The decision by the US to retain the leverage ratio has been validated by the events of the financial crisis and spared the country from an even more severe fiscal implosion, a senior Federal Deposit Insurance Corporation (FDIC) official has claimed.
Speaking yesterday during a webcast looking at the future of Basel II in the wake of the financial crisis, Nancy Hunt, in charge of capital markets policy in the FDIC's division of supervision and consumer protection, described the US's failure to implement the Basel II Accord before the crisis hit as fortunate.
"Is it fortuitous that the US has not fully implemented the advanced approaches in Basel II? Would Basel II have allowed US banks to hold less capital? Yes, this would have been limited for the first couple of years by our capital floors but after three years those floors would have, in fact, disappeared," said Hunt.
"Would the US financial system have been even worse off and required additional government intervention [if Basel II had been implemented before the crisis]? I think the simple answer to that is yes," she added.
Five US regulators – the Federal Reserve, the FDIC, the Securities and Exchange Commission, the Office of Comptroller of the Currency and the Office of Thrift Supervision – took the view that only large and internationally active 'core banks' with total assets of more than $250 billion should be able to adopt the advanced approaches to calculate their regulatory capital requirements for credit, market and operational risk.
Political disagreements between the five agencies over how the Basel II proposals should be implemented in the US meant the Accord fell more than two years behind schedule in the US while European nations pushed ahead as planned.
One of the main points of contention was the FDIC's insistence upon the retention of the leverage ratio, a blanket minimum capital floor that stated strong financial institutions must hold at least 3% of Tier I capital against total assets while all other institutions must hold at least 4%.
While the deposit insurer argued repealing the ratio would threaten bank capitalisation, financial institutions hit back by claiming that retaining the floor would negate the capital relief offered by the risk-sensitive framework, lumbering firms with all of the compliance costs but none of the benefits of the accord.
In the aftermath of the crisis, Hunt proposed that the FDIC's opposition to the abolition of the leverage ratio has been proven as the right course of action, especially since the Basel Committee is now also advocating the introduction of an international leverage measure.
"The FDIC chairman [Sheila Bair] was particularly concerned about declines in risk-based capital and she insisted on keeping the leverage ratio and pushed for tougher floors in the US implementation of Basel II," she said. "With supplementary measures of leverage – which is Basel speak for what we in the US refer to as the leverage ratio – the goal is to develop a stock-based measure of leverage. The FDIC chairman proposed an international leverage ratio several years ago and her proposal was summarily dismissed. I would say times have certainly changed since then," Hunt concluded.
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