Regulatory update: U.S. issues proposed rules to implement Basel II

Many are beginning to ask whether the Basel Committee will meet its ambitious deadline to produce a final rule governing the new Accord by the end of this year. Given that the new rules must be adopted by the individual participant countries once they are finalized, it is becoming ever more likely that those questioning the current timeline will be correct.

Consider the timeline in the U.S., for instance. On August 4, the four bank regulatory agencies published in the Federal Register proposed rules to implement Basel II. The industry must comment by November 3, 2003. The U.S. agencies are expected to issue a revised proposed rule incorporating industry views in the first half of 2004. The industry would then have another 90 days to comment on the revised proposal before the agencies issue a final rule. Once the final rule is proposed, the industry would have an additional 90-day opportunity to comment.

Thus, it is entirely possible that U.S. rules to implement Basel II will not be in place until sometime in 2005. The European Union and its individual members must adopt regulation to implement the new Basel Accord as well and are also unlikely to do so before the close of 2004, the date by which the new Accord is scheduled to become effective.

The U.S. Congress has stepped into the Basel reform debate also, which could slow the process further. At hearings held this summer, with more scheduled this fall, public policy makers raised a number of questions about the level of complexity contained in the proposed new Basel Accord. Fairness issues also surfaced, including the desirability of having two, separate capital regulation standards: one for very big, internally active banks, and one for smaller banks.

The U.S. bank regulatory agencies echoed these very questions when they issued the proposed rules to implement the new Capital Accord. It is therefore quite likely that the debate will continue for some time.

Do capital regulations that allow institutions to align regulatory capital requirements to the level of risk they are taking benefit those institutions that are allowed to do so? The answer to this question is undoubtedly an unqualified yes. However, it is not entirely clear at this point that the new Capital Rules will accomplish this goal. Moreover, the new rules could fail to align regulatory, capital to the true underlying risk, and advanced institutions would be no better off than they are today. Indeed, things could get worse if the new rules are very complex, burdensome, and costly yet fail to reflect best practices within the industry.

Many in the industry have argued that those institutions unable to implement the new Capital Rules will be disadvantaged in the marketplace. However, they will be no more disadvantaged than they are at present, since the most advanced institutions are already using internal risk assessment systems to assign economic capital. The most advanced institutions, including banks both large and small, understand how their capital is deployed and price their products accordingly. Moreover, it's not necessary to implement the new Basel Accord for institutions to more effectively manage capital. In many ways, the Basel Committee is only attempting to catch up with what the best within the industry are already doing.

While it can be argued that the Basel Committee has fallen short of this objective, many of the Committee's recommendations do represent best practices. For instance, no one would question the benefit of a dual risk-rating system. The new Basel Accord requires it and, indeed, much, much more. For this reason, it is a very good idea for all institutions, both large and small, to take a look at what the U.S. regulators are proposing for Basel II implementation. It is also a very good idea to comment upon the proposed rule. RMA will be doing so.

RMA has been active in the Basel reform process since 1999, when we formed the RMA Capital Working Group. All of the work produced by the Group to date is on RMA's Web site: www.rmahq.org/ Basel2/Basel_intro.htm.

RMA believes that regulatory capital requirements should be more closely aligned with underlying risk. Indeed, we have watched this best practice emerge within the industry and believe that, ultimately, the market will require all institutions to maximize their capital base.

Pamela Martin is executive editor of The RMA Journal and director of Regulatory Relations and Communications at RMA--The Risk Management Association.

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