US finally reaches compromise on Basel II

Basel 1A dropped and advanced approaches to be consistent with international standards

US regulators appear to have listened to industry protest and plan to issue Basel II rules that more closely follow those of their global counterparts.

The four US regulators responsible for implementation – the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency and the Office of Thrift Supervision – said on Friday they had agreed to enact advanced rules more in line with other interpretations of the Basel II accord, and would remove the Basel 1A approach as an option for smaller banks.

The regulators have also dropped the alternative minimum capital requirements, which allowed the Basel framework to be revised if aggregate reductions in risk-based capital requirements decreased by more than 10%.

Advanced approach
In a joint statement, the regulators said the advanced approaches “should be technically consistent in most respects with international approaches.”

This news will come as a welcome relief to the 11 large banks set to adopt the advanced version of Basel. The banks had complained that previous drafts of the Basel II rules would give their European and Asia-Pacific counterparts a competitive advantage.

Basel 1A
The regulators also agreed that smaller banks will be allowed to adopt the Basel II standardised approach, rather than Basel 1A.

Basel 1A, a revised version of the first Basel accord, was seen by some as outmoded.

Randall Kroszner, a governor at the Federal Reserve, said recently that Basel I was inadequate for the modern banking industry because its “risk-bucketing approach creates perverse incentives for risk-taking and because it is “inadequate for dealing with capital markets transactions”.

The three-year transition period – which allows for maximum cumulative reductions of 5% during the first year of implementation, 10% in the second and 15% in the final year – was retained.

Delays
The regulators came under pressure from the Senate Banking Committee last Tuesday to agree on Basel fast.

Chris Dodd, a senator and chair of the Committee, said in a letter to regulators: “We urge you to continue your work [on Basel II] with the goal of reaching a consensus as soon as practicable.”

Following Friday’s agreement, Dodd said: “We commend banking regulators for reaching a unanimous agreement and appreciate their stated commitment to achieve consensus throughout implementation.”

Disagreements between the FDIC and the other agencies over the effectiveness of the advanced approaches led to the US falling behind in adopting the Basel II accord.

The inclusion of stringent reviews in the implementation process appears to have appeased the FDIC’s head, Sheila Bair.

Bair said: “We all want the advanced approaches to work in producing a more risk-sensitive framework that maintains strong levels of capital to protect the safety net. But many questions remain about the framework, and this agreement will help assure that we will be able to fix any problems before capital levels are allowed to drop precipitously.”

Some market commentators see the agreement as a victory for the Federal Reserve. Kroszner defended both the advanced approaches and a framework more in line with those due to be introduced in other jurisdictions earlier this month.

The regulators could now meet the September target set for the release of the final rules.