for their implementation of a new capital regime.
Regulators have taken actions to reduce some of the uncertainty
surrounding implementation of Basel II by providing information to aid
examiners and banks in interpreting the rules. Regulators have updated
some publicly available information on the process they will use to
qualify banks for the advanced approaches and examine them under Pillar
2. Regulators have also engaged in discussions among themselves
concerning posting additional information in a question and answer
format on their Web sites. The timely issuance of additional
information on the advanced approaches and a final standardized
approach rule, which is in process, will enable banks to best prepare
to meet the new risk-based capital requirements and will help to ensure
regulatory consistency across the banks. As a result, we encourage the
regulators to continue providing joint information in a timely manner
on both the advanced and standardized approaches.
We recognize that regulators have taken steps to reduce some
uncertainties related to Basel II; however, the regulators could take
additional steps to address uncertainties that are not related to their
need for flexibility to respond to innovation in the industry and to
unintended consequences that the rules may have. For example, in the
final rule, the regulators did not specify which banks technically met
the definition of core banks. Although, the rule specifically says that
certain banks may be exempted by their primary regulator from the
advanced approaches requirements, it does not provide well-defined
criteria for evaluating requests for exemptions. Because this clarity
has not been provided and specific criteria have not been laid out,
regulators may not provide exemptions in a consistent manner. The
issuance of more specific guidance on which banks will be exempt from
applying the advanced approaches would provide clarity and enable banks
to plan accordingly. Also, the question in the NPR for the standardized
approach about whether core banks should be able to use the proposed
standardized approach indicates that the primary federal regulators
continue to have questions about whether the advanced approaches are
the best risk-based capital requirements for core banks. Regulatory
differences on these issues can lead to increased costs for the banks,
inefficiencies for their regulators, and may weaken the overall
effectiveness of the regulatory system by creating opportunities for
banks to engage in regulatory arbitrage.
In our 2007 report, we recommended that regulators issue public reports
on the progress and results of implementation efforts and that this
reporting should include an articulation of the criteria by which they
would assess the success of Basel II. While the regulators have
proposed a study of the core banks after the second transitional year
of the implementation of the advanced approaches, they have not yet
developed the criteria on which to base the study's design and
objectives. These are needed for a determination of whether Basel II is
effective for regulatory capital-setting purposes and whether to
ultimately allow banks to move past the third transitional period to
full Basel II implementation. As delineated in the advanced approaches
rule, the study will measure the changes in capital and portfolios held
by the core banks and will look at the differences in required capital
for these banks if they were under the standardized approach rule or
Basel I---necessary steps for evaluating the competitive impact of
Basel II--but it does not explicitly describe components needed to
determine if there are material deficiencies in the rule or for
regulators to reach agreement on whether banks should be permitted to
fully implement the advanced approaches. However, the gradual
implementation of the advanced approaches in the United States affords
regulators time to jointly establish criteria for evaluating Basel II
and to fully develop a study that flows from those criteria--including
(1) a broad enough scope--inclusion of non-core banks, CSEs, and
foreign-based banks--to capture competitive effects; (2) consideration
of a number of methodologies; and (3) the resolution of the timing
issue. Such actions would help the regulators make better-informed
decisions on an interagency basis about whether changes to the rules
were necessary and whether to permit banks to fully implement Basel II.
Without these criteria, it will be difficult for regulators to make
these judgments and provide consistent guidance for banks.
Recommendations for Executive Action:
We are making two recommendations to the heads of the FDIC, Federal
Reserve, OCC, and OTS:
To further limit any potential negative effects, where possible,
regulators should move to minimize the uncertainty surrounding certain
aspects of Basel II. Specifically, regulators should clarify how they
will use certain regulatory flexibility under the advanced approaches
rule, particularly with regard to how they will exercise exemptions for
core banks from the advanced approaches requirement and the extent to
which core banks will be allowed to adopt the standardized approach.
To improve the understanding of potential competitive effects of the
new capital framework, the regulators should take steps jointly to plan
for the study to determine if major changes need to be made to the
advanced approaches or whether banks will be able to fully implement
the current rule. In their planning, they should consider such issues
as the objectives, scope, methodology, and timing needs for the future
evaluation of Basel II. The plan should include how the regulators will
evaluate competitive differences between core and non-core banks in the
United States, between core banks and CSEs, and between U.S.-based
banks and banks based in other countries.
Agency Comments and Our Evaluation:
We provided the heads of the Federal Reserve, FDIC, OCC, OTS, SEC, and
Department of the Treasury with a draft of this report for their review
and comment. We received written comments from the banking regulators
in a joint letter. These comments are summarized below and reprinted in
appendix IV. The banking regulators also provided technical comments
that we incorporated in the report where appropriate. We did not
receive comments from SEC or the Department of the Treasury.
In their letter, the banking regulators strongly endorsed our opening
statement that ensuring that banks maintain adequate capital is
essential to the safety and soundness of the banking system and said
that it is this overarching objective that will guide their efforts and
has led them to include additional prudential safeguards in their
implementation of the Basel II rules. In a somewhat related matter, the
regulators said that the report emphasizes the cost to banks of holding
capital but did not discuss how a bank's strong capital base confers
competitive strength and create strategic opportunities. While we
describe some of the costs to banks of holding additional capital
because this is an important channel through which the new capital
rules could affect the competitiveness of U.S. banking organizations,
we also note that more capital reassures creditors and reduces the cost
of borrowing. In addition, as noted in the draft, banks hold capital
for this and other reasons including the ability to take advantage of
strategic opportunities such as acquiring other banking institutions.
As we detailed in the draft, the banking regulators highlighted the
actions they have taken to address many of the concerns that bankers
and others have raised about the potential competitive equity effects
of the implementation of Basel II and said that they are in general
agreement with our recommendations. Specifically, they said that they
will work together to resolve, at the earliest possible time, the
question posed for comment in the proposed standardized approach rule
regarding whether and to what extent core banks should be able to use
the standardized approach. With regard to clarifying how they will
decide whether to grant requests from core banks to be exempt from the
requirement to adopt the advanced approaches, the regulators said they
will assess each exemption request in light of the specific facts and
circumstances applicable to the institution seeking the exemption and
that they have already commenced discussions to ensure a clear and
consistent interpretation of these provisions is conveyed to U.S.
banks.
Regarding the need to jointly plan the required study, the regulators
commented that they will work together to develop "plans for the
required study of the impact of the advanced approaches of Basel II."
Specifically, they said that they will begin to develop more formal
plans for the study once they had "a firmer picture of banks'
implementation plans" but noted the difficulties concerning drawing
definitive conclusions about the effects of changes in regulatory
capital rules. They also said that they would consider including in
their analysis the potential competitive effects with CSEs and foreign
banks as we recommended. While we are encouraged by the regulators'
recognition of the need for more formal plans and consideration of the
scope of the study to include CSEs and foreign banks, we noted a number
of additional factors that also should be considered, such as
developing criteria that will help them determine whether there are
material deficiencies that can be attributed to the new rules and what
changes, if any, could address those deficiencies. Finally, because
Basel II affords an opportunity to consider the impacts of regulatory
capital on bank behaviors and among groups of banks adopting different
requirements at different times, we noted in the draft that it is
important that regulators consider a number of methodologies for
evaluating the new capital rules and potential competitive effects to
determine which are the most appropriate.
As agreed with your offices, unless you publicly release its contents
earlier, we plan no further distribution of this report until 30 days
from its date of issue. At that time we will send copies of this report
to interested congressional committees, the Chairman of the Board of
Governors of the Federal Reserve System, Chairman of the Federal
Deposit Insurance Corporation, the Comptroller of the Currency, the
Director of the Office of Thrift Supervision, the Chairman of the
Securities and Exchange Commission, and the Secretary of the Treasury.
We will also make copies available to others on request. In addition,
the report will be available at no charge on GAO's Web site at
[hyperlink, http://www.gao.gov].
If you or your staff have any questions regarding this report, please
contact me at (202) 512-8678 or williamso@gao.gov. Contact points for
our Offices of Congressional Relations and Public Affairs may be found
on the last page of this report. GAO staff who made major contributions
to this report are listed in appendix V.
Signed by:
Orice M. Williams:
Director, Financial Markets and Community Investment:
[End of section]
Appendix I: Objectives, Scope, and Methodology:
Our objectives in this report were to discuss (1) the nature of the
competitive environment in which U.S. banking organizations compete,
(2) the extent to which different capital requirements may have
competitive impacts on U.S. banking organizations internationally and
domestically, and (3) actions regulators could take to address
competitive effects and other potential negative effects of the new
capital rules during implementation.
For all our objectives, we reviewed a variety of documents, including
regulators' statements; the international Basel II framework (entitled
"International Convergence of Capital Measurement and Capital
Standards: A Revised Framework") and other documents from the Basel
Committee, such as the 1988 Basel Capital Accord (Basel I); the Basel
II, Basel 1A, and Standardized Approach Notices of Proposed Rulemaking
(NPR) and the final rule on the advanced approaches; supervisory
guidance; academic articles, and our previous reports on banking
regulation.[Footnote 41] We interviewed senior supervisory officials at
the Board of Governors of the Federal Reserve System and Federal
Reserve Banks of Boston, New York, and Richmond (Federal Reserve),
Office of Management and Budget, Office of the Comptroller of the
Currency (OCC), Federal Deposit Insurance Corporation (FDIC), Office of
Thrift Supervision (OTS), Securities and Exchange Commission, and
Department of the Treasury. We also interviewed officials from the
Accord Implementation Group, several foreign banking regulatory
agencies, domestic, international, and foreign trade associations,
credit rating agencies, and several academics and consultants with
banking expertise. In addition, we interviewed officials from all of
the core banks and other banks, both foreign and domestic, with
operations in the United States. Finally, we attended several
conferences held by regulators and trade associations that included
discussions related to Basel II.
To describe the competitive environment in which U.S. banks operate, we
collected data from several sources to illustrate which types and sizes
of banks are active in which kinds of products. We used data from the
Federal Reserve's Structure and Share Data for U.S. Banking Offices of
Foreign Entities, and Consolidated Financial Statements for Bank
Holding Companies (i.e., FR Y-9C). These data include the amount of
assets in particular products that bank holding companies hold on and
off of their balance sheets. For banks and thrifts that do not report
assets in particular products at the consolidated level to their
regulator, we used data on banks and thrifts in the Federal Financial
Institutions Examination Council's (FFIEC) Consolidated Reports of
Condition and Income (FFIEC 031 or Call Report) and OTS's Thrift
Financial Reports, respectively. We also used data from FFIEC's Country
Exposure Lending Survey.
To compare activities across banks of different sizes, we used data at
the consolidated level because banks generally compete on an
enterprisewide basis. For bank holding companies, we used data provided
by the Federal Reserve. Almost all bank holding companies that have
assets greater than $500 million report assets in particular product
categories on a consolidated basis to the Federal Reserve using the Y-
9C form; however, a large proportion of those with assets under $500
million about 80 percent of the bank holding companies and a few larger
bank holding companies do not report consolidated assets on a product
basis to the Federal Reserve. We included these bank holding companies
that have few assets outside their chartered commercial banks in our
analysis, by having staff at the Federal Reserve group the commercial
banks by bank holding company and sum the assets reported in the Call
Reports accordingly. Thrift holding companies do not report data on
assets by product category to OTS on a consolidated basis. Because
thrift holding companies are often engaged in a wide variety of
activities outside of banking, we could not rely on the thrift
financial report data on individual thrifts to approximate the holding
company for some thrifts as we did in the case of some bank holding
companies. However, we were able to have OTS staff provide thrift
financial report data that we used to approximate the thrift holding
companies for those thrift companies primarily in banking. We did this
by having OTS staff group the thrifts by holding company for those
where thrifts make up 95 percent of the assets of the holding company
and where they make up 75 percent of the assets of the holding company.
The allocation of assets across product lines was substantially the
same for these two categories, which allowed us to conclude that the
data gave us a good approximation of differences between thrift holding
companies that are primarily in the business of banking and bank
holding companies. We concluded that they do differ in that thrifts
that are engaged primarily in the business of banking hold a much
larger percentage of their assets-in residential mortgages than do bank
holding companies across all size categories. To assess the reliability
of these data, we talked with knowledgeable agency officials about the
data and tested the data to identify obvious problems with completeness
or accuracy. We determined the data were sufficiently reliable for the
purposes of this report.
To determine the extent to which different capital requirements may
impact how various U.S. banking organizations compete, we reviewed the
available academic literature on the role capital plays in bank
competition. We also estimated minimum required capital for some assets
under the advanced and standardized approaches for credit risk, Basel
I, and leverage requirements, based on available information and data
from the U.S. federal banking regulators' fourth quantitative impact
study (QIS-4) and Moody's Investors Service. There are some limitations
associated with the data from QIS-4. At the time, the regulators
emphasized that QIS-4 was conducted on a "best efforts" basis without
the benefit of either a definitive set of proposals or meaningful
supervisory review of the institutions' systems. We assessed the
reliability of the data we used and found that, despite limitations,
they were sufficiently reliable for our purposes.
We conducted this performance audit from May 2007 to September 2008 in
Amsterdam, The Netherlands; Brussels, Belgium; Boston, Massachusetts;
Chicago, Illinois; and Charlotte, North Carolina; London, United
Kingdom; New York, New York; Toronto, Canada; and Washington, D.C., in
accordance with generally accepted government auditing standards. Those
standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe that
the evidence obtained provides a reasonable basis for our findings and
conclusions based on our audit objectives.
[End of section]
Appendix II: Three Pillars of the Advanced Approaches:
Pillar 1: Minimum Capital Requirements:
Pillar 1 of the advanced approaches rule features explicit minimum
capital requirements, designed to ensure bank solvency by providing a
prudent level of capital against unexpected losses for credit,
operational, and market risk. The advanced approaches, which are the
only measurement approaches available to and required for core banks in
the United States, will make capital requirements depend in part on a
bank's own assessment, based on historical data, of the risks to which
it is exposed.
Credit Risk:
Under the advanced internal ratings-based (A-IRB) approach, banks must
establish risk rating and segmentation systems to distinguish risk
levels of their wholesale (most exposures to companies and governments)
and retail (most exposures to individuals and small businesses)
exposures, respectively. Banks use the results of these rating systems
to estimate several risk parameters that are inputs to supervisory
formulas. Figure 7 illustrates how credit risk will be calculated under
the Basel II A-IRB. Banks must first classify their assets into
exposure categories and subcategories defined by regulators: for
wholesale exposures those subcategories are high-volatility commercial
real estate and other wholesale; for retail exposures those
subcategories are residential mortgages, qualifying revolving exposures
(e.g., credit cards), and other retail. Banks then estimate the
following risk parameters, or inputs: the probability a credit exposure
will default (probability of default or PD), the expected size of the
exposure at the time of default (exposure at default or EAD), economic
losses in the event of default (loss given default or LGD) in
"downturn" (recession) conditions, and, for wholesale exposures, the
maturity of the exposure (M). In order to estimate these inputs, banks
must have systems for classifying and rating their exposures as well as
a data management and maintenance system. The conceptual foundation of
this process is that a statistical approach, based on historical data,
will provide a more appropriate measure of risk and capital than a
simple categorization of asset types, which does not differentiate
precisely between risks. Regulators provide a formula for each exposure
category that determines the required capital on the basis of these
inputs. If all the assumptions in the supervisory formula were correct,
the resulting capital requirement would exceed a bank's credit losses
in a given year with 99.9 percent probability. That is, credit losses
at the bank would exceed the capital requirement with a 1 in 1,000
chance in a given year, which could result in insolvency if the bank
only held capital equal to the minimum requirement.
Figure 7: Computation of Wholesale and Retail Capital Requirements
under the Advanced Internal Ratings-based Approach for Credit Risk:
This figure is an illustration showing the computation of wholesale and
retail capital requirements under the advanced internal ratings-based
approach for credit risk.
[See PDF for image]
Source: GAO analysis of information from the advanced approaches rule.
Notes: This figure focuses on wholesale and retail nondefaulted
exposures, an important component of the total credit risk calculation.
The total credit risk capital requirement also covers defaulted
wholesale and retail exposures, as well as risk from securitizations
and equity exposures. A bank's qualifying capital is also adjusted,
depending on whether its eligible credit reserves exceed or fall below
its expected credit losses.
[End of figure]
Banks may incorporate some credit risk mitigation, including
guarantees, collateral, or derivatives, into their estimates of PD or
LGD to reflect their efforts to hedge against unexpected losses.
Operational Risk:
To determine minimum required capital for operational risk, banks will
use their own quantitative models of operational risk that incorporate
elements required in the advanced approaches rule. To qualify to use
the advanced measurement approaches (AMA) for operational risk, a bank
must have operational risk management processes, data and assessment
systems, and quantification systems. The elements that banks must
incorporate into their operational risk data and assessment system are
internal operational loss event data, external operational loss event
data, results of scenario analysis, and assessments of the bank's
business environment and internal controls. Banks meeting the AMA
qualifying criteria would use their internal operational risk
quantification system to calculate the risk-based capital requirement
for operational risk, subject to a solvency standard specified by
regulators, to produce a capital buffer for operational risk designed
to be exceeded only once in a thousand years.
Market Risk:
Regulators have allowed certain banks to use their internal models to
determine required capital for market risk since 1996 (known as the
market risk amendment or MRA). Under the MRA, a bank's internal models
are used to estimate the 99th percentile of the bank's market risk loss
distribution over a 10-business-day horizon, in other words a solvency
standard designed to exceed trading losses for 99 out of 100 10-
business-day intervals. The bank's market risk capital requirement is
based on this estimate, generally multiplied by a factor of three. The
agencies implemented this multiplication factor to provide a prudential
buffer for market volatility and modeling error. The OCC, Federal
Reserve, and FDIC are proposing to incorporate their existing market
risk rules and are proposing modifications to the market risk rules, to
include modifications to the MRA developed by the Basel Committee, in a
separate NPR issued concurrently with the proposal for credit and
operational risk. OTS is proposing its own market risk rule, including
the proposed modifications, as a part of that separate NPR.
In previous work, regulatory officials generally said that changes to
the rules for determining capital adequacy for market risk were
relatively modest and not a significant overhaul. The regulators have
described the objectives of the new market risk rule as including
enhancing the sensitivity of required capital to risks not adequately
captured in the current methodologies of the rule and enhancing the
modeling requirements consistent with advances in risk management since
the implementation of the MRA. In particular, the rule contains an
incremental default risk capital requirement to reflect the growth in
traded credit products, such as credit default swaps, that carry some
default risk as well as market risk.
Pillar 2: Supervisory Review:
The Pillar 2 framework for supervisory review is intended to ensure
that banks have adequate capital to support all risks, including those
not addressed in Pillar 1, and to encourage banks to develop and use
better risk management practices. Banks adopting Basel II must have a
rigorous process of assessing capital adequacy that includes strong
board and senior management oversight, comprehensive assessment of
risks, rigorous stress testing and validation programs, and independent
review and oversight. In addition, Pillar 2 requires supervisors to
review and evaluate banks' internal capital adequacy assessments and
monitor compliance with regulatory capital requirements. Under Pillar
2, supervisors must conduct initial and ongoing qualification of banks
for compliance with minimum capital calculations and disclosure
requirements. Regulators must evaluate banks against established
criteria for their (1) risk rating and segmentation system, (2)
quantification process, (3) ongoing validation, (4) data management and
maintenance, and (5) oversight and control mechanisms. Regulators are
to assess a bank's implementation plan, planning and governance
process, and parallel run performance. Under Pillar 2, regulators
should also assess and address risks not captured by Pillar 1 such as
credit concentration risk, interest rate risk, and liquidity risk.
Pillar 3: Market Discipline in the Form of Increased Disclosure:
Pillar 3 is designed to encourage market discipline by requiring banks
to disclose additional information and allowing market participants to
more fully evaluate the institutions' risk profiles and capital
adequacy. Such disclosure is particularly appropriate given that Pillar
I allows banks more discretion in determining capital requirements
through greater reliance on internal methodologies. Banks would be
required to publicly disclose both quantitative and qualitative
information on a quarterly and annual basis, respectively. For example,
such information would include a bank's risk-based capital ratios and
their capital components, aggregated information underlying the
calculation of their risk-weighted assets, and the bank's risk
assessment processes. In addition, federal regulators will collect, on
a confidential basis, more detailed data supporting the capital
calculations. Federal regulators would use this additional data, among
other purposes, to assess the reasonableness and accuracy of a bank's
minimum capital requirements and to understand the causes behind
changes in a bank's risk-based capital requirements. Federal regulators
have developed detailed reporting schedules to collect both public and
confidential disclosure information.
[End of section]
Appendix III: Basel II Timeline:
This figure is a base II timeline.
[See PDF for image]
Source: GAO.
[End of figure]
[End of section]
Appendix IV Comments from Federal Banking Regulators:
Office of the Comptroller of the Currency:
Board of Governors of the Federal Reserve System:
Federal Deposit Insurance Corporation:
Office of Thrift Supervision:
September 3, 2008:
Ms. Orice M. Williams:
Director, Financial Markets and Community Investment:
United States Government Accountability Office:
Washington, D.C. 20548:
Dear Ms. Williams:
The Federal Reserve Board (FRB), Federal Deposit Insurance Corporation
(FDIC), Office of the Comptroller of the Currency (OCC), and the Office
of Thrift Supervision (OTS) (collectively, the "Agencies") have
received and reviewed your draft report titled, "New Basel II Rules
Reduced Certain Competitive Concerns, but Bank Regulators Should
Address Remaining Uncertainties." This joint response summarizes the
Agencies' overall reaction to the draft report. Additional technical
comments have been provided separately by staff of each of the
Agencies.
In the draft report, the GAO concluded that the Agencies have addressed
some of the earlier competitive concerns of banks. The report also
describes bankers' concerns about regulatory constraints on their
ability to reduce their capital requirements, and their concerns about
lingering uncertainty regarding key aspects of the rule. The report
recommends that U.S. bank regulators (1) clarify how they will use the
flexibility built into the rules, and (2) fully develop plans, on a
joint basis, for the study of the impacts of Basel II the Agencies have
committed to undertake.
The first sentence of the report states, "Ensuring that banks maintain
adequate capital is essential to the safety-and-soundness of the
banking system." The Agencies strongly endorse this statement. The
ultimate objective of our capital rules is to promote the overall
safety and soundness of U.S. banking institutions. It is this
overarching objective that will guide our efforts and has led us to
include additional prudential safeguards in our implementation of the
Basel II rules.
While the report emphasizes the cost to banks of holding capital, an
important issue that is not discussed is how a bank's strong capital
base confers competitive strength. For example, by defusing concerns
about a bank's ability to absorb losses, strong capital can help
preserve a bank's access to funding on competitive terms. And as we
have seen during this period of economic adversity, strongly
capitalized institutions are more likely to have the financial
flexibility to expand lending when other institutions falter.
We are pleased that the GAO acknowledges actions that the Agencies have
taken to address many of the concerns that bankers and others have
raised about the potential competitive equity effects of the
implementation of Basel II. Specifically, as acknowledged by the
report, the Agencies have:
* Eliminated many of the prior differences between the U.S. advanced
approaches rule and the Basel II mid-year text. These changes will help
reduce compliance costs and competitive concerns for internationally
active institutions.
* Proposed a standardized approach that is more consistent with the
international Basel II Framework than was the Agencies' earlier "Basel
IA" proposal.
* Actively worked together and with regulators across the world to
coordinate our reviews of banks' implementation plans and risk models
and share information. As core banks reported to the GAO, these actions
have "been helpful in addressing potential negative impacts for U.S.
firms" and "limited the compliance costs of subsidiaries of U.S. banks
operating abroad."
* Established processes to coordinate implementation of the new rules
across charter types.
* Developed joint guidance, issued in July 2008, on the qualification
process the Agencies will use for advanced approaches institutions.
The Agencies are in general agreement with the recommendations
contained in the report. The Agencies will work together to attempt to
resolve, at the earliest possible time, the question posed for comment
in the proposed rule on the standardized approach, on whether or to
what extent core banks should be able to use the standardized approach.
Of course, any potential change to current requirements for core banks
in this regard would require revisions to the advanced approaches rule.
Under existing requirements, core banks are expected to comply with the
advanced approaches rule.
With regard to clarifying how the Agencies will decide whether to grant
requests from core banks to be exempt from the requirement to adopt the
advanced approaches, the rule lists the factors the Agencies will
consider. The Agencies will assess each exemption request in light of
the specific facts and circumstances applicable to the institution
seeking the exemption. The Agencies have already commenced discussions
to ensure a clear and consistent interpretation of these provisions is
conveyed to U.S. banks.
The Agencies also will work together to develop plans for the required
study of the impact of the advanced approaches of Basel II. As the
report correctly notes, our regulatory capital priorities to date have
been to: a) take actions to reduce/mitigate potential competitive
effects of our Basel II-related proposals; b) respond to current market
disruptions, including making enhancements to the advanced approaches
framework; c) provide guidance and discuss implementation plans and
issues with core banks; and d) finalize the standardized approach rule.
We will begin to formulate more formal plans for the study after we
have a firmer picture of banks' implementation plans. In formulating
our plans, we will consider the GAO's recommendations to include in our
analysis the potential competitive effects with Consolidated Supervised
Entities and foreign banks. We would caution that the fundamental
shifts occurring across the financial industry in light of the recent
market disruptions — both in terms of individual firm and aggregate
industry risk profiles — will accentuate the difficulties the GAO has
noted in drawing definitive conclusions about the effects of changes in
regulatory capital rules.
We appreciate the professionalism of the GAO review team that prepared
the report. Thank you for the opportunity to comment on the draft.
Sincerely,
Signed by:
Comptroller:
Office of the Comptroller of the Currency:
Signed by:
Governor:
Board of Governors of the Federal Reserve System:
Signed by:
Chairman:
Federal Deposit Insurance Corporation:
Signed by:
Director:
Office of Thrift Supervision:
[End of section]
Appendix V: GAO Contact and Staff Acknowledgments:
GAO Contact:
Orice M. Williams (202) 512-8678 or williamso@gao.gov:
Staff Acknowledgments:
In addition to the contact named above, Barbara I. Keller (Assistant
Director), Nancy Barry, Emily Chalmers, Michael Hoffman, Joe Hunter,
Robert Lee, Marc Molino, Carl Ramirez, Barbara Roesmann, Paul Thompson,
and Mijo Vodopic made key contributions to this report.
[End of section]
Related GAO Products:
Financial Market Regulation: Agencies Engaged in Consolidated
Supervision Can Strengthen Performance Measurement and Collaboration.
GAO-07-154. Washington, D.C.: March 15, 2007.
Risk-Based Capital: Bank Regulators Need to Improve Transparency and
Overcome Impediments to Finalizing the Proposed Basel II Framework. GAO-
07-253. Washington, D.C.: February 15, 2007.
Deposit Insurance: Assessment of Regulators' Use of Prompt Corrective
Action Provisions and FDIC's New Deposit Insurance System. GAO-07-242.
Washington, D.C.: February 15, 2007.
Financial Regulation: Industry Changes Prompt Need to Reconsider U.S.
Regulatory Structure. GAO-05-61. Washington, D.C.: October 6, 2004.
Risk-Focused Bank Examinations: Regulators of Large Banking
Organizations Face Challenges. GAO/GGD-00-48. Washington, D.C.: January
24, 2000.
Risk-Based Capital: Regulatory and Industry Approaches to Capital and
Risk. GAO/GGD-98-153. Washington, D.C.: July 20, 1998.
Bank and Thrift Regulation: Implementation of FDICIA's Prompt
Regulatory Action Provisions. GAO/GGD-97-18. Washington, D.C.: November
21, 1996.
[End of section]
Footnotes:
[1] In this report, the term bank generally refers to depository
institutions (commercial banks and thrifts) as well as bank holding
companies. Where the distinction is significant, we refer to bank
holding companies as the depository institution's ultimate U.S. holding
company. Since thrift holding companies are not subject to Basel
capital requirements, they are not included in the term bank in this
report.
[2] In June 2004, the Basel Committee published "Basel II:
International Convergence of Capital Measurement and Capital Standards:
A Revised Framework."
[3] GAO, Risk-Based Capital: Bank Regulators Need to Improve
Transparency and Overcome Impediments to Finalizing the Proposed Basel
II Framework, GAO-07-253 (Washington, D.C.: Feb. 15, 2007).
[4] In this report, we discuss competitive concerns that could arise
from the differential impact of capital rules or their implementation
on firms providing similar products or services.
[5] For a more detailed discussion about risk-management practices in
place during the market turmoil, see the following reports: Senior
Supervisors Group, Observations on Risk Management Practices during the
Recent Market Turbulence (New York: Mar. 6, 2008) and International
Monetary Fund, Global Financial Stability Report: Containing Systemic
Risk and Restoring Financial Soundness (Washington, D.C.: April 2008).
[6] Department of the Treasury, Blueprint for a Modernized Financial
Regulatory Structure (Washington, D.C.: March 2008).
[7] Some earlier work includes GAO, Financial Regulation: Industry
Changes Prompt Need to Reconsider U.S. Regulatory Structure, GAO-05-61
(Washington, D.C.: Oct. 6, 2004) and GAO, Financial Regulation:
Industry Trends Continue to Challenge the Federal Regulatory Structure,
GAO-08-32, (Washington, D.C.: Oct. 12, 2007).
[8] For more detailed description of Basel II and its history, see our
earlier report GAO-07-253.
[9] Credit risk is the potential for loss resulting from the failure of
a borrower or counterparty to perform on an obligation. Operational
risk is the risk of loss resulting from inadequate or failed internal
processes, people, and systems or from external events.
[10] Market risk is the potential for loss resulting from movements in
market prices, including interest rates, commodity prices, stock
prices, and foreign exchange rates. Regulators have allowed certain
banks to use their internal models to determine required capital for
market risk since 1996 (known as the market risk amendment or MRA).
Generally, under the MRA, a bank's internal models are used to estimate
the 99th percentile of the bank's market risk loss distribution over a
10-business-day horizon, in other words a solvency standard designed to
exceed trading losses for 99 out of 100 10-business-day intervals.
[11] 72 Fed. Reg. 69288 (Dec. 7, 2007).
[12] The four phases are (1) the parallel run--four consecutive
quarters in which a bank meets the qualification requirements and is
subject to the Basel I rules but simultaneously calculates its risk-
based capital ratios under the advanced approaches; (2) the first
transitional period--a period of at least four consecutive quarters in
which the bank computes its risk-based capital ratios using the Basel I
rule and the advanced approaches rule, and required risk-based capital
must be at least 95 percent of the Basel I requirement; (3) the second
transitional period--a period of at least four consecutive quarters in
which the bank computes its risk-based capital ratios using the Basel I
rule and the advanced approaches rule, and required risk-based capital
must be at least 90 percent of the Basel I requirement; and (4) the
third transitional period--a period of at least four consecutive
quarters in which the bank computes its risk-based capital ratios using
the Basel I rule and the advanced approaches rule, and required risk-
based capital must be at least 85 percent of the Basel I requirement.
[13] Banks must hold total capital equal to at least 8 percent of the
total value of their risk-weighted assets and Tier 1 capital of at
least 4 percent. Tier 1 capital is considered most stable and readily
available for supporting a bank's operations. It covers core capital
elements, such as common stockholder's equity and noncumulative
perpetual preferred stock. All assets are assigned a risk weight
according to the credit risk of the obligor or the nature of the
exposure and the nature of any qualifying collateral or guarantee,
where relevant. Off-balance sheet items, such as credit derivatives and
loan commitments, are converted into credit equivalent amounts and also
assigned risk weights. The risk weight categories are broadly intended
to assign higher-risk weights to--and require banks to hold more
capital for--higher-risk assets, and vice versa. See 12 C.F.R. Part 3
(OCC); 12 C.F.R Part 208 and Part 225, App. A & B (Federal Reserve); 12
C.F.R. Part 325 (FDIC); and 12 C.F.R. Part 567 (OTS).
[14] Banks and thrifts holding the highest supervisory rating have a
minimum leverage ratio of 3 percent; all other banks must meet a
leverage ratio of at least 4 percent. See 12 C.F.R. §§ 3.6 (OCC), 208 &
App. B (FRB), 325.3 (FDIC), and 567.8 (OTS). Bank holding companies
that have adopted the MRA or hold the highest supervisory rating are
subject to a 3 percent minimum leverage ratio; all other bank holding
companies must meet a 4 percent minimum leverage ratio. 12 C.F.R. Part
225, App. D. Thrift holding companies are not subject to specific risk-
based or leverage ratios, but are instead required by OTS to hold
adequate capital at the holding company level.
[15] See GAO, Deposit Insurance: Assessment of Regulators' Use of
Prompt Corrective Action and FDIC's New Deposit Insurance System, GAO-
07-242 (Washington, D.C.: Feb. 15, 2007), which responds to a
legislative mandate that GAO review federal banking regulators'
administration of the prompt corrective action program (P.L. 109-173,
Federal Deposit Insurance Reform Conforming Amendments Act of 2005,
Section 6(a), Feb. 15, 2006).
[16] Three of the four CSEs are also thrift holding companies. See GAO,
Financial Market Regulation: Agencies Engaged in Consolidated
Supervision Can Strengthen Performance Measurement and Collaboration,
GAO-07-154 (Washington, D.C.: Mar. 15, 2007) on the overlapping
responsibilities of OTS and SEC with regard to these firms.
[17] Paul S. Calem and James F. Follain, "Regulatory Capital Arbitrage
and the Potential Competitive Impact of Basel II in the Market for
Residential Mortgages," Journal of Real Estate Finance and Economics,
vol. 35 (2007), and Diana Hancock, Andreas Lehnert, Wayne Passmore, and
Shane M. Sherlund, An Analysis of the Potential Competitive Impacts of
Basel II Capital Standards on U.S. Mortgage Rates and Mortgage
Securitization, Federal Reserve Board Working Paper (April, 2005); Mark
J. Flannery, Likely Effects of Basel II Capital Standards on
Competition within the 1-4 Family Residential Mortgage Industry,
manuscript, (Gainesville, Fla.: October, 2006).
[18] Consolidated data for thrift holding companies that would be
comparable to the information in table 2 is not readily available from
OTS. By looking at those thrifts that make up a high percentage of the
assets of the holding company, we see that thrifts and thus their
holding companies hold a higher percentage of their assets in retail
markets especially mortgage markets. They have only a small percentage
of their assets in wholesale markets and these are concentrated in
commercial real estate. Those thrift holding companies where the thrift
is not a large part of the holding company are often in a wide range of
businesses outside of banking including insurance, retail sales, and
manufacturing. As a result only a few of these such as GE Capital
Company and Ameriprise Financial Inc. would be competing with bank
holding companies.
[19] W.W. Lang, L.J. Mester, and T.A. Vermilyea, Competitive Effects of
Basel II on U.S. Bank Credit Card Lending, Federal Reserve Working
Paper 07-9 (Philadelphia, Pa.: March 2007).
[20] See, GAO Small Business Administration: Additional Measures Needed
to Assess 7(a) Loan Program's Performance, GAO-07-769 (Washington,
D.C.: July 13, 2007).
[21] See Allen N. Berger, "Potential Competitive Effects of Basel II on
Banks in SME Credit Markets in the United States," Journal of Financial
Services Research, 29:1 (2006), pp. 5-36.
[22] Holding capital involves balancing the needs of creditors and
equity investors. More capital reassures creditors that banks will be
able to repay loans, which reduces the cost of borrowing. But more
capital also means that banks retain more shareholder equity, which
reduces return on equity, an important benchmark for investors.
[23] In previous work, officials at several banks told us that they
weigh a number of factors when deciding how much capital to hold,
including regulatory requirements, internal economic capital models,
strategic needs, and market expectations, which are often exemplified
by assessments from credit rating agencies such as Moody's and Standard
and Poor's. Officials at one of these rating agencies agreed that banks
manage capital to meet these demands.
[24] In particular, there is very little "exogenous variation"
(variation caused by regulation and not by banks themselves) in minimum
capital requirements across banks, making it extremely difficult to
estimate the impact of changes or differences in minimum capital
requirements.
[25] A decrease in required capital was met with a reduction in actual
capital of only 20 percent of the size of the decrease in required
capital. However, it is not clear that these quantitative estimates
would apply to banks competing in the United States. Because small
banks tend to hold a relatively large buffer of capital over minimum
requirements, changes in those requirements may result in relatively
little change in the amount of capital these banks hold. Isaac Alfon,
Isabel Argimón and Patricia Bascuñana-Ambrós, "How do individual
capital requirements affect capital at UK banks and building
societies." Documentos de Trabajo No. 0515, Banco De España, 2005.
[26] W. Mark Crain, The Impact of Regulatory Costs on Small Firms, for
the Small Business Administration Office of Advocacy, September 2005.
This study does not necessarily represent the views of the Office of
Advocacy or the Small Business Administration.
[27] As part of the Department of the Treasury, OCC and OTS are subject
to Executive Order 12866, as amended, which requires executive agencies
to submit to OMB a regulatory impact analysis when issuing rules or
regulations that will likely exceed annual costs of $100 million or
more to government entities or the private sector.
[28] OMB and the Secretariat General of the European Commission, Review
of the Application of EU and US Regulatory Impact Assessment Guidelines
on the Analysis of Impacts on International Trade and Investment: Joint
Draft for Comment (Washington, D.C./Brussels, Belgium: Nov. 8, 2007).
[29] See appendix III for a timeline of Basel II implementation in the
United States.
[30] Of the foreign countries we visited, only Canada has a leverage
requirement that is similar in some ways to the one in the United
States. The Swiss National Bank is also considering the introduction of
a leverage requirement. Some Basel Committee member countries have
other supplementary capital measures, akin to the well-capitalized
designation for U.S. depository institutions, which are generally based
on risk and assessed in Pillar 1 or Pillar 2.
[31] The Basel Committee has issued general principles for information
sharing between home and host countries. See Basel Committee, Home-host
Information Sharing for Effective Basel II Implementation (Basel,
Switzerland: June 2006).
[32] Established in 1996 under the aegis of the Basel Committee, the
International Organization of Securities Commissions, and the
International Association of Insurance Supervisors, the Joint Forum on
Financial Conglomerates (Joint Forum) deals with issues common to the
banking, securities, and insurance sectors, including the regulation of
financial conglomerates.
[33] A number of factors could have caused QIS-4 to either
underestimate or overestimate minimum required capital. In addition,
the sensitivity of the advanced approaches to economic conditions and
the good economic environment during QIS-4 were important factors in
explaining lower estimates of required capital. There are some
limitations associated with the data from QIS-4. At the time, the
regulators emphasized that the QIS-4 was conducted on a "best efforts"
basis with limited data and without the benefit of fully articulated
final rules for U.S. implementation.
[34] Note that neither study's conclusions are based on an analysis of
a standardized approach. Paul S. Calem and James F. Follain,
"Regulatory Capital Arbitrage and the Potential Competitive Impact of
Basel II in the Market for Residential Mortgages," Journal of Real
Estate Finance and Economics, vol. 35 (2007), and Diana Hancock,
Andreas Lehnert, Wayne Passmore, and Shane M. Sherlund, An Analysis of
the Potential Competitive Impacts of Basel II Capital Standards on U.S.
Mortgage Rates and Mortgage Securitization, Federal Reserve Board
(April 2005).
[35] The proposed standardized rule incorporates many features that
U.S. regulators proposed in Basel IA, which also was proposed to limit
potential competitive advantages core banks may have had over non-core
banks. For example, Basel IA included the increased risk-sensitivity in
residential mortgages that is also in the proposed standardized
approach.
[36] Alternatively, banks could eliminate the leverage requirement and
receive the lower, risk-based capital requirement by converting the
asset to an off-balance sheet activity, such as by selling a guarantee
on that asset in the event of default. To the extent risk-based capital
requirements decrease for some assets under the advanced approaches,
the incentive for core banks to do so may increase.
[37] Basel Committee, Proposed Revisions to the Basel II Market Risk
Framework (Basel, Switzerland: July 2008).
[38] Basel Committee, Principles for Sound Liquidity Risk Management
and Supervision (Basel, Switzerland: June 2008). Liquidity risk is the
risk that a bank will be unable to meet its obligations when they come
due, because of an inability to liquidate assets or obtain adequate
funding.
[39] See GAO-07-154.
[40] Under the final rule, other issues that regulators will consider
as part of the study are: the potential cyclical implications of the
rule; comparison of regulatory capital requirements to market-based
measures of capital adequacy, such as risk premiums on subordinated
debt; examination of robustness of risk management processes related to
capital adequacy; and analysis of interest rate and concentration
risks.
[41] 71 Fed. Reg. 55830 (Sept. 25, 2006) (Basel II NPR); 71 Fed. Reg.
77446 (Dec. 26, 2006) (Basel IA NPR); 72 Fed. Reg. 69288 (Dec. 7, 2007)
(final rule on advanced approaches); and 73 Fed. Reg. 43982 (July 29,
2008) (proposed standardized rule).
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