US agency forms working group on Basel II’s third pillar

FDIC chairman Donald Powell said yesterday there is a balance to be achieved in implementing the pillar 3 provisions of the Accord, and “we should work together with the industry to find it”. The FDIC is one of the main US banking regulatory agencies.

The Basel II capital Accord, which global regulators hope to introduce in late 2006, is based on three pillars. Pillar 1 requires capital charges against banking risks and pillar 2 provides for the supervision of banks. Pillar 3, which Powell said has not been talked about very much, seeks to exert market discipline on banks through greater disclosure of their risk management policies.

In some cases, disclosure will have to be increased and the ensuing market discipline will be an extra defence against poor judgement, a faulty strategy, or a flawed assumption, Powell told a banking conference on Basel II in New York. The conference was jointly hosted by the FDIC and investment bank Credit Suisse First Boston (CSFB).

“But we regulators have to be disciplined about how we approach this,” he added.

The proposed working group would seek to recommend a disclosure policy based on four principles, Powell said.

First, it should provide financial markets access to important and timely information, so investors can make sound decisions and impose market discipline.

Second, it should enhance the safety, soundness and stability of the financial system.

Third, the policy should ensure a level playing field on disclosure between US banks and their overseas competitors.

Fourth, the disclosure regime should ensure timely implementation of Basel II.

Powell said that while Basel II is expected to have an impact on only a handful of large international banks at the outset, it “brings on important issues for both the financial services industry as well as the regulatory community”.

The Basel Committee on Banking Supervision, the architect of Basel II and the body that effectively regulates international banking, agreed the main issues of the oft-delayed Accord in July. The agreement came after several months of uncertainty, during which time some banks and regulators doubted the Accord would ever come into force.

Meanwhile, a senior CSFB official told yesterday’s conference that the Basel II capital rules will be substantial, and could push some commercial banks out of the financial system.

CSFB head of strategic risk management, D Wilson Ervin, estimated the cost of meeting the new capital standards at $25 million to $50 million for a medium-sized bank and perhaps two to three times that amount for a large bank.

“That’s a considerable percentage of bank profitability, particularly in a market like this one,” Ervin said. He said if system costs were high, banks would earn a lower return on capital and therefore grow more slowly.

“There may even be some incentives to de-bank altogether. In short, we may get a better-regulated commercial banking system, but there may be fewer banks to regulate over time,” Ervin said. CSFB is a unit of Swiss banking group Credit Suisse.

But Adam Gilbert, head of corporate treasury at US bank JP Morgan Chase, said the Basel II changes were heading in the right direction, and would align supervisors’ risk management practices with those used internally by banks. Regulators were simply catching up, he said.

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