QIS 4 results are worrisome, say banking agencies

American federal banking agencies have told Congress of their deep concerns about the results of the fourth Basel II Quantitative Impact Study (QIS4).

At a congressional hearing on Basel II: Capital Changes in the U.S Banking System and the Results of the Impact Study, representatives of the banking regulators all said the results of the QIS4 were too widely varied and that they needed more analysis.

"QIS4 shows excessive reductions in risk-based capital requirements. Capital requirements fell by more than 26% in more than half of the institutions in the study. This is without fully factoring in the benefits of credit risk hedging and guarantees that are likely to reduce capital requirements significantly more.

"For individual loan types at individual banks, over one third of the reductions in capital requirements were in the range of 50% to almost 100%. Numbers like this do not provide comfort that the Basel framework will require capital adequate for the risks of individual activities," said Thomas Curry, director of the Federal Deposit Insurance Corporation (FDIC), in his testimony.

Curry said the FDIC was concerned that the dispersion of results suggests there is a difficulty in applying the framework consistently across banks. "Capital requirements in Basel II are very sensitive to inputs. Achieving consistency in Basel II depends on the idea that best practices and best data will lead to convergence in the capital treatment of similar loan portfolios across banks. At present, however, at least as indicated by QIS4, there is little commonality in the approaches the various banks used to estimate their risk inputs," he said.

Susan Bies, member of the board of governors of the Federal Reserve System, said in her testimony that the final adoption of Basel II in the US would only occur after "we are satisfied that Basel II is consistent with safe and sound banking in this country." She hoped that the agencies would release the NPR in autumn 2005.

Richard Riccobono, the acting director of the Office of Thrift Supervision, said it was important that the rewriting of Basel I does not lag the Basel II process. "We strongly support amending the existing domestic Basel I regulations simultaneously, or in close proximity to, rule-making efforts implementing Basel II," said Riccobono.

The FDIC also argued for the preservation of the leverage ratio alongside a Basel II framework. Curry said the leverage ratio is necessary because it covers the risks that are left out by the Basel Accord.

"Basel II is not comprehensive; for example, capital is not required for interest rate risk associated with loans held to maturity, or liquidity risk. These are material risks. The elimination of the leverage ratio would send the signal that these are secondary risks of little importance to the regulatory community. Also, no matter how the data used to drive the capital calculation is sliced, we cannot lose sight of the fact that the past 10 years have been some of the best years in banking. It is difficult to expect this data - collected during good economic times - will be sufficient to generate capital requirements robust enough to withstand extreme losses under adverse conditions," said Curry.

Bies also urged Congress not to enact the United States Financial Policy Committee For Fair Capital Standards Bill, which seeks to set up a Committee for the banking and thrift regulators to reach a common US position on the Basel issue, and authorises the secretary of the Treasury, as its chairman, to determine a common position on any issue about which the regulators could not agree.

"The Federal Reserve believes that the bill does not fully reflect the existing process used by the four agencies to develop and modify Basel II and we would counsel that Congress not enact it. The ability of the US agencies to negotiate effectively at Basel would be severely constrained if our foreign counterparts knew that we had to return to a committee before we could agree.

"The formalised 'decision by committee' approach of the bill would not advance US interests in the complex and dynamic Basel negotiation process," she said.

BaselAlert.com