Banks get set to prepare feisty responses to the US ANPR

NEW YORK - US banks are going to hit back hard at the country's regulatory agencies in their responses to the advance notice of proposed rulemaking (ANPR).

US banks are among the strongest opponents of the Pillar I operational risk charge under the new Basel II framework, as published in the Basel Committee on Banking Supervision’s third consultative paper (CP3) and echoed in the US regulators’ proposals. The banks are preparing responses to the ANPR that will attempt to undermine the rationale for the charge, and shift it into Pillar II. The banks will also raise a number of other difficulties in the implementation of the op risk framework.

Banks have hinted strongly at the probable tone of their ANPR responses in their published responses to Basel’s CP3, and in remarks at various conferences and interviews. Indeed, US regulators are paying close attention to those documents. "There are some specific issues in the CP3 document that have come back to us in the commentary," said CK Lee, special advisor to the chairman at the Federal Deposit Insurance Corporation (FDIC) at an Incisive Risk Waters conference in New York, in mid-September. "We can begin to work on these and try to address them right now."

Concerns
For a start, many US banks seem confused about the origins of Basel II, and deeply suspicious that it is a ‘European’ project. For example, the Massachusetts Bankers Association wrote in its CP3 response: "The Accord is an extremely comprehensive framework created originally for large European banks." It continued: "Unlike the US market, however, there are few regional or community banks serving as viable retail lenders in Europe. Therefore, the competitive threat caused by this regulatory proposal will only destabilize US markets."

There also seems to be a general feeling among US banks that they have somehow been left out of the Basel II process. The author of the response to CP3 from MBNA, a Delaware-based bank, wrote that the bank "has been a very diligent and active participant throughout the Basel II process, but many of our concerns have been largely ignored".

Another substantial concern among the US banks is, ironically, that the Basel II framework is only going to be applied to 11 institutions in the US, and they will have to adopt the advanced measurement approach (AMA). All other US banks will remain on Basel I. The banks that will be on Basel II, according to regulatory sources and the firms themselves, include: Bank of America, Bank of New York, Bank One, Citigroup, Fleet Boston, JP Morgan Chase, MBNA, State Street, Wachovia, Washington Mutual and Wells Fargo.

Although banks initially lobbied heavily in favour of restricting the number of institutions that would be forced to adopt Basel II, many institutions now say that this will create substantial competitive disadvantages across a number of fronts.

Said Boston-based State Street in its CP3 response: "By leaving many US banks outside the reach of the New Accord, and thus not subject to an operational risk capital requirement, US regulators will aggravate the competitive distortions created by the proposal. Under the US proposed implementation of the New Accord, banks competing in identical business lines will face markedly different capital requirements."

State Street itself, for example, will probably see a substantial rise in its overall regulatory capital position because of an increased op risk charge, while securities firms regulated by the Securities and Exchange Commission will be exempt from Basel II. And non-bank banks - institutions that can perform bank-like functions but that fall outside of the jurisdiction of banking regulators - are also exempt.

Others express concern that banks will be forced to jump immediately from Basel I to the AMA, whether they are so-called mandatory banks or they are opting in. The Philadelphia-based Risk Management Association’s (RMA) Working Group on Operational Risk Regulation said that the US should permit banks that are "opting in" to the AMA to use the basic indicator approach or the standardised approach on some business lines as they make the transition to the AMA.

Wrote the RMA: "Partial options should increase the number of Opt-In banks in the United States and encourage more improvements in operational risk management sooner than otherwise."

Certain banks will also, there is little doubt, continue to lobby heavily for shifting the operational risk charge from Pillar I to Pillar II. Pittsburgh-based Mellon Bank, for example, wrote that the existence of op risk as a Pillar I charge is one of its most "significant concerns". But US regulators privately say that it is unlikely that op risk will be shifted out of Pillar I, and point out that support for the approach is increasing. Says one Federal Reserve official: "Of course in some quarters the opposition is still as fervent as ever - but I do think there is more acceptance than in earlier go-arounds."

Lower down the pile
There are also a host of smaller issues that deal with the implementation of the ANPR. The role of expected loss (EL) in the calculation of the op risk charge is a sore point that numerous banks will raise, including JP Morgan Chase, according to one of the bank’s executives. In the ANPR, US regulators have set standards that will make it difficult for US banks to be able to exclude EL from their op risk capital calculations. As a result, many respondents sought clarification on the Basel Committee’s position on EL, hoping to influence change in the US.

"The exclusion of EL from the operational risk charge should be promoted as best practice by the Accord," says the RMA’s response to CP3, for example. "CP3 requires banks to demonstrate that EL is accounted for in operational costs before they can be excluded from the operational risk capital charge. It would be better to require banks to recognize EL as operating cost wherever accounting rules permit."

Other issues that will be commented on in depth include the 99.9% confidence interval for modelling operational risk, and the potential use of external data in modelling, according to senior operational risk executives from US banks.

In spite of this flurry of opposition, US regulators try to strike a moderate tone when discussing potential comments to the ANPR. Said William Rutledge, executive vice president at the New York Federal Reserve at the mid-September Incisive Risk Waters conference in New York: "We are seeking comment on specific elements of the guidance, as well as on the broader question of whether an appropriate balance has been struck between flexibility and specificity. The US supervisory agencies are interested in all views on the draft supervisory guidance, including any instances where current sound risk management practices would not fit neatly into, or be considered appropriate under, the proposed supervisory guidance."

Comments on the ANPR are due in to US regulators on November 4.Operational Risk