[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]
THE NEW BASEL ACCORD: IN SEARCH
OF A UNIFIED U.S. POSITION
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
FINANCIAL INSTITUTIONS AND CONSUMER CREDIT
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTH CONGRESS
FIRST SESSION
__________
JUNE 19, 2003
__________
Printed for the use of the Committee on Financial Services
Serial No. 108-40
91-770 U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 2003
____________________________________________________________________________
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HOUSE COMMITTEE ON FINANCIAL SERVICES
MICHAEL G. OXLEY, Ohio, Chairman
JAMES A. LEACH, Iowa BARNEY FRANK, Massachusetts
DOUG BEREUTER, Nebraska PAUL E. KANJORSKI, Pennsylvania
RICHARD H. BAKER, Louisiana MAXINE WATERS, California
SPENCER BACHUS, Alabama CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York NYDIA M. VELAZQUEZ, New York
EDWARD R. ROYCE, California MELVIN L. WATT, North Carolina
FRANK D. LUCAS, Oklahoma GARY L. ACKERMAN, New York
ROBERT W. NEY, Ohio DARLENE HOOLEY, Oregon
SUE W. KELLY, New York, Vice Chair JULIA CARSON, Indiana
RON PAUL, Texas BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio GREGORY W. MEEKS, New York
JIM RYUN, Kansas BARBARA LEE, California
STEVEN C. LaTOURETTE, Ohio JAY INSLEE, Washington
DONALD A. MANZULLO, Illinois DENNIS MOORE, Kansas
WALTER B. JONES, Jr., North CHARLES A. GONZALEZ, Texas
Carolina MICHAEL E. CAPUANO, Massachusetts
DOUG OSE, California HAROLD E. FORD, Jr., Tennessee
JUDY BIGGERT, Illinois RUBEN HINOJOSA, Texas
MARK GREEN, Wisconsin KEN LUCAS, Kentucky
PATRICK J. TOOMEY, Pennsylvania JOSEPH CROWLEY, New York
CHRISTOPHER SHAYS, Connecticut WM. LACY CLAY, Missouri
JOHN B. SHADEGG, Arizona STEVE ISRAEL, New York
VITO FOSSELLA, New York MIKE ROSS, Arkansas
GARY G. MILLER, California CAROLYN McCARTHY, New York
MELISSA A. HART, Pennsylvania JOE BACA, California
SHELLEY MOORE CAPITO, West Virginia JIM MATHESON, Utah
PATRICK J. TIBERI, Ohio STEPHEN F. LYNCH, Massachusetts
MARK R. KENNEDY, Minnesota ARTUR DAVIS, Alabama
TOM FEENEY, Florida RAHM EMANUEL, Illinois
JEB HENSARLING, Texas BRAD MILLER, North Carolina
SCOTT GARRETT, New Jersey DAVID SCOTT, Georgia
TIM MURPHY, Pennsylvania
GINNY BROWN-WAITE, Florida BERNARD SANDERS, Vermont
J. GRESHAM BARRETT, South Carolina
KATHERINE HARRIS, Florida
RICK RENZI, Arizona
Robert U. Foster, III, Staff Director
Subcommittee on Financial Institutions and Consumer Credit
SPENCER BACHUS, Alabama, Chairman
STEVEN C. LaTOURETTE, Ohio, Vice BERNARD SANDERS, Vermont
Chairman CAROLYN B. MALONEY, New York
DOUG BEREUTER, Nebraska MELVIN L. WATT, North Carolina
RICHARD H. BAKER, Louisiana GARY L. ACKERMAN, New York
MICHAEL N. CASTLE, Delaware BRAD SHERMAN, California
EDWARD R. ROYCE, California GREGORY W. MEEKS, New York
FRANK D. LUCAS, Oklahoma LUIS V. GUTIERREZ, Illinois
SUE W. KELLY, New York DENNIS MOORE, Kansas
PAUL E. GILLMOR, Ohio CHARLES A. GONZALEZ, Texas
JIM RYUN, Kansas PAUL E. KANJORSKI, Pennsylvania
WALTER B. JONES, Jr, North Carolina MAXINE WATERS, California
JUDY BIGGERT, Illinois DARLENE HOOLEY, Oregon
PATRICK J. TOOMEY, Pennsylvania JULIA CARSON, Indiana
VITO FOSSELLA, New York HAROLD E. FORD, Jr., Tennessee
MELISSA A. HART, Pennsylvania RUBEN HINOJOSA, Texas
SHELLEY MOORE CAPITO, West Virginia KEN LUCAS, Kentucky
PATRICK J. TIBERI, Ohio JOSEPH CROWLEY, New York
MARK R. KENNEDY, Minnesota STEVE ISRAEL, New York
TOM FEENEY, Florida MIKE ROSS, Arkansas
JEB HENSARLING, Texas CAROLYN McCARTHY, New York
SCOTT GARRETT, New Jersey ARTUR DAVIS, Alabama
TIM MURPHY, Pennsylvania
GINNY BROWN-WAITE, Florida
J. GRESHAM BARRETT, South Carolina
RICK RENZI, Arizona
C O N T E N T S
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Page
Hearing held on:
June 19, 2003................................................ 1
Appendix:
June 19, 2003................................................ 59
WITNESSES
Thursday, June 19, 2003
Elliott, Steven G., Senior Vice Chairman, Mellon Financial
Corporation.................................................... 44
Ferguson, Hon. Roger W. Jr., Vice Chairman, Board of Governors of
the Federal Reserve System..................................... 7
Gilleran, Hon. James E., Director, Office of Thrift Supervision.. 17
Green, Micah S., President, The Bond Market Association.......... 48
Gup, Benton E., Chair of Banking, University of Alabama.......... 46
Hawke, Hon. John D. Jr., Comptroller, Office of the Comptroller
of the Currency................................................ 11
Powell, Hon. Donald, Chairman, Federal Deposit Insurance
Corporation.................................................... 15
Thomas, Karen M., Director of Regulatory Affairs and Senior
Regulatory Counsel, Independent Community Bankers of America... 50
APPENDIX
Prepared statements:
Oxley, Hon. Michael G........................................ 60
Bachus, Hon. Spencer......................................... 62
Gillmor, Hon. Paul E......................................... 65
Elliott, Steven G............................................ 66
Ferguson, Hon. Roger W. Jr................................... 82
Gilleran, Hon. James E....................................... 114
Green, Micah S............................................... 122
Gup, Benton E................................................ 128
Hawke, Hon. John D. Jr....................................... 141
Powell, Hon. Donald.......................................... 167
Thomas, Karen M.............................................. 182
Additional Material Submitted for the Record
Davis, Hon. Artur:
Letter to Federal Reserve Chairman Alan Greenspan with
response, May 2, 2003...................................... 189
Maloney, Hon. Carolyn B.:
Federal Banking Agencies letter, June 25, 2003............... 195
KeyCorp, prepared statement...................................... 197
THE NEW BASEL ACCORD: IN SEARCH
OF A UNIFIED U.S. POSITION
----------
Thursday, June 19, 2003
U.S. House of Representatives,
Subcommittee on Financial Institutions and
Consumer Credit
Committee on Financial Services,
Washington, D.C.
The Subcommittee met, pursuant to call, at 10:06 a.m., in
Room 2128, Rayburn House Office Building, Hon. Spencer Bachus
[Chairman of the Subcommittee] presiding.
Present: Representatives Bachus, Kelly, Toomey, Hart,
Capito, Tiberi, Hensarling, Murphy, Brown-Waite, Oxley (ex
officio), Sanders, Maloney, Watt, Sherman, Velazquez, Davis and
Frank (ex officio).
Chairman Bachus. [Presiding.] Good morning. The
Subcommittee on Financial Institutions and Consumer Credit is
convened. The Subcommittee meets to examine the proposed Basel
II Capital Accord and its potential effects on the domestic and
international banking systems.
The goal of Basel II is to develop a more flexible and
forward-looking capital adequate framework that better reflects
the risks facing banks and encourages them to make ongoing
improvements to their risk assessment capabilities. The
Subcommittee on Domestic and International Monetary Policy,
Trade and Technology held a hearing in February to examine the
proposal, where we heard from a distinguished panel of
regulators, including Federal Reserve Vice Chairman Ferguson,
Comptroller Hawke, Chairman Powell and a panel of private
sector witnesses.
This hearing revealed that the federal regulators did not
have a unified position on the scope and merits of Basel II.
Following this hearing, I along with Congresswoman Maloney,
Chairman Oxley, Ranking Member Frank, introduced H.R. 2043, the
United States Financial Policy Committee for Fair Capital
Standards Act.
H.R. 2043 requires the federal banking regulators to
develop a unified position on issues under consideration and
the Basel Committee on Banking Supervision. Today, we will hear
from the Federal Reserve, OCC and FDIC, along with OTS Director
James Gilleran.
Our second panel of private sector witnesses includes
representatives of a large bank, a financial services trade
association and university professor. I look forward to hearing
from today's witnesses and thank them for taking time from
their busy schedules to join us.
I applaud the intent and the objectives of Basel II
agreement: to ensure solvency of our banking institutions and
protect against substantial losses; to create international
standards to better manage risk; and align regulatory capital
to economic risk.
The distinguished witnesses on our first panel are to be
commended for the work they have already accomplished on this
agreement. Nonetheless, I have concerns regarding Basel II on
several grounds.
First, I believe it is unnecessarily complex and costly,
with inflexible formulas replacing current rules and
supervisory examinations. In addition, I believe that the
current draft would create an uneven playing field, one that
unfairly penalizes many banks in this country, particularly our
regional banks.
But my main concern is about the transparency of the Basel
process as a whole and specifically, how the U.S. position at
the Basel Committee is determined. I know that there has been
an extensive comment period. And representatives of the Federal
Reserve Board assure me that the banks that would be subject to
Basel II approve of it.
Nonetheless, some of the banks have indicated to me,
through their representatives, that they are in fact
tremendously concerned about Basel. I understand that banks
that have reservations about the U.S. position are hesitant to
object openly to a regulatory agency that exercises power over
them.
This concern seems reasonable to me. I believe we must
arrange for a full airing of the views of all interested
parties, without institutional constraint.
In addition, it has become clear to me that the bank
regulators are not in agreement on the desirability of the
accord as currently drafted. I am hesitant about this Congress
supporting fundamental changes to our banking system in the
face of a lack of consensus among thoughtful regulators.
And I note at this time that the Senate testimony yesterday
by banking representatives did describe Basel II as a
fundamental change in banking supervision and regulation. H.R.
2043 would require the regulators to reach agreement by
establishing a procedural framework for further deliberations
on Basel.
Our bill would create an interagency Committee, chaired by
the Treasury Department, and include federal banking
regulators. If the members cannot reach consensus on a
position, the position of the Treasury would prevail.
It is important that the secretary, as part of the elected
administration, set U.S. policy. Yesterday, I announced at the
Exchequer Club, that the Subcommittee plans to mark up this
legislation in July.
In closing, I want to thank Chairman Oxley, Ranking Member
Frank and Mrs. Maloney for working with me to develop this
legislation. I look forward to working with them and other
members of this Subcommittee on this important issue. I also
look forward to the testimony of our regulators this morning
because, as I have said on two or three occasions, we are
concerned that there are different opinions on Basel II and its
effect on the banking institutions and our financial system as
a whole.
I now am pleased to recognize Mrs. Maloney for an opening
statement. Or Mr. Frank--I am sorry. Mr. Frank has come in.
[The prepared statement of Hon. Spencer Bachus can be found
on page 62 in the appendix.]
Mrs. Maloney. I defer to the ranking member of the
Committee and appreciate so much his intelligent concern on
this issue and so many others. Thank you, Barney.
Chairman Bachus. I just simply did not see that you had
come in. So I apologize.
Mr. Frank. I try to be as unobtrusive as possible, Mr.
Chairman.
[Laughter.]
I appreciate your acknowledging that. I want to comment--
and I appreciate your diligence in giving us a chance to be
involved in this. I must say, I do get the feeling from the
Federal Reserve that our interest is not entirely welcome. But
that is one of the things that concerns me.
I have procedural concerns here as much as substantive. And
I was pleased to hear that you plan to move on this legislation
because I think we have a very big problem in the way in which
we formulate policy here.
Globalization is a fact. It is probably as important in the
financial markets, given the nature of money and its
fungability in finance. Globalization is as powerful a force
there as anywhere else.
So formulating American policy to deal with these global
issues is very important. And I think we do not have a coherent
process in place for formulating these.
And we began these conversations. And some financial
institutions had substantive concerns, called them to my
attention and the attention of some others.
We began these discussions based on those. But my concern
broadened to include the procedures because we were initially
told that there was a Committee of U.S. regulators that had
come up with this common position.
But it now is clear that two of the three federal agencies
disagree with the position to some extent. And frankly, we were
told, to some extent, by the Federal Reserve it seemed to me,
that everybody was in agreement.
And then we heard from the Comptroller of the Currency and
the head of the FDIC that there was not agreement. And to adapt
the line from Chico Marx when he was caught at something he had
denied, the question became, ``Who are we going to believe,
them or our own ears?''
And I am going with my ears. And I think what we need to do
is to create a structure here.
I also continue to believe that while I, along with
everybody else, have not just respect but gratitude for the
great work that the New York Federal Reserve Bank does in
helping us manage our financial institutions, it ought never to
be considered to be on a par with those institutions of the
federal government which have a Presidential appointee at the
head who was confirmed by the Senate.
So when we are told that there is a four-member Committee
and it is the Federal Reserve Board, the New York Fed and the
Comptroller of the Currency and the FDIC, I think that is not
an appropriate structure. I should add that I have been
concerned about some of the substance. And I will ask some
questions specifically about that.
But I also believe that, given the lack of coherence in the
procedures and given the disagreements that evidently exist--
and they are legitimate disagreements. These are not easy
questions to answer.
There is nothing wrong at all with there being legitimate
differences of opinion among regulators. To some extent, they
have different regulatory functions. But they also have
inarturial perspectives. And these are the things that we ought
to have discussed.
But given the obvious differences that continue to exist
among the responsible regulators, it seems to me an error for
us to go forward with what purports to be an American
government position, which does not represent not just some of
the important regulators, but frankly does not seem to have a
lot of support in Congress.
And as much as I respect the work that the Federal Reserve
does, it is not, I think, empowered to speak for the U.S.
government by itself to the extent that it seems to me to be
doing in this situation. I do think that there needs to be some
better working together.
Now I would assume the Fed would have a major role here, a
lead role in some ways. But I think that we have gotten ahead
of ourselves in purporting to have a unified position from
which there is significant dissent among the relevant
regulators and within the Congress and the relevant Committees.
So I appreciate this further chance to address that. And I
thank you very much, Mr. Chairman, for your very diligent work
in this regard.
Chairman Bachus. Thank you. Are there other members wishing
to make--Chairman Oxley? Would you like to make an opening
statement?
Mr. Oxley. Thank you, Mr. Chairman. And thank you for
calling this hearing.
I think the presence of the Chairman and the ranking member
of the full Committee indicate how concerned we are about the
whole process and that this rarely occurs. And I do think it
does point out some concerns that we have, particularly because
it does appear that the regulators have different opinions on
this.
Certainly, the last hearing reflected that. And subsequent
events have also indicated a fissure within the regulating
community here. And obviously, there are some concerns on this
side of the dais as well.
I am going to ask unanimous consent that my formal
statement be made a part of the record, Mr. Chairman.
Chairman Bachus. Without objection.
Mr. Oxley. But only to say that I echo some of the concerns
that the gentleman from Massachusetts brought up in regard to
the substance, as well as the process going forward. This is a
big deal. And the decisions ultimately will reflect and affect
the financial system in this country for a long, long time.
And it is critical that we get it right, not just from the
banking perspective, but a number of non-banking perspectives
as well. I notice we have, on the second panel, some testimony
from the Bond Market Association, which would indicate that
there are some folks that have, perhaps, some opinions as well
that are not technically in the banking community.
So this has a broad reach and a long effect, a long-term
effect on our markets and our banking system. And that is why I
applaud the Chairman for his diligence in this.
We thank him for scheduling a markup on the Oxley-Frank
legislation. And I think it does reflect some of the very
sincere concerns that many of us have.
We have a great deal of respect for Mr. Ferguson and for
the Fed and for their distinguished leadership. It does appear
that there is a difference of opinion on this issue. And we
need to make certain that, at the end of the day, we have a
unified position from this side before going forward.
And with that, I yield back the balance of my time.
[The prepared statement of Hon. Michael G. Oxley can be
found on page 60 in the appendix.]
Chairman Bachus. Thank you.
Mrs. Maloney?
Mrs. Maloney. I thank the Chairman for holding this second
hearing on the Basel II Capital Accord. For more than a year
now, I have been closely following the progress of Basel II.
I participated in the earlier hearing. And I have met with
regulators and bankers. After all this discussion, I still
believe there are significant issues appropriate for
congressional review. As early as last August 14, I wrote the
regulators about this issue. And I believe that many of my
concerns expressed then are still relevant. I remain concerned
about the inclusion of operational risk in Pillar 1. And most
importantly, I want to know more about what the ultimate impact
of the accord will be on U.S. competitiveness.
As a New Yorker, I am very aware of the contingency
planning effort that financial institutions are taking for
physical attacks. I want to be reassured that investments and
business continuity planning, backup systems and insurance will
not be reduced because institutions have to devote resources to
capital charges for operational risk.
From an international competitiveness standpoint, the U.S.
is fortunate that we have the opportunity today to receive
testimony from probably the most sophisticated and most
professional group of financial service regulators in the
world. In each country where Basel II is applied, the domestic
regulators will ultimately be responsible for the compliance of
the in-country institutions.
Not every country has as distinguished a group of
regulators as the U.S. And I fear that differing levels of
application by various international regulators of such an
enormously complex proposal could affect the competitiveness of
our industry and have an impact on all of our constituents and
our economy.
For these reasons, I am pleased to have joined Chairman
Bachus, Chairman Oxley and Ranking Member Frank in introducing
H.R. 2043, the United States Financial Policy Committee for
Fair Capital Standards Act. This legislation takes a balanced
approach to ensuring a unified U.S. position at Basel and a
full study of the effects of the accord on our domestic
industry.
I look forward to the markup in July. And I look forward to
working with the Chairman on this proposal. And I thank him
again for making it a priority of this Subcommittee.
And as I said, I am highly, highly concerned about the
impact of Basel on the competitiveness of our financial
institutions, our financial system. We should not do anything
that would place the United States at a disadvantage by having
a higher capital standard for U.S. institutions.
I yield back.
Chairman Bachus. Gentleman from Pennsylvania is recognized.
Mr. Toomey. Thank you, Mr. Chairman. I just want to briefly
second the comments generally that the gentlelady from New York
just made. One of my concerns is that we have the most robust,
in some ways most aggressive and most effective regulatory
framework for financial institutions arguably in the entire
world.
We also have some of the most competitive and most
successful financial institutions in the world. And I am a
little bit concerned about one specific aspect of the proposed
capital requirements.
And that would be that we would use a Pillar 1 approach for
operational risk, which strikes me in many ways more
appropriately dealt with under the Pillar 2 approach. And I am
concerned that if we go with the Pillar 1 specific capital
requirement, we would in fact be placing our financial
institutions, extremely well regulated, extremely successful in
a variety of ways, at a competitive disadvantage to other
financial institutions.
So I hope we get a chance to explore that issue at this
hearing today. And I thank you for conducting this hearing, Mr.
Chairman.
Chairman Bachus. Mr. Davis, do you have an opening
statement? All right. Thank you.
Ms. Kelly or Mr. Hensarling? All right.
If there are no further opening statements, at this time I
want to welcome our first panel of distinguished witnesses.
From my left to right, they are: the Honorable Roger W.
Ferguson, Jr., Vice Chairman, Board of Governors of the Federal
Reserve System; the Honorable John D. Hawke, Jr., Comptroller,
Office of Comptroller of the Currency; the Honorable Donald
Powell, Chairman of the Federal Deposit Insurance Corporation;
and the Honorable James E. Gilleran, Director, Office of Thrift
Supervision.
I would like to commend you gentlemen on your work to date
on the Basel Agreement, Basel II, and for the attention you
have paid to this issue. I think there have already been
positive changes in the U.S. position. We applaud those.
I note from your testimony today, Vice Chairman, that you
indicated further movement on the real estate issue, and I
commend you for that.
At this time, we will start with Vice Chairman Ferguson. We
welcome your testimony. You will not be limited by the 5-minute
rule. And I am sorry that some of you may not have received
that message earlier. I apologize for that.
STATEMENT OF HON. ROGER W. FERGUSON, JR., VICE CHAIRMAN, BOARD
OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. Ferguson. Chairman Bachus, members of the Subcommittee
on Financial Institutions and Consumer Credit, Chairman Oxley,
Ranking Member Frank, thank you for inviting me to testify on
behalf of the Federal Reserve Board on Basel II and H.R. 2043.
I will be brief. But I ask that my entire statement be
included in the record.
The development of Basel II over the past 5 years has been
transparent and has been supported by a large number of public
papers and documents on the concepts, framework and options, as
well as by a large number of meetings with bankers. Over the
past 18 months, I have chaired a series of meetings with
bankers, often jointly with Comptroller Hawke.
The banking agencies last month held three regional
meetings with banks that would not, under the U.S. proposal, be
required to adopt Basel II, but may have an interest in
choosing to do so. The comment period for the third Basel
consultative paper, sometimes called CP-3, is now in progress.
And in about a month, the banking agencies in this country
hope to release an advance notice of proposed rulemaking, so-
called ANPR, that will outline and seek comment on specific
proposals for the application of Basel II in this country. We
continue to be open-minded about new suggestions, backed by
evidence and analysis, and approaches that simplify the
proposal, but still attain its objectives.
When the comments on CP-3 and ANPR have been received, the
agencies will review them and meet to discuss whether change
are required in the Basel II proposal. In November, we have
scheduled to meet in Basel to negotiate our remaining
differences.
Realistically, this part of the schedule may be too tight
because it may not provide U.S. negotiators with sufficient
time to digest the comments on the ANPR and develop a national
position to present to our negotiating partners. Some slippage
in the schedule will no doubt occur.
Implementation in this country of any final agreement on
Basel II would require a notice of proposed rulemaking, an NPR,
in this country in 2004 and, of course, a review of comments
from that notice of proposed rulemaking. Additional
quantitative impact studies starting in 2004, and probably
conducted for the next 2 years, will also be necessary so we
can be more certain of the impact of the proposed changes on
individual banks and the banking system.
As it stands now, by the fall of 2004, core and opt-in
banks will be asked to develop an action plan leading up to
final implementation. Whenever a final rule is developed, in
2004 or in 2005, there would be at least a 2-year lag before
implementation.
Within that implementation interval, the large banks to
which Basel II will be applied in this country will be
developing their individual bank implementation work plans in
conjunction with their supervisor. As you know, most of the
banks in this country will remain under the current capital
rules. No bank that will be required or chooses to adopt the
new capital accord would be forced into a regime for which it
is not ready.
To be sure, supervisors will expect a formal plan with a
reasonable implementation date from the latter banks once a
final rule is developed. But no bank will be required to adopt
Basel II if it has not yet built the required infrastructure.
At any time during that period, we can slow down the
schedule or revise the rules if there is a good reason to do
so.
Mr. Chairman, you have asked for the Board's views on H.R.
2043. We understand and support the bill's objective, to ensure
that the people sitting at this table work together
cooperatively and that all of us shape our positions,
especially at Basel, with a full understanding of the likely
effects of any decisions on our economy.
With respect, however, the Board believes that the current
process achieves those goals and that legislation is not
necessary.
Moreover, H.R. 2043 could be counterproductive. In the
Board's view, the agencies have demonstrated their ability to
work together, one must admit sometimes not as smoothly as
perhaps others would like.
But also, we have demonstrated our ability to change our
minds on the basis of evidence and persuasion, as you have
indicated, Mr. Chairman, in your opening remarks. The bill
would reduce our ability to negotiate with our foreign
counterparts, eliminate the room for us to disagree and work
out our differences and involve Congress in technical
supervisory and regulatory issues that are probably better left
to the supervisors.
Obviously, of course, we recognize the appropriate interest
and role of Congress in aggressive oversight. And in that
regard, I am obviously pleased to be here.
Let me now turn to three other issues that have been raised
about the current Basel II proposal. The first is competitive
equity.
While this concern takes several forms, the most frequently
voiced is the view that competitive imbalances might result
from what is called a bifurcated set of rules, requiring Basel
II for large banks, while applying the current capital rules
for all other U.S. banks.
The fear is that the banks that remain under the current
capital rules, with capital charges that are not as risk
sensitive, might be at a competitive disadvantage compared to
Basel II banks that would get lower capital charges on less
risky assets.
We take this concern seriously and will be exploring it
through the ANPR. But without prejudging the issue, there are
reasons to believe that little, if any, competitive
disadvantage would be brought to those banks remaining under
the current capital regime.
The basic question is the role of minimum regulatory
capital requirements in the determination of the price and
availability of credit. Our understanding of bank pricing is
that it starts with the capital allocations that the banks
themselves make internally, within their own organizations,
then factors in explicit recognition of the riskiness of the
credit and is then further adjusted on the basis of market
conditions and local competition from bank and non-bank
sources.
In some markets, some banks will be relatively passive
price takers. In either case, regulatory capital is mostly
irrelevant in the pricing decision and therefore, unlikely to
cause competitive disparities.
Moreover, most banks--and especially the smaller ones--hold
capital far in excess of regulatory minimums for various
reasons. Thus, changes in their own or others' minimum
regulatory capital, as might occur under Basel II, probably
would not have much effect on the level of capital they choose
to hold and would therefore not necessarily affect either
internal capital allocations or the resulting pricing.
Finally, the banks that most frequently express a fear of
being disadvantaged by a bifurcated regulatory regime have for
years faced capital arbitrage from larger rivals, who are able
to reduce their capital charges by securitizing loans, for
which the regulatory charge was too high relative to the market
or economic capital charge.
The advanced versions of Basel II to be adopted here would
provide, in effect, risk-sensitive capital charges for lower-
risk assets that are similar to what the larger banks have, for
years, already obtained through capital arbitrage. In short,
competitive realities between banks might not change in many
markets in which minimum regulatory capital charges would
become more explicitly risk sensitive.
Now I do not mean to dismiss competitive equity concerns.
Indeed, I hope that the comments on the ANPR bring forth
insights and analyses that respond directly to the issues,
particularly the observations that I have just made.
But to take a different view, we need to see reasoned
analysis, and not just assertions.
The second area of concern that I would like to focus on is
the proposed Pillar 1 treatment of operational risk.
Operational risk refers to losses from failures of systems,
controls or people.
Capital charges for such risks have been implicit under
Basel I for the last 15 years. These risks will, for the first
time, be explicitly subject to capital charges under the Basel
II proposal. Operational disruptions have caused banks to
suffer huge losses and, in some cases, failures--both here and
abroad. My written testimony provides some recent and familiar
examples.
In an increasingly technologically-driven banking system,
operational risks have become an even larger share of total
risk. At some banks, they are indeed the dominant risk.
To avoid addressing them would be imprudent and would leave
a considerable gap in our regulatory system. The Advanced
Measurement Approach--or the so-called AMA approach--which I am
sure we will discuss further, for determining capital charges
and operational risk, is a principles-based approach that would
obligate banks to evaluate their own operational risks in a
structured but flexible way.
Importantly, a bank could reduce its operational risk
charge by adopting procedures, systems and controls that reduce
its risk or by shifting the risk to others through measures
such as insurance. Some banks, for which operational risk is
the dominant risk, oppose an explicit capital charge and would
prefer the operational risk be handled case by case through the
supervisory review of buffer capital under Pillar 2 of the
Basel II proposal, rather than being subject to an explicit
regulatory capital charge under Pillar 1.
The Federal Reserve believes that would be a mistake
because it would greatly reduce the transparency of risk and
capital that is such an important part of Basel II. It would
lessen potential market discipline and would make it very
difficult to treat risk comparably across banks because Pillar
2 is judgmentally based.
The third concern I would like to discuss is the fear that
the combination of credit and operational risk capital charges
for those U.S. banks that are under Basel II would decline too
much for prudent supervisory purposes. Speaking for the Federal
Reserve Board, let me undermine that we could not support a
final Basel II that caused capital to decline to unsafe and
unsound levels at the largest banks.
There will be several stages before final implementation,
at which resulting capital levels can and will be evaluated. At
any of those stages, if the evidence suggests that the capital
were declining too much, the Federal Reserve would insist that
Basel II be adjusted or recalibrated, regardless of the
difficulties with bankers here and abroad, or with supervisors
in other countries.
But let us keep this in mind: supervisors can achieve their
objective of maintaining the same level of average capital in
the banking industry either by requiring that each bank
maintain its Basel I capital levels or by recognizing that
there will be some divergence levels of capital among banks
because they will be dictated by different risk profiles of the
banks.
To go through the process of devising a more risk-sensitive
capital framework, just to end with the Basel I result in each
bank, is pointless. Greater dispersion in required capital
ratios, if reflective of underlying risk, is an objective, not
a problem to be overcome.
Of course, one must also recognize that capital ratios are
not the sole consideration. The improved risk measurement and
management and its integration into the supervisory system
under Basel II are also critical to ensuring the safety and
soundness of the banking system.
Let me just say, by way of conclusion, that the Basel II
framework is the product of an extensive, multi year dialogue
with the banking industry, regarding evolving best practice
risk management techniques in every significant area of banking
activity. Accordingly, by aligning supervision and regulation
with these techniques, it provides a great step forward in
protecting our financial system and those of other nations to
the benefit of our own citizens.
We now face three choices. We can reject Basel II or we can
delay Basel II as an indirect way of sidetracking it. Or we can
continue the domestic and international process, using the
public comment and implementation process to make whatever
changes are necessary to make Basel II work effectively and
efficiently.
The first two options require staying on Basel I, which is
not a viable option for our largest banks. The third option
recognizes that an international capital framework is in our
self interest, since our institutions are the major
beneficiaries of a sound international financial system.
The Fed strongly supports the third option.
I will be happy to respond to questions. Thank you, Mr.
Chairman.
[The prepared statement of Hon. Roger W. Ferguson can be
found on page 82 in the appendix.]
Chairman Bachus. I appreciate that.
Comptroller Hawke?
STATEMENT OF JOHN D. HAWKE, JR., COMPTROLLER, OFFICE OF THE
COMPTROLLER OF CURRENCY
Mr. Hawke. Thank you, Chairman Bachus, members of the----
Chairman Bachus. Is the microphone on?
Mr. Hawke. It is the job of the Fed to help the OCC.
[Laughter.]
Chairman Bachus. That was the Vice Chairman that turned
your microphone on.
Mr. Hawke. Again, I think it reflects on the fact that they
have an unlimited budget and they can study things like this.
[Laughter.]
Chairman Bachus, thank you, Chairman Oxley, Ranking Member
Frank and members of the Subcommittee. We appreciate the
opportunity to participate in this hearing. And I very much
welcome the interest and involvement of the Subcommittee in
these important issues.
I want to assure the Subcommittee that the OCC, which has
the sole statutory responsibility for promulgating capital
regulations for national banks, will not endorse a final Basel
II framework for U.S. banks until we have determined, through
our domestic rulemaking process, that any changes to our
capital regulations are practical, effective and in the best
interests of the U.S. public and our banking system.
In response to a point that Ranking Member Frank made in
his introductory remarks about who is in charge here, I think
it is important to recognize that Congress has clearly
allocated to each of the federal banking agencies
responsibility for overseeing the capital of banks within their
jurisdiction and for adopting capital regulations. The Fed has
authority over bank holding companies and state member banks;
the FDIC over state non-member banks; and the OCC over national
banks. So it is up to each of us, in the final analysis, to
make our own decision. But the need for achieving agreement
among the agencies, I think, is recognized by us all.
My written testimony provides a detailed discussion of the
background and content of Basel II and the important issues
with which this Subcommittee is properly concerned. I would
like to use this time to make several important points that may
help to put today's testimony into proper focus.
First, all of the U.S. banking agencies share a concern
about the potential effect of Basel II on the capital levels of
large U.S. banks. Our banking system has performed remarkably
well in the difficult economic conditions in recent years, and
I believe that is due, in significant part, to the strong
capital position our banks have maintained. While a more risk-
sensitive system of capital calculation might be expected to
have the effect of reducing the capital of some banks, we would
not be comfortable if the consequence of Basel II were to bring
about very large decreases in required minimum capital levels.
By the same token, if Basel II were to threaten significant
increases in the capital of some banks, it could undermine
support for the proposal itself and might threaten the
competitiveness of those banks. As things stand today, we
simply do not have sufficiently reliable information on the
effect of these proposals on individual institutions or on the
banking industry as a whole.
Before we can make a valid assessment of whether the
results are appropriate and acceptable, we have to know, to a
much greater degree of reliability than we now have, just what
the results of Basel II will be.
The OCC believes that significant additional quantitative
impact analysis will be necessary. Even if the Basel Committee
does not itself undertake such a study--and I think that would
be the preferred approach--I believe it is absolutely essential
that the U.S. agencies make such an assessment prior to the
adoption of final implementing regulations. I strongly believe
that we cannot responsibly adopt final rules implementing Basel
II until we have not only determined with a high degree of
reliability what the impact will be on the capital of our
banks, but have made the judgment that that impact is
acceptable and conducive to the maintenance of a safe and sound
banking system in the United States.
Second, a number of Subcommittee members have commented on
differences among the U.S. banking agencies and are of the view
that a new interagency coordinating mechanism is needed. Mr.
Chairman, you and some of your colleagues have introduced H.R.
2043, a bill that would establish an interagency Committee
whose purpose would be to resolve such differences. While I am
sympathetic to the concerns that underlie this legislation,
with great respect, I suggest that it is not necessary at this
time.
There have, indeed, been some differences among the
agencies during this process. But I believe the agencies have
generally worked exceedingly well together on the Basel II
project for the past 4 years, and I am confident that we will
continue to do so. To be sure, we have not always agreed on
every one of the multitude of complex issues that Basel II has
presented, but that is no more than one would expect when a
group of experts have brought their individual perspectives to
bear on difficult and complex issues. Where there have been
differences, we have worked our way through them in a highly
professional and collaborative manner. In a few weeks, we will
be jointly issuing an Advance Notice of Proposed Rulemaking,
seeking broad comment on the Basel II structure, together with
draft supervisory guidance for those of our banks that will be
subject to Basel II. Both the ANPR and the guidance have been
developed in a collaborative process in which each of the
agencies has had substantial input.
I believe we agree on the need for further quantitative
impact study before Basel II is finally put in concrete
although I do not want to speak for Governor Ferguson on that.
I think it is probably correct to say that we at the OCC
have had some reservations that the Fed does not share about
the overall approach to Basel. For example, I commented in my
earlier testimony about the complexity of Basel II. I have a
concern about complexity because it seems to me that complexity
could work toward competitive inequalities across countries,
given the difference in the nature of supervision from country
to country. Governor Ferguson, I think at the last hearing,
pointed out that we live in a complex world and we are dealing
with complex subjects, and complexity is a necessary
consequence of this process.
We may have some difference of perspective on time
schedule. I think the Fed wants--and I do not mean to speak for
the Fed--but I think the Fed wants to adhere to the current
time schedule. We certainly would like to, if it is possible.
But I think we may have the view, more so than others, that
achieving the present time schedule is a daunting challenge.
While we had differed on operational risk at earlier stages
of this process, I want to make clear that we are completely
comfortable and supportive of the treatment of operational risk
under the AMA approach in Pillar 1. And I would like to expand
on that just for a moment because this is such an important
issue for the Subcommittee.
As the Subcommittee knows, I had argued earlier in the
Basel Committee that operational risk should be treated under
Pillar 2 because it involved qualitative judgments about the
adequacy of internal control systems. Nobody else on the
Committee agreed with that. And it was very clear to me that
that view would not be accepted by the Committee.
As a result, we and the Fed worked very closely together
developing the Advanced Measurement Approach to operational
risk. The product of that collaboration, I think, has been very
productive. We are completely comfortable that the AMA approach
to operational risk imports a degree of supervisory discretion
and judgment of exactly the sort that would come to bear if
this had been a Pillar 2 issue. Indeed, I think that if
operational risk were to be treated under Pillar 2, it would be
essential for us to have a framework for the consideration of
operational risk that would probably look very much like what
we presently have under the AMA approach. So I do not think the
Pillar 1 versus Pillar 2 issue should any longer be a matter of
significant concern.
Third, as I said earlier, I think we are all committed to a
process that has real integrity to it. The current Basel
Committee timeline presents, as I said, a daunting challenge to
both the U.S. banking agencies and the banking industry. And
while it is clearly necessary to address the acknowledged
deficiencies in the current Basel Capital Accord, the banking
agencies must better understand the full range and scale of
likely consequences before finalizing any proposal.
We have identified in our written testimony a lengthy and
formidable list of critical milestones that the agencies must
meet under the current Basel II timeline. They include: first,
consideration by the Basel Committee itself of the comments
that have been received on CP-3, its latest consultative paper.
Next, the preparation and issuance by the U.S. agencies of the
Advanced Notice of Proposed Rulemaking and draft supervisory
guidance that goes with it, with a 90-day period for comments.
At the end of that comment period, we will jointly consider
those comments, analyze them, and make a judgment about the
implications of those comments for the final iteration of the
Basel document.
The Basel Committee is presently scheduled to meet in
December, which will give us the opportunity to feed back into
the Committee the results of that ANPR process. We are also
going to be requesting comment in the ANPR process on the
economic impact of Basel II.
Executive Order 12866 requires that we make an economic
impact analysis in the case of any significant regulatory
action, which is defined to mean an action that will have an
annual effect on the economy of $100 million or more. We are
soliciting information to enable us to determine whether that
executive order will be triggered by the Basel proposal. If it
is, we will conduct that economic analysis as part of this
process.
After the Basel Committee issues the definitive paper, the
U.S. agencies will jointly draft and put out for additional
public comment the final version of the regulations that will
implement Basel II. At some point during that process--earlier
rather than later, I hope--we will conduct an additional
quantitative impact study to determine exactly what the capital
impact will be.
We will then consider all the comments that are received in
the NPR process and come to a final decision as to whether we
should issue the final U.S. implementing regulation and what it
should look like. If we find that our current target
implementation date of January 1, 2007 is simply not doable,
consistent with that process--and my personal opinion is that
realization of that target may be very difficult--we will take
additional time. But I think it is still too early to draw that
conclusion.
The important point here is that we will take great care
not to let the timeframe shape the debate. If we determine that
changes to the proposal are necessary, we will make those views
known to the Basel Committee. And we will not implement the
accord until those changes are made.
I would like to make one more point. Some have viewed the
new Basel II approach as leaving it up to the banks to
determine their own minimum capital essentially, putting the
fox in charge of the chicken coop. I do not think that is the
case by any means.
While the banks internal models and risk assessment systems
will be the starting point for the calculation of capital, bank
supervisors will be heavily involved at every stage of the
process. We will publish extensive guidance and standards that
the banks will have to observe. There will be standards set out
in the Basel documents themselves. We will not only validate
the models and systems that banks propose to use, but we will
assure that they are being applied with integrity.
In my view, the bank supervisory system that we have in the
U.S. is unsurpassed anywhere in the world, in both its quality
and in the intensity with which it is applied, and we are not
going to allow Basel II to change that. In fact, if we do not
believe, at the end of the day, that Basel II will enhance the
quality and effectiveness of our supervision, we should have
serious reservations about proceeding in this direction.
Moreover, while Basel II has largely been designed by
economists and mathematicians and while these ``quants'' will
play an important role in our oversight of the implementation
of Basel II, the role of our traditional bank examiners will
continue to be of enormous importance. Such values as asset
quality, credit culture, managerial competence and the adequacy
of internal controls cannot be determined by mathematical
models or formulas, nor can many of the risks that banks face
be properly evaluated except by the application of seasoned and
expert judgment. I can assure you that those national banks
covered by Basel II will continue to be closely monitored and
supervised by highly qualified and experienced national bank
examiners who will continue to have a full-time, on-site
presence.
I am pleased to have the opportunity to provide our views
on this important initiative, I would be happy to answer any
questions you may have.
[The prepared statement of Hon. John D. Hawke can be found
on page 141 in the appendix.]
Chairman Bachus. Thank you.
Chairman Powell?
STATEMENT OF DONALD POWELL, CHAIRMAN, FEDERAL DEPOSIT INSURANCE
CORPORATION
Mr. Powell. Thank you, Chairman Bachus and members of the
Subcommittee for your interest in the new Basel Capital Accord.
I believe that Basel II ranks among the most important pieces
of proposed banking regulation in our nation's history.
The FDIC supports the goal of lining up capital regulation
with the economic substance of risk that banks take. Basel II
encourages a disciplined approach to risk management and it
addresses important weaknesses in our current capital rules. We
applaud the intense and prolonged efforts that have been made
to address these important issues.
Since my testimony before the Subcommittee on Domestic and
International Monetary Policy, Trade and Technology, on
February 27, 2003, there has been good progress on the domestic
implementation efforts. The federal banking and thrift
regulatory agencies are working hard to issue an Advance Notice
of Proposed Rulemaking for comment this summer. The proposed
rulemaking will identify those aspects of Basel II that will be
proposed for adoption in the U.S. for application to a small
group of large banking organizations. At this time, we are
addressing various technical issues, developing interagency
guidance and conducting industry outreach.
Specifically, we have conducted outreach sessions to
banking institutions of varying size at meetings held in
Chicago, Atlanta and New York. We are approaching a crossroads
where judgments will need to be made on some critical issues.
The interagency process and the public comment period will help
us reach those judgment, and I am confident that our process
will result in an appropriate outcome. My written testimony
provides a broad overview of some of the critical judgments
that will need to be made before the agencies commit to adopt
Basel II in the United States.
The first key issue is capital adequacy. The Basel II
formulas allow, at least in principal, for significant capital
reductions. The proposals issued by the Basel Committee specify
that after a phase-in period, there would be no floor on the
level of risk-based capital that banks would be required to
hold.
The level of risk-based capital that banks actually hold
would depend upon their own internal estimates of risk--
validated by their supervisors--and on the demands of the
marketplace. It is difficult to predict the ultimate effect of
Basel II on overall bank capital, but we do know that the
formulas are forceful tools for affecting risk-based capital
requirements.
There is no question the Basel formulas will help the
regulators segregate risk. But the formulas cannot stand on
their own.
Banks face other risks besides credit risk and operational
risk. Lending behavior can change over time, causing losses to
escalate in activities perceived as low risk.
The simple fact is that no one knows what the future holds.
For these and other reasons, the FDIC believes that Basel II
must be supplemented by the continued application of existing
regulatory minimum leverage capital and prompt corrective
action requirements. I am gratified at the support that my
fellow bank regulators have expressed for this conclusion.
We also understand that a leverage ratio alone cannot
provide protection without the support of sound, risk-based
capital rules. It will be necessary to better understand the
impact of the proposals on the capital required for specific
activities. Finally, maintaining capital adequacy under Basel
II would be an ongoing task. Validating banks' internal risk
estimates would be a challenge. Doing so consistently across
agencies would be a greater challenge, for which an interagency
process would be needed.
The other key issue is competitive equity. Basel II has
been expected to provide some degree of regulatory capital
relief. The banks that stand to be directly affected by Basel
II have expressed strong support for such capital relief. They
have expressed concern where they believe Basel II capital was
too high.
The key policy question is: what economic benefits and
costs would come with changes in regulatory capital
requirements? Would the economic benefit of lower risk-based
capital requirements for large banks enhance their competitive
posture or accelerate industry consolidation?
We recognize there are differences of opinion about the
importance of competitive equity issues, and that is why we
need to pay close attention to the comments we receive on this
issue. The agencies received a number of comments on both sides
of this issue at recent industry outreach meetings, and this
dialogue will continue.
With respect to proposed House legislation, the FDIC
appreciates the goal of H.R. 2043, ``The United States
Financial Policy Committee for Fair Capital Standards Act.'' We
share in Congress's desire to ensure that uniform U.S.
positions are developed and communicated to the Basel
Committee. However, we do not believe that H.R. 2043 is the
best means to accomplish this end. The legislation would, in
effect, move the important task of capital regulation away from
the agencies with decades of experience in this arena to the
United States Treasury Department.
This could compromise the independence of the federal
banking regulators and impair our ability to handle an
important function of prudential regulation at a particularly
sensitive time.
As our testimony indicates, we are working with the other
regulatory agencies to develop interagency positions regarding
the domestic application of Basel II. The bank regulatory
agencies are actively engaged in an almost daily dialogue on
issues and concerns. We will take whatever time is necessary to
seek input from all interested parties prior to the final
adoption of the new framework in the U.S., especially the
concerns of banks that may feel they will be disadvantaged in
competing with Basel II banks.
In short, the ingredients for the success of Basel II
continue to be: one, appropriate minimum capital standards;
two, a consistent approach to validating banks' risk estimates;
three, an adequate vetting of competitive issues; and four,
time to address these and other policy issues as we finalize
our views on this new Accord.
We will continue to work closely with our fellow regulators
to work through these important issues and reach the right
conclusions. We are committed to evaluating the cost and
benefits of the Basel II proposal and their impact on the U.S.
banking industry and the safety-and-soundness of the financial
system. Thank you for the opportunity to present the views of
the FDIC.
[The prepared statement of Hon. Donald Powell can be found
on page 167 in the appendix.]
Chairman Bachus. All right.
Director?
Thank you. Thank you.
Mr. Gilleran, I am sorry.
STATEMENT OF JAMES GILLERAN, DIRECTOR, OFFICE OF THRIFT
SUPERVISION
Mr. Gilleran. Mr. Chairman, Ranking Member Frank, thank you
for including me in this panel.
Chairman Bachus. I think we have a microphone problem.
Mr. Gilleran. I think all of the concerns that I have--the
OTS has--have been already expressed. So I will just make some
general comments before we turn it over to questions. I would
ask that my written comments be included in the record.
Up until this time, the OTS has not been involved in the
international accord efforts, even though we have had people
who have been involved in Subcommittee work here in the United
States. Bill McDonough did invite me to attend the last Basel
meeting as an observer, which I did.
And subsequently, I have asked the replacement for Mr.
McDonough as head of the Basel Committee, who is now the head
regulator in Spain, for an official seat on the Basel
Committee. And I am told that that is a definite possibility
for the future.
I think it is important that the OTS be included as a full
voting member on Basel because of the OTS unique focus on the
mortgage industry. And our interest is, number one, to share
with others our perspective on mortgage lending here in the
United States and internationally, since at least one of our
major thrifts will be included within the Basel Accord, if it
is adopted.
And we also have a focus on interest rate risk that is
unique in the industry. And each quarter, we mark to market our
entire industry, from an interest rate-risk point of view. So I
think that that also is a contribution to the understanding of
interest rate and the whole subject of risk and capital.
My own personal views on Basel are that I believe that the
Basel work to date has moved the ball forward in terms of
understanding the relationship of risk and setting capital.
Basel I was a simple method, but very effective really, since
it was first adopted because Basel I capital has held up very
well over very tumultuous economic times.
And it has produced capital levels that are now viewed as
being quite substantial. And in fact, the financial services
industries have just completed 2 years of probably the best
results it has ever had. And in addition, this year looks
awfully good too.
So Basel I has functioned well, even though I think that
almost everybody would admit that if we just stayed with Basel
I, we would want to make additions to it, so that it takes into
consideration more of the kinds of differentiation of risks
that we now have in the financial services industry. So I
completely support the fact that we would have to do additional
work on Basel I if that was the only thing that we had.
It has been expressed here that Basel II would only be
applicable to 10 of the major international banks in the United
States and perhaps 10 others who will opt in. I have received
information from a number of people that there will be
literally hundreds of other banks that will make application to
the regulators to be able to use Basel II because I think it is
perceived that Basel II will result in lower capital levels.
And I think everybody--almost everybody--concludes that
lower capital levels will mean greater competitiveness. It is
also an issue too in connection with what happens to the
community banks in the United States.
Because if the major banks are allowed to have lower
capital levels but the community banks will continue with
higher capital levels under Basel I, then that will mean that
they can be acquired, quite simply, by the major banks. And we
will have a further roll-up of the community banking system
here in the United States. And that has to be evaluated by
Congress, along with everything else, as to whether or not that
is a good thing to have happen.
So I believe we have to do a lot of work. I believe a lot
of work has been done.
I salute those who have really been working on it so hard
in the past. We intend to be part of it going forward in the
future. And I believe that your attention to this matter is
very well deserved.
Thank you for inviting me. I look forward to questions.
[The prepared statement of Hon. James E. Gilleran can be
found on page 114 in the appendix.]
Chairman Bachus. Thank you. At this time, we will start
questions.
And Vice Chairman Ferguson, my first question is, you have
commented--let me read testimony from yesterday's hearing in
the Senate. D. Wilson Ervin, Credit Suisse First Boston, are
you aware of his testimony on Basel II?
Mr. Ferguson. I am generally aware of it. But it would
certainly be helpful for you to read the quote that you want me
to respond to.
Chairman Bachus. He said the proposed accord is not a minor
refinement to the banking regulatory process, but is instead a
wholesale reform of bank regulation, a regime that covers
roughly $2 trillion of capital and is a key economic engine. Do
you agree with that?
Mr. Ferguson. I believe that what the proposed accord is
doing is to catch up with where the leading edge banks are. So
yes, it is a change. It is a change from Basel I, without
question.
We have to move from Basel I because we believe it is no
longer appropriate for our largest banks. It does not give good
signals on the risks that they are undertaking. I do believe it
is a major change, yes.
It is, however, a change that is catching up with what the
leading edge banks are doing. The ideas embedded in Basel II
are not things that we, as regulators, thought up independently
from the industry. It is a catching up to where the industry
is.
But yes, it is a major change.
Chairman Bachus. All right. What I guess I am having
trouble seeing is--and you said that Basel II is an
acknowledgment of what the largest banks are doing today.
Mr. Ferguson. What the leading edge largest banks are
doing--not all of them, but what many of them are doing.
Chairman Bachus. Many of them. And your part of your
testimony--is designed to have a regulatory capital system that
reflects what the largest banks are doing today. And I think
Senator Sarbanes asked you. And you saw it as just an
acknowledgment about what they were doing today.
You mean what they need to be doing today or what they are
doing today?
Mr. Ferguson. I am trying to use the word ``leading edge.''
Out of the many banks that we have, there are some--not all,
some--that are using the kind of quantitatively-driven
approaches to estimating their own internal capital, economic
capital, getting a much better feel for the risks in their
lending behavior, their credit behavior.
Importantly, we had a discussion at the Federal Reserve
Bank of New York about 10 days ago, almost 2 weeks ago now,
where we saw again some leading edge banks are doing exactly
the same kind of quantified approach to operational risk that
is being proposed under the AMA. So both on the credit risk
side and the operational risk side, there are examples of banks
that are moving very much in this direction.
There are some large banks that I think are further behind,
some that are further ahead. So it is a validation, in a sense,
that we reflect, and we encourage banks and give them
incentives to continue to move in this direction. And we think
it is quite doable because there are a number of banks that
have already started to move in this direction.
It still will require the, supervisory validation of the
databases that they use, the approaches that they use to
quantify. So as my colleague, Comptroller Hawke has indicated,
there is still a great deal of room for supervisory oversight
to guarantee that what comes out seems appropriate.
And, it is important to recognize that the information that
the banks provide is an input to formulas that the supervisors
put forward. So that ultimately, it is the supervisors and the
supervisory approaches and formulas that determine the capital.
Chairman Bachus. Let me ask you this. The same gentleman
testified that the current Basel proposal is unnecessarily
complex and costly. But you are actually saying that----
Mr. Ferguson. I am the first to admit that it is complex. I
am not denying in any sense the complication here.
I think it is too simple to say that, in my view, it is
complex because we live in a complex world. That is partially
true. But that is----
Chairman Bachus. Can you tell me some banks that would
comply with this today? You say that some of the leading edge
banks already are?
Mr. Ferguson. Well, would comply with every component of it
today? I am not sure there are any banks that would comply with
every component.
Chairman Bachus. With the major components.
Mr. Ferguson. There are a number that are moving in this
direction relatively quickly. I am a little cautious here to
give out confidential information. But I will assure you that
there are some banks that we have looked at. And we are
comfortable that, certainly by the implementation date, they
will be ready.
Chairman Bachus. But all your major banks today----
Mr. Ferguson. I am sorry, sir?
Chairman Bachus. All your major banks today are sound.
Mr. Ferguson. This is not a question of sound----
Chairman Bachus. I understand that. But their own models
show that several of them are going to have to raise
significant amounts of capital. Do you disagree with their
models?
Mr. Ferguson. That they are going to have to raise capital?
I think what will happen is that some will find that their
regulatory minimum capital goes up. Some will find that the
regulatory minimum----
Chairman Bachus. Right. Some go up, some go down. But for
those that go up----
Mr. Ferguson. But that is not a bad sign. It means that
their regulatory capital is going to reflect what many of them
already recognize as what they need to hold internally.
I do not think there are any banks that are going to have
to go out and raise new capital. They will simply have
regulatory capital that is adjusted either up or down. But it
is not inconsistent with their own view, necessarily, of their
risk.
Chairman Bachus. Okay. All right. Let me ask you this. This
is probably, maybe, the most important question I will ask you
today.
Comptroller Hawke and Chairman Powell said that we will
take whatever time necessary to reach a consensus. Do you agree
with that statement?
Mr. Ferguson. I do. As Comptroller Hawke was describing
areas of agreement and disagreement, I sent him a little note
and perhaps a little body language that suggest otherwise. But
I think we are in close agreement on exactly that point.
I have said in my opening statement here that the original
timetable of trying to meet in November is unreasonable at this
stage, and seems likely to slip. He described it as daunting. I
would not have made it to this table if I were not prepared to
take on a daunting challenge, so I am not intimidated by it.
But I know we will have a lot of work to do. I am
cautiously optimistic that we will get to the end of the year
and have plenty of time to look at the comments, listen to the
comments and respond to them, and develop a negotiating
position.
If it turns up that we cannot, then we will take the time
required.
Chairman Bachus. Okay. So we do not have--there is no
deadline out there. We cannot say we have to do it by a
certain----
Mr. Ferguson. Let me be very clear. As with anything in
life, there are cost and benefits. It is appropriate to get the
benefit of taking a sufficient amount of time, sir. But it is
also important for all of us to recognize that there are great
costs of uncertainty to our banks.
There are a number of banks that want to know where they
should be investing, what kind of databases are required. So we
have to move ahead as expeditiously as possible, in order to
minimize the uncertainty in the banking industry.
This is not a matter to take lightly on either side. It is
not a matter to rush into and ignore the comments, which we
would not do. Nor is it a matter to go too slowly and leave
uncertainty in the banking industry. Having seen 4 to 5 years
of consultative papers, outreach meetings, quantitative impact
studies, they are asking for a certain amount of certainty.
And one of the things that you certainly will have seen,
because you followed yesterday's testimony as well, while there
are a range of views, when it is wrapped up, everyone
recognizes that we need to move off of Basel I, both on the
first panel and the second.
I think Senator Sarbanes asked the question, in which the
agreement was yes. Everyone recognizes that we need to move to
a framework that is quite like Basel II, without question.
There is still room to discuss a lot of the details. But
the concept of moving in this direction is well accepted, both
by the regulators and, I think, in general the private sector.
And we have to be careful not to slow it down
unnecessarily, slow it down enough to listen to the comments,
but not unnecessarily to the point that we are leaving
uncertainty in the banking industry and leaving our largest
banks on an old accord that we know has passed its useful life,
as far as the largest banks are concerned.
Chairman Bachus. Thank you.
Ms. Maloney? Mr. Frank, I am sorry.
Mr. Frank. Thank you, Mr. Chairman. I know there has been
frankly some effort to say that there really is agreement and
you are all going to be able to work this out.
But I would just make a suggestion to you. If this is an
agreement, if you guys ever disagree, sell tickets, because it
will be a hell of a show.
Mr. Powell on June 9th said in a memo that we have, ``The
framework is being rushed into place with discussions of
significant alternatives now virtually ruled out by the
timeline and by the international collaborative nature of the
project.'' You do say, in a generous show of courtesy, you
acknowledge the recognition by Vice Chairman Ferguson that this
may, indeed, be the case.
You know, virtually anything may indeed be the case in this
world. But then Mr. Ferguson expressed his view that this great
rush to judgment may indeed be the case, in his answering memo,
by saying, ``The Fed believes it is important to move on to the
next step in an international process that has already created
too much uncertainty.''
I mean, there is clearly more disagreement here than people
are acknowledging. And I do not understand what you think you
gain by that. And I understand there are some constraints and
let's be polite.
But I have to say, Mr. Ferguson, you lose some credibility
with me when you say, ``We are all together here.'' There seems
to be much more disagreement.
I do have a couple of specific questions.
Mr. Hawke, you say that when you were for Pillar 2 instead
of Pillar 1, you were the only member of the Committee who felt
that, so you were outvoted. Mr. Powell, did you have a horse in
that race between Pillar 1 and Pillar 2?
Mr. Powell. I did not.
Mr. Frank. You did not. So Mr. Hawke, you were outvoted one
to one.
Mr. Powell. I am sorry?
Mr. Frank. Then Mr. Hawke was outvoted one to one. I mean,
there were three federal agencies on this. You did not have a
vote.
Mr. Powell. I came into the process late. But I would have
to refer to some of our folks that were in the process. But I
think we were in support of Pillar 2.
Mr. Frank. You were for Pillar 2? And Mr. Hawke, you were
for Pillar 2. And Mr. Ferguson was for Pillar 1. So Pillar 2
lost one to two.
Mr. Hawke. Pillar 2 lost, Congressman Frank, in the Basel
Committee. Pillar 2 lost by----
Mr. Frank. Oh, not within the United States, but
internationally, is that?
Mr. Hawke. Yes.
Mr. Frank. Okay, so the United States position----
Mr. Hawke. I made that argument in the Basel Committee.
Mr. Frank. I was not clear about that. The other question I
would have for the gentleman from the OTS, you said you were
asked to be made a voting member of the Basel Committee.
Mr. Gilleran. I was not a voting member, no. Not.
Mr. Frank. You said you had asked to be one.
Mr. Gilleran. Yes.
Mr. Frank. Well, who are the voting members of the Basel
Committee. Are the other three? I mean, there is an
international Basel Committee. You are all voting members. I am
now unclear.
Mr. Gilleran. There are three U.S. members.
Mr. Frank. What?
Mr. Gilleran. One is the head of the New York Fed. And then
there is a Washington----
Mr. Frank. Excuse me, are you asking to be a voting member
of the International Basel Committee or the American Basel
Committee?
Mr. Gilleran. I would like to be either. But I will take
the U.S.
Mr. Frank. So you are asking to be a voting member of the
U.S. Committee. But they do not seem to count the votes. I
mean, that is like--I do not know why you want to vote.
Then I continue to be perplexed by this. And let me ask,
Mr. Ferguson, both Mr. Powell and Mr. Hawke seem to have severe
reservations about the current timeline. At least, that is--can
you tell us that until they agree, their agencies agree that we
are ready to go, that we are not going to go? Is that something
we can----
Mr. Ferguson. I can tell you that. Yes.
Mr. Frank. Okay. Then let me ask you another question. And
I understand, Mr. Powell, you make a point about getting
Treasury into it. And that is something I will think about.
But I still have to say, this is the most incoherent
decision making process I have encountered on very important
issues. And by the way, who will it be up to to make him a
voting member?
Do you know? You said you talked to the guy from Spain. I
mean, is he deciding who is a voting member in America?
Mr. Gilleran. Right. Well, he is the Chairman of the
Basel----
Mr. Frank. But does he decide who gets a vote in the United
States?
Mr. Gilleran. He has a vote. And he is now Chairman. So he
will determine when other countries and whether or not----
Mr. Frank. But what is his input into whether you get a
vote in the United States Committee? I mean, I thought you said
you were trying to get to be a voting member of the U.S.
Committee. And we are going to ask a guy from Spain to do that?
Mr. Gilleran. Well, I did.
Mr. Frank. That is why I think we need some clarity.
Now Mr. Ferguson, one substantive question. I understand
one of your arguments has been--and I appreciate the
willingness you have had to meet with us and talk and explain
these things. I mean, it can be frustrating because these are
complicated and we do not ever know as much about them as you
do because of the difference in our focus of attention--and
maybe even our attention span, but I will speak only personally
there.
On the question, you have said, well, the amount of capital
may not be that much. It would not be necessarily increased.
But there is a big gain in transparency.
And you and I have had this conversation, that you said
that you thought some of the institutions, while they might now
have capital, have not been transparent about it. I relayed
that concern to some of the institutions that had raised this
with me.
And I am told that one of them, State Street Bank, said
that they would be willing to work on ways to increase the
transparency of the capital. And that did not seem to resonate
much.
So are there not ways or are there ways that we could
require these institutions--talking about operational risk
now--to increase the transparency of the capital that might be
helpful here? And I was frankly--I encouraged them to go and
talk to you about that. And the impression I got was that they
did not think this really meant as much to you as I had thought
it did.
Mr. Ferguson. Transparency always means a great deal to me.
And there should not be any doubt about it.
And yes, the institution that you talked to called me the
other day to say they would be interested in pursuing ways to
have more transparency. Recognize the benefits of Pillar 1,
which is what we are talking about, versus Pillar 2 are in part
because of transparency, not exclusively.
Mr. Frank. Right.
Mr. Ferguson. I am sorry, Congressman Frank, may I finish?
Mr. Frank. I am sorry. I thought you were finished.
Mr. Ferguson. No, not yet.
Mr. Frank. My attention span again. I apologize.
Mr. Ferguson. There are a number of other benefits from
Pillar 1 that are important. One is that it allows for greater
comparability because it is important to have framework----
Mr. Frank. Okay. In other words, what you are saying is
that even if they could resolve the transparency issue, that
would not affect your view on----
Mr. Ferguson. No, I did not say it did not have any effect
on my view. What I said, Congressman, is not that it would not
have an effect on my view. Obviously, it would have an effect
on my view.
I think it is not the only reason to favor Pillar 1.
Mr. Frank. Okay.
Mr. Ferguson. And as you have heard now at this stage, the
regulatory group in front of you----
Mr. Frank. By a vote of one to two.
Mr. Ferguson. No, Congressman Frank, that is unfair.
Mr. Frank. How did the American--what was----
Mr. Ferguson. It is unfair because, as I think you heard
the Comptroller say, we collectively developed what we think of
as a very solid middle ground.
Mr. Frank. After he felt he had been outvoted, he said
that.
Mr. Ferguson. He had been outvoted by the entire Committee.
Mr. Frank. But let me--if the Comptroller thinks I am
misquoting him, he is free to interrupt me. I give him that
permission.
The last question I have is this. You say one of the
reasons for speed or for moving quickly, despite others'
reservations, is----
Mr. Ferguson. Can I interrupt you? I did not say ``moving
quickly.'' I said ``reasons to move ahead.''
Mr. Frank. Okay. But you said one of the problems was the
uncertainty that the financial institutions are suffering from.
I just want to give you a comment.
Not a single bank has called me up and said, ``Hey, I am
really feeling angst here from the uncertainty. Would you move
quickly?''
So you say that it is important to move quickly because you
want to relieve the uncertainty of the banks. But they are
calmer than you think they are.
Mr. Ferguson. It is a good thing we have calm regulators
and calm banks. I did not say ``move quickly.'' I said to
``continue to move.''
Mr. Frank. I understand. But you said a reason for progress
and not as much delay.
Mr. Ferguson. Right.
Mr. Frank. Are you not in disagreement with your colleagues
about how much delay?
Mr. Ferguson. No, I am not in disagreement with my
colleagues at all.
Mr. Frank. Dr. Ferguson, I have to say I do not believe
that. I mean, you are not leveling with us. There is clearly a
difference of opinion on how quickly this ought to go.
Mr. Ferguson. No, Congressman Frank, there is not a
disagreement on how quickly this should go. We all agree that
we have to put out an ANPR in about----
Mr. Frank. Okay, well then----
Mr. Ferguson. We all agree that we need to have a comment
period. We all agree----
Mr. Frank. Report to----
Mr. Ferguson. Sir, may I finish?
Chairman Bachus. Let me say this, we have actually got 2
minutes left on the floor.
Mr. Frank. All right. I apologize.
Mr. Ferguson. No, I think it is fair to ask questions. But
I am giving you honest answers. I am not, in any sense,
disagreeing with what anyone else here----
Mr. Frank. That is not what these two memos clearly
suggest.
Chairman Bachus. Could I interject? Vice Chairman, could
you--would you write Chairman Oxley and Chairman Frank a letter
and just confirm what you have said this morning?
Mr. Ferguson. That we will have a comment period?
Chairman Bachus. That you will not----
Mr. Ferguson. Of course.
Chairman Bachus. That you will not move forward until----
Mr. Frank. Mr. Chairman, I will return to listen, not to
ask any questions. But I owe them. I will return after I vote
to listen.
Chairman Bachus. We will return. And we ask the panel--we
will reconvene at a quarter till 12. Thank you.
[Recess.]
Chairman Bachus. The hearing will come to order. We welcome
our four witnesses back. And at this time, two of the witnesses
wanted to respond to Mr. Frank. So I will recognize the ranking
member for that purpose.
Mr. Frank. I simply--both Dr. Ferguson and Mr. Gilleran had
comments to make. And I, having used up my time, I hope they
will get as much time as they need to respond.
Mr. Gilleran. I just wanted to clarify the record is that
the OTS is fully engaged with the other regulators here going
forward in the United States. And we are a party to the ANPR
that will be coming out.
And it is the international piece in Basel that I was
talking about, that we have not been--had a seat at the table.
I have been informed by Comptroller Hawke that Basel has never
really ever taken a vote.
So you cannot be a voting member. But we would like to be
at the table going forward, so that we can add our unique
perspective on the mortgage market to the group.
Mr. Frank. Dr. Ferguson may have felt that I did not give
him a chance. So I apologize.
Mr. Ferguson. I have the impression that some of my
colleagues here want to deal with some of your questions.
Mr. Powell. May I make a comment, Congressman? With regard
to the different views and differences of opinions, clearly
that is true.
In my short period in Washington, I have watched; there is
not much consensus on very many issues. And time builds
consensus. People have an opportunity to express their views.
I indeed did send that memorandum to Vice Chairman Ferguson
and to Comptroller Hawke and expressed our views. And I have
met with Vice Chairman Ferguson at least on two different
occasions, going over some of my concerns and some of my views.
He has accepted those concerns and views in the spirit they
were given. On one occasion, he called me back and said that he
is doing some more study about one of the specific issues that
I talked about.
I am confident--I am confident--in the process. As
Comptroller Hawke mentioned, people of good will, in fact, have
differences of opinion. And I think it is important that we
express our differences of opinion.
But I am confident that the process will ultimately get us
to a consensus. There will be give and take in this process,
and as each of the panel members here have expressed, we will
not be governed by the timeline just in order to make a certain
timeline. Governor Ferguson, Comptroller Hawke, Director
Gilleran, and I do have differences of opinion. But we have
worked through other issues. And I am confident we will work
through these issues.
Mr. Frank. Let me just--you do not then feel pressured by
any timeline? You feel you have adequate time to work it out?
Mr. Powell. No, sir. I do not feel pressure in any way.
Mr. Frank. And you will not feel pressured to give in
before you are satisfied?
Mr. Powell. Nor do I feel pressure to change my views, nor
feel any pressure not to express my views.
Mr. Frank. I have never noticed a deficiency in your
willingness to deal in those regards.
Mr. Powell. Thank you.
Chairman Bachus. Let me clarify something. Right before we
left, Vice Chairman, I asked you--in fact, Chairman Powell's
statement just then sort of reminded me that he is confident.
And Comptroller Hawke has said he is confident that you all
will come to a consensus at some point.
And you assured us that--I believe I have heard that you
have assured us that you will not sign off until there is
consensus and agreement between the regulators?
Mr. Ferguson. That is correct.
Chairman Bachus. Now in that regard, we are talking about
the same thing, and that is the international Basel agreement?
Mr. Ferguson. Yes, that is correct.
Chairman Bachus. Okay. Thank you.
So you will not sign the international agreement until
there is.
Mr. Ferguson. I cannot. I mean, you have to understand that
the Fed is only one of the regulators here. We cannot,
independently of the other regulators, move forward. We need to
have exactly what you want us to have, which is a common view
before we go ahead.
Chairman Bachus. But there is a U.S. agreement on how you
regulate between the regulators. There is also the
international agreement which you sign.
And what I am focusing on is that you will not sign.
Mr. Ferguson. First, there is nothing to sign. But we will
not agree to anything that we are not all appropriately
comfortable with.
Chairman Bachus. Okay.
Comptroller Hawke?
Mr. Ferguson. Are you comfortable with that, sir?
Chairman Bachus. Yes.
Mr. Hawke. Mr. Chairman, let me go back to the timeline of
the process itself. The comment period on our ANPR closes in
October. There is a meeting of the Basel Committee scheduled in
December. We will take a broad range of comments that come out
of that ANPR process and make an initial judgment about whether
and to what extent we think changes should be made in the final
document that is going to come before the Committee in
December. The Committee will then put that out as the final
document. The Committee, in the 4.5 years that I have been on
it, has never taken a vote on anything. Things seem to get done
by osmosis.
That document will be the Committee's view on the final
paper. We are not obligated to apply it to U.S. banks until we
complete our domestic rulemaking process that implements Basel
II through our rules.
The final step in that rulemaking process will be the
Notice of Proposed Rulemaking, which will come after the
issuance of the Basel paper. That is when we are going to do
the final quantitative impact study that will measure the
impact on capital of the Basel paper. If that quantitative
impact study returns information to us that suggests that the
impact on U.S. bank capital is going to be unacceptable, as the
Vice Chairman said, there are a number of things that we can
insist on with the Basel Committee before we go final with our
implementing regulations.
So there are a number of decision points along the way
before we get to the very end of the line, which is the
adoption of the U.S. regulations implementing Basel II.
Mr. Frank. Mr. Chairman, would you yield to me for 30
seconds for a question? Because that is interesting to me. And
I must say, my impression before the Comptroller spoke was that
once the agreement was signed, our flexibility was not very
great.
I mean, how much could you undo? Are you not bound by--are
you talking about details? Or could you say, ``Well, we do not
want operational risk capital'' or ``We do not want this?''
Subsequent to signing, when we do our regulation, how much
are we constrained by international obligation? How free are
we?
Mr. Hawke. Well, first of all, this is not a treaty where
we have a legal obligation. But I think it is probably fair to
say that once the Basel Committee goes out with its final
paper, we either should object to it if we have fundamental
reservations, or we should acquiesce in its being published.
But during the subsequent domestic rulemaking proceeding and
the quantitative impact study that will accompany that, we are
going to have to make a very important judgment, and that is:
what is the impact of this paper going to be on the capital of
our banks? We have not had a reliable----
Mr. Frank. How free will you feel to undo parts of what you
agreed to?
Mr. Hawke. Well, I would feel free if we conclude as a
result of the quantitative impact study that the capital impact
on our banks would be unacceptable--unacceptably high or
unacceptably low to simply not implement it.
Chairman Bachus. And that would mean, even if it resulted
in some competitive disadvantages for certain banks over other
banks or if it impacted specialty banks or if it impacted banks
with high commercial real estate holdings.
Mr. Hawke. Those are issues, Mr. Chairman, that I think we
ought to have a better hold on at the end of the ANPR process.
We are going to be receiving comment on the competitive impact
before the end of this year. So we ought to be informed on
those issues before we go back to the Basel Committee in
December.
Mr. Frank. Can we hear from Dr. Ferguson on that, Mr.
Chairman?
Mr. Ferguson. Let me first agree with the direction that
Comptroller Hawke was going in response to your question,
Congressman Frank. We should have a strong sense of agreement
about the broad contours before the Committee wraps up its
work, without question.
I agree with him that the proposal or the approach for next
year will be to put out a notice of proposed rulemaking; to
start a quantitative impact study; to get the comments from
that notice of proposed rulemaking; to get the input from the
quantitative impact study; to collectively make a judgment as
to whether or not there is a need to go back and reopen; to do
what we call recalibration, which is to adjust some of the
weights in one way or the other, to make other adjustments that
we think are appropriate before we sign on.
And as the Comptroller has indicated, this is not self-
executing. It needs some rules here in the U.S. And before we
finalize those rules, I think it is important to do the
process.
Mr. Frank. But you are assuming----
Mr. Ferguson. And, if we need to, go back and renegotiate.
And we have said that. This is not the first time we have said
that.
Mr. Frank. When you talk about the timetable, you are
assuming that this would be done by the end of this year, the
international agreement.
Mr. Ferguson. As the Comptroller says, it is a daunting
task. We have to work hard to see if we can get there. We will
go to the December meeting with our collective reflections on
the comments and lay out to our negotiating partners what the
U.S. positions are. And we will see how far we can get.
The expectation, the commitment the Committee has made to
the world, is that we will attempt to get some finality the end
of this year. I want to try to live up to that if we can.
If it turns out that we cannot reach a consensus on the
Committee, then so be it.
Let me add one other point on this. If I can take another
minute to give the Committee a really clear view, because I see
this is an issue of some uncertainty.
Not only is 2004 a chance where we will have a quantitative
impact study. But as I said in my opening statement, there will
be--I think--a quantitative impact study in 2005. There will
probably be one in 2006.
At each one of those, we will get a better handle on the
impact on our banks and the banking system overall. And
frankly, I believe that if we have to go back and reopen and
recalibrate to some degree, we have the right to do that. We
have been clear that we intend to do it.
Chairman Bachus. When you say you think that we have that
right.
Mr. Ferguson. No, we intend to do it. We have the right.
Chairman Bachus. We do have the right?
Mr. Ferguson. We have the right to do it. We will, if we do
not like and are uncomfortable with the quantitative impact on
the banks in the U.S., go back and recalibrate. Period. Full
stop. Declarative sentence. I hope it is clear.
Mr. Hawke. Mr. Chairman, can I just add one point on that?
Chairman Bachus. Yes.
Mr. Hawke. Up until now, the Committee itself has done
three quantitative impact studies, but they have not had a
final document to work against. So it has not been possible to
calculate the impact of Basel II on our banks because we were
dealing with a work in progress. It will not really be possible
to calculate the impact until our banks get all their systems
up and running and we have a fully operational system. But
after the Committee comes out with the final version of the
paper, we will be in a much better position to go through a
quantitative impact study, that will be carefully overseen by
the regulators, to make a judgment about what the impact will
be. That is an absolutely essential step, in my view, and
satisfactory results will be a precondition to our final
adoption of the implementing regulation.
Chairman Bachus. Thank you. And let me say this, what I am
going to do at this time, Mr. Toomey, the gentleman from
Pennsylvania, is going to take the chair and recognize Mr.
Gilleran. He has been wanting to respond.
What we are doing, as you have noticed, is we are going to
give each member remaining here 10 minutes of questioning
because these are very important matters. And I think, Mr.
Frank, I would agree, we have taken close to 10 minutes.
[Laughter.]
Mr. Frank. Is 12 close to 10?
[Laughter.]
Chairman Bachus. So what we will do is Mr. Toomey will take
the chair. He will have his 10 minutes to question. Then we
will go to Ms. Maloney and the other two members that are here.
And the other members that arrive after that will have 5
minutes.
Mr. Toomey. [Presiding.] Thank you, Mr. Chairman. At this
time, I would recognize Mr. Gilleran to respond.
Mr. Gilleran. I just want to say that Basel II is no
different than Basel I as far as it relates to the authority of
the U.S. supervisors to request capital and to obtain capital
that they think is necessary. If Basel I came up with the
calculation that the regulators disagreed with, the regulators
are not bound by Basel I, in terms of the capital that is
required.
And they would not be bound by Basel II in any different
way. And I think it is very important to point that out, that
Basel II is a technique to get to a number. But it does not
bind the regulators as to what is required in any specific
instance.
Mr. Toomey. Thank you. I would like to begin my questions
following up on the question of the question of the impact on
the competitiveness of American banks if we were to proceed
with the Basel II proposals. And specifically, it is my
understanding that the majority of the institutions that engage
in the asset management operations, for instance, do not come
under Basel requirements at all. It does not apply to them.
And in addition, it is my understanding that the actual
capital required by the market for the conduct of this business
is considerably less than what the Pillar 1 requirement under
Basel II would impose. So I guess my first question for either
Mr. Ferguson and/or Mr. Hawke would be, number one, does this
discrepancy between what the market requires and what the Basel
proposal proposes, does that suggest a flaw in the
requirements?
And secondly, if we were to adopt this Pillar 1
requirement, wouldn't that put our American institutions at a
significant competitive disadvantage and have all the
unintended consequences that flow from that, including creating
incentives to push this business elsewhere to avoid this
capital requirement?
Mr. Ferguson. Was that question addressed to me, sir?
Mr. Toomey. Actually, if you and Mr. Hawke would both
address the question, I would appreciate that.
Mr. Ferguson. Okay. Well, I hope we get the same answer.
First, we will be asking questions about the competitive
impact broadly. And it will include, by implication, the kinds
of issues that you have just raised. So we will get the facts,
as far as the industry sees them.
Secondly, I would say, recognize that there are already
bank and non-bank participants in the asset management
activity. As far as I can tell, the capital requirements are
probably slightly different because the market has slightly
different requirements versus what the banks have to hold.
There are reasons that we have capital requirements for
banks, obviously, because they are regulated institutions. They
have access to a variety of things that deal with the safety
net. And so as we think about the competitive differences, we
have to calibrate it against what currently exists, as opposed
to an ideal world.
To try to respond to a technical question, just to make
sure you understand what the accord calls for, it calls for
capital with respect to the credit elements of the asset
management activity. Insofar as a bank that is an asset manager
makes a loan as part of that activity, that would require
capital.
General asset management as an activity does not, I
believe, attract capital. And the way that gets calculated will
depend very much on the inputs, the probability of default, et
cetera, that are involved.
Mr. Toomey. I may have misspoke. I was referring to the
operational activities generally.
Mr. Ferguson. Oh, operational activities generally. Oh, I
am sorry. So your issue then is about operational risk.
Mr. Toomey. That is right.
Mr. Ferguson. Oh. I thought you said asset management.
Mr. Toomey. I am sorry. I did, I think.
Mr. Ferguson. Let me then, since you and I know
Congresswoman Maloney is also interested in this issue, I will
also continue a bit on operational risk.
The first point to make is operational risk already
attracts an implicit capital charge. We are not doing something
new by having capital for operational risk.
Excluding or even leaving what the regulators call for,
large financial institutions, large banks in particular,
already hold economic capital, the capital they themselves
determine, in order to deal with the challenge of operational
failures. We have done a survey that shows in the world at
large, for larger institutions, out of their economic capital,
the capital they impose upon themselves, about 14 to 15 percent
of that capital is being held for operational risk matters.
So just to get the lay of the land, there is already
regulatory capital for operational risk, regulatory minimum
capital and the banks themselves impose their own economic
capital.
Mr. Toomey. But that is a significantly lower number than
what is contemplated by Pillar 1?
Mr. Ferguson. No, that is not true. No, that is not true.
Mr. Toomey. Oh, it is not.
Mr. Ferguson. I think there may be a little bit of a
misunderstanding. There was a time, several drafts ago, when
operational risk charges were either tied to gross revenue or
you may be thinking of a number of 20 percent that was floated
at one point.
That is not the proposal. The proposal under the Advanced
Measurement Approach, the AMA approach, as I have described it
and as Comptroller Hawke, who was part of developing this idea
described a bit, is a principles-based approach that does not
have implicit in it a specific target number of capital.
Rather, it asks the banks to use some quantification that
we as regulators can replicate, that we can understand, that is
not purely top-down, judgmental, a guess, if you will. But
based on an analysis of their own experience, the experience of
others, what is called scenario analysis and a few other
techniques that are relatively common in this area, to
determine their perception of the operational risks they might
face.
Mr. Toomey. Okay.
Mr. Ferguson. And then how they offset it. And that will
lead to a capital charge. But it will not necessarily be
higher. We do not know if it is going to be higher or lower
than the 15 percent that--or 14 to 15 percent--of economic
capital that is currently held, that I have just alluded to.
Mr. Toomey. Okay.
Mr. Ferguson. I hope that is clear.
Mr. Toomey. Yeah, it is surprising. I was under the
impression that it is extremely likely that it would be
considerably higher than the economic capital that the market
requires today. But that is----
Mr. Ferguson. I do not think we can have a point of view
that it is extremely likely to be one thing or another until
the banks work their way through it. A number of banks have
already developed some of these approaches and are moving
along, which gives me some comfort that what we are proposing,
what is being proposed with this AMA approach, is really quite
doable.
But it is, I think, premature to say it is extremely likely
to lead to a particular number in the industry.
Mr. Toomey. Okay.
Mr. Hawke, is that your view as well?
Mr. Hawke. I generally agree with Governor Ferguson. I
would just make a couple of points.
We already have differences today between regulated
financial institutions that carry on such things as asset
management activities and non-regulated institutions that carry
on the same activities. There are pluses and minuses in each
case. The regulated institutions have access to the discount
window. They have the benefit of the federal safety net and the
like. The non-regulated institutions do not have the burden or
regulatorily imposed minimum capital requirements.
We are going to be seeking comment on the competitive
effects in the Advanced Notice of Proposed Rulemaking
proceeding. We would be concerned if one of the consequences of
Basel II were to cause the de-banking of banks that were
engaged in these activities. So this is an issue that we are
going to focus on in this process.
Mr. Toomey. Okay. So do you share the view that it is not
possible to determine, generally speaking, that these rules
would require greater capital than the market currently
imposes?
Mr. Hawke. I think it is premature to make that judgment.
The AMA approach has a lot of complexities to it. We have very
extensive supervisory guidance that is about to be put out for
comment that details this whole process. Until that guidance is
finalized and we get a final Basel paper, I think it is
premature to make a judgment about what the ultimate capital
impact is going to be from the operational risk charge.
Mr. Toomey. My next question for you, Mr. Hawke, is that
you had mentioned earlier that you had previously argued
against the Pillar 1 capital for operational risk, if I
understand correctly. And I am not aware of what has changed
with regard to the arguments that have historically been made
against that. So I am just wondering what your thought process
was to cause you to come to a different conclusion.
Mr. Hawke. Well, in part--and I do not mean to be
facetious--but in part, it was deference to the shortness of
life. I argued in the Committee for 4 years that because
operational risk was a subject that involved the need to make
qualitative judgments about a bank's internal control systems,
it was appropriate to deal with it under Pillar 2.
The Committee does not take votes, but I can tell you that
there was nobody on the Basel Committee--25 people--who shared
that view. It was not going to prevail. So rather than
continuing to make the argument, we and the Fed worked
together, I think very constructively, to develop the AMA
approach.
I am completely comfortable with the AMA approach to
operational risk because I think it imports exactly that degree
of supervisory discretion and supervisory qualitative analysis
that I would have hoped for under Pillar 2. And I made the
point earlier that even if this were a Pillar 2 issue, we would
still have to have a framework for the supervisors to assess
operational risk. My guess is that that framework would end up
looking a lot like what we have in the AMA approach.
Mr. Toomey. Okay. Well, thank you very much. My time is
running out.
I would be happy to recognize the gentlelady from New York.
Mrs. Maloney. Thank you, Mr. Toomey. Thank you. And I thank
all of the panelists.
What I am most concerned about is the competitiveness
feature. And apparently, all of you agree that it will not be a
disadvantage to American financial systems.
I would just want to know what proof there is. You
mentioned we have had two quantitative studies. There is
another one that will be ongoing.
So I would like to ask Mr. Ferguson and Mr. Hawke, I would
like to see the proof and the studies that you have done to
make sure that American institutions are not disadvantaged. You
testified that the capital requirement would be lower under the
number two accord.
Is that correct? Requirements for American banks? I heard
someone say that. No?
It will not be? Okay, but----
Mr. Hawke. That remains to be seen.
Mrs. Maloney. It remains to be seen. And what studies have
you done and what proof do you have--beginning with Mr.
Ferguson--to show that we will not be at a competitive
disadvantage? What was your process to determine that?
Mr. Ferguson. First, what we are expressing is an opinion.
We will be asking questions in the ANPR to determine how others
view this.
Let me explain a bit of how at least I have come to the
opinion at this stage that----
Mrs. Maloney. Do you have anything in writing that supports
your opinion? Any studies or research that support the opinion
you came to?
Mr. Ferguson. Well, if you would let me, I will tell you
what I have and then you can tell me if it is sufficient. Does
that work?
Mrs. Maloney. Great.
Mr. Ferguson. Good. Here is why I had the view that I have.
First, the reason we are engaged in an international exercise
is to create a level playing field across nations. If we chose
one capital approach and other countries chose another, the
probability of an uneven playing field would go up.
So the entire goal of having an international accord that
is hammered out over 4 years and has a variety of approaches
that you have heard about, is to increase the probability of a
level playing field internationally. Because large,
internationally active banks will be on a comparable set of
rules, by and large.
Secondly, one of those rules involves transparency, which
is to say banks disclosing not just the regulatory minimum
capital under the set of rules, but also disclosing some of the
inputs--not anything that is competitively sensitive, but some
of the inputs--so that market analysts can observe the inputs
of Bank A versus Bank B, whether or not the capital outcome
looks the same. So it is not just that the rules are, broadly
speaking, similar, but also the disclosure allows the market to
do some comparisons across institutions.
The third thing that we have tried to do in order to
minimize the risk of disparities is create a process within
this Committee, called the Accord Implementation Group that
brings together the various regulators from around the world
that are involved in this to talk about how they are making
judgments on things, such as: How do you validate the inputs?
What data does one look at? That type of thing, to try to
create a strong sense of a level playing field among, if you
will, the umpires, the regulators internationally. So that we,
here in the U.S., are to some degree encouraging improved
supervisory oversight that we think will come closer to ours,
which again should give us some comfort.
The fourth degree of comfort frankly is that if it turns
out that this is not the case, that these three things I have
just talked about are not the case, we will certainly hear from
our institutions if they are feeling competitively
disadvantaged. I have not heard that at this stage. But it will
be the ultimate control.
And finally, as I said, we will be asking questions to see
if the industry or others see within the accord and the
approaches that we are planning to take to implement it, any
flat spots, any lacunae, any gray areas where they can see some
room for competitive disadvantage.
I believe that those different approaches should be
sufficient to give us a much better feel in response to your
question. And you may have other questions. But that is the
basis on which I have based the opinion I have so far.
Mrs. Maloney. Well, are you concerned that the vigor with
which the Basel Accord is implemented in the U.S. by our
regulators, which are very vigilant, could be a potential
disadvantage for other international banks where their
regulators are not as stringent? That could be a possible
disadvantage to our banks.
Mr. Ferguson. Are you addressing that question to me or to
someone else?
Mrs. Maloney. Yes, to anyone.
Mr. Ferguson. Well, I will answer. But then I would be more
than happy to have some of my colleagues on the panel answer as
well.
Mrs. Maloney. It may be applied differently in different
countries.
Mr. Ferguson. That is the reason why we have developed this
Accord Implementation Group, to try to create a more consistent
application of this accord across borders. I would say one
other thing as well, I believe that we have the world's
strongest banking system, some of the most sophisticated banks.
Mrs. Maloney. Without a doubt.
Mr. Ferguson. Without a doubt.
I believe that is partially the case because they are, by
their nature, well managed. In fact, much of it is due to that.
I think some of it is due to the fact that we have very
solid regulators here that are pushing the best practice. I
think there is--and one can look at other countries where their
banking system is, to use a colloquial term, ``flat on its
back'' because they have had frankly perhaps lax--too lax--
regulations.
Mrs. Maloney. Exactly, that is my point.
Mr. Ferguson. Exactly. But let me finish. I understand. And
the point I am making is that a strong banking system does not
result from lax regulation. A strong banking system results
from good regulation.
We are going to continue to do good regulation here,
supporting a strong banking system. And, through this Accord
Implementation Group, encouraging others to maintain a level of
supervisory behavior --
Mrs. Maloney. In all due respect, I have noticed our
country, through the United Nations and through other means,
try to impress other countries with certain standards. And they
really have not listened to us, from the Presidents, the
premiers, their elected government. But I would like to hear
from Mr. Hawke. I am specifically interested in written
documentation that I can read that shows that our financial
institutions will not be placed at a disadvantage.
This is tremendously important to me. The financial system
is the main employer in the district that I represent. And they
are domestic banks, international banks.
And I am concerned that there be some type of way, that
either with this capital charge or the operational charge or
whatever, we could be placed--or even with regulatory, more
severe regulatory oversight, placed at a disadvantage. And I am
interested in any written documentation that shows the process
that we will not be disadvantaged.
Do you know of any? Or have you done any, Mr. Hawke?
Mr. Hawke. Congresswoman Maloney, I do not know that there
is any--or could be any--written documentation of the sort that
you are asking for. Let me say that I completely agree with
everything that Governor Ferguson has said. I think he gave a
very complete and cogent answer to the question of competitive
equality. The whole purpose of this Basel effort is to try to
bring about competitive equality.
I do share the concern that differences in the nature of
supervision from country to country could result in disparate
application of Basel II, but the Accord Implementation Group
will be one of the safeguards there. Frankly, I think the Basel
Committee itself needs to address standards of supervision in
member countries. That is certainly something that we will be
arguing for.
But I cannot hold out that there is any documentation that
could be created or that exists of the sort you are looking for
on these issues. We are going to be making a quantitative
impact study that will look at the impact of Basel II on the
capital of our banks. We will have to make a judgment whether
that is acceptable or not acceptable and what it does to the
competitiveness of our banks.
Mrs. Maloney. So that will be written evidence when you
complete this study.
Mr. Hawke. That will be some evidence that will enable us
to make a judgment, that is right.
Mrs. Maloney. Can I ask, Mr. Hawke, how would a regulatory
capital charge, as contemplated by Basel II, have benefited a
bank located near the World Trade Center on September 11th? Can
you explain what benefit and operational risk-based capital
charge could have played in preventing the financial impact of
the terrorist attack?
Specifically, are you concerned that requiring banks to
hold capital for such extreme events as September 11th could
divert resources from contingency planning and development of
backup facilities?
Mr. Hawke. No, not at all. I think, with great respect,
that pointing to the September 11th events and catastrophic
events of that sort misses the point. The point is that every
bank has operational risks that adhere in the nature of the
business to one extent or another.
The objective is to focus banks' attention on how they
manage those risks. How does the bank itself get prepared to
deal with a whole variety of different types of operational
glitches, whether it is the defalcation of a key employee or a
system going down because of some external event? And the
objective is to assure that the bank is holding capital that
would help it protect itself against those risks. So you cannot
really say that operational risk is going to do something
specific with respect to a catastrophic event like----
Mrs. Maloney. Well, then another specific question for you
and Mr. Ferguson on operational risk, as it now stands, the
capital proposal includes a charge for the potential costs
associated with U.S. tort liability, discrimination,
suitability and similar laws that we have passed. Many of the
protections are not available to individuals in the EU or Japan
or other countries.
In the U.S., these protections are the result of decades of
work to promote civil rights. And do you think a capital charge
for this will have an adverse competitive impact on U.S. banks
and perhaps reduce the compliance efforts?
In other words, is there a danger that we are encouraging
other countries not to protect civil rights or undermining our
own protections by requiring capital for these kinds of suits?
And what is the evidence that the costs associated with
litigation has resulted in a bank failure?
Mr. Ferguson. I guess I will take the first pass to that.
And let me echo and reinforce something that Comptroller Hawke
said.
The purpose of having capital is not to prevent. We could
not possibly with capital prevent something like September
11th. That is not what capital does.
Mrs. Maloney. I want to talk about the response from it.
Mr. Ferguson. Let me--let me----
Mrs. Maloney. Okay.
Mr. Ferguson. The point of this focus, as Comptroller Hawke
has indicated, on operational risk is that it is a real risk.
In my statement, I have included 10 examples. A few of them
were ones in which banks failed because of an operational
problem--fortunately, small and medium-sized banks, not large
banks.
A number of them are examples where an operational failure,
failure to comply with laws, failure to run a system smoothly,
led to a large reduction in or could have led to a large
reduction in capital, costing literally $600 million, $700
million--hundreds of millions of dollars. So part of the
challenge here is to build a sufficiently strong capital base
to deal with a risk of an operational failure.
The advantage, as Comptroller Hawke implied and I will try
to make clear, and we saw this on September 11th, is that
institutions that have a strong capital base continue to have
access to markets so they can get the liquidity that they need
to keep their ongoing operations. It will not prevent a
failure.
Now the second part of it, the second reason to have this
focus on operational risk and to have a capital charge
associated with it, is that a number of banks have indicated
and we have seen as an independent supervisory judgment, that
the need to understand the operational risk that an institution
might be subject to does, in fact, do just what you want to
have does, in fact, do just what you want to have done. That
understanding gives those banks an incentive to comply with
laws, to build the kinds of safeguards to avoid defalcation, to
move their backup sites to locations that are more secure, et
cetera.
All of that gets an advantage under these kinds of accords,
the AMA that we are talking about. Or purchasing insurance also
will give an advantage.
So the entire structure of the AMA is meant to give
incentives to make the investments, to comply with laws, et
cetera, that you have indicated. It does not undercut it. In
fact, it reinforces the kinds of good management behavior that
you and we both want to reinforce in these operational areas.
Mr. Hawke. Can I just add one point? I think there is some
misconception about how this works.
We are not going to tell a bank that they have to have an
operational risk charge that deals with tort liability and
another charge that deals with some other potential risk. We
are going to be asking the banks, first of all, to assemble
data about the kinds of losses that they have had in the past
and to look at where the losses have been with other banks. We
are going to be looking at their internal risk management
systems and how they themselves address these operational
risks.
If tort liability is a risk that U.S. banks have that their
foreign counterparts do not have, that is not caused by bank
regulators. That is caused by our legal system. The practical
reality is that it is a risk that our banks have that other
banks do not have. The question that we ask is how are our
banks managing that risk? How are they responding to that risk?
The idea of an operational risk charge is to make sure that the
capital base of our banks takes into account the whole variety
of operational risks that our banks face.
Mr. Ferguson. And one other thing, international banks that
operate here in the U.S. should be holding capital for the
kinds of risks they face here in the U.S. And so if they are
operating in the U.S. and are subject therefore to the kinds of
concerns that you have just raised, one would expect, their
regulators should expect and we should expect their local
subsidiaries, if they are on this approach, to be holding
capital. So there is no international inequity that would
emerge in this.
Mrs. Maloney. Okay, my time is up. But these small banks
that you say failed would not have been covered by Basel II.
Mr. Ferguson. There are large banks. The whole goal here is
not only to avoid failure. It is also to deal with having a
capital cushion so that when you have a large hit of hundreds
of millions of dollars, and if you look at my chart, you see
hits as big as $1.2 billion--$1.1 billion, $1.3 billion you can
survive.
It is true, medium-sized banks have failed. But it is also
true that large banks have been asked to leave the United
States or have had a change of ownership or have also had some
difficulties, for which we want and they should have a capital
base, even if they do not suffer a failure.
One should not think of this as an on-off switch. Either
you fail or you do not. There is also a risk of a severe
reduction in capital for which you want to build a cushion to
avoid failure.
And so you should not think of this as purely: did they
fail or did not they fail? You should also think of whether or
not you need the capital base to keep ongoing operations and
avoid failure. And that is what capital does. It allows you to
continue in the market and continue to thrive, to fund
yourself.
So that failure is not the only test that matters here. It
is also significant loss of hundreds of millions of dollars
that would eat into the capital base.
And there is a great deal of evidence of losses of the $400
million, $500 million, $600 million amount, that we as
regulators should not simply ignore because it was not a
failure.
Mrs. Maloney. My time is up.
Chairman Bachus. [Presiding.] Thank you.
Mr. Ferguson, I am going to ask you one question. Then Mr.
Watt will conclude the panel's questions.
You have indicated on page five of your testimony that we
have concluded that despite our supervisory judgment on the
potential risk of these exposures--I am talking about the
commercial real estate loan capitalization--that we could not
support requiring a higher minimum capital charge on these
loans. And we will not do so.
What do you see the final standards will look like on the
capital charge for commercial real estate?
Mr. Ferguson. The proposed accord has the possibility of
two different types of capital charges for commercial real
estate, some higher and some lower, depending on the nature of
the real estate. Based on the data that has come forward--and
there may be some new data that comes--but based on the data
that has come forward, I believe the proposal will have most
commercial real estate on what is called the low volatility
curve or a lower curve that is similar to the C&I, the
commercial and industrial loan curve. And that is, I think,
quite consistent with the input from a number of banks.
There may be some kind of high volatility real estate--
acquisition, development and construction loans of certain
sorts--where the data still suggests they should have a
slightly higher charge. But I think the vast majority of
commercial real estate will be on the lower curve and have a
charge similar to commercial and industrial loans.
Chairman Bachus. And you know I have expressed my concern
to you before. And I appreciate the changes that you all have
made, based on this new evidence.
We do not want to retard growth. And in some areas of the
United States, they are growing very rapidly. And you mentioned
construction loans. Obviously, that is new construction. And
that is evidence of growth.
And I hope that you will continue to look at that.
I am not sure that construction lending, in my mind, is as
risky--and I am just anecdotally--because that represents
someone's investing in a new project.
Mr. Ferguson. We do not want to retard growth at all. We
want capital to reflect risk. And as you know, because you were
referring to it, when the data come in, we change our minds if
the data are supportive of a change of opinion. We will
continue to watch this pretty closely.
We have already shown a great deal of flexibility. And if
new data sets suggest that we should rethink the position we
have now, you have my commitment that we will do that because
we have already given evidence that we have done it in the
past.
Chairman Bachus. Because as you know, we have states that
are growing at 20 percent every 10 years in population, unlike
most parts of Europe, where they do not have those.
Mr. Ferguson. Well, this is an area, sir, where there is
national discretion. So we will develop a capital approach with
respect to real estate and these two different curves that
reflect U.S. data primarily.
Chairman Bachus. Thank you.
Mr. Watt?
Mr. Watt. Thank you, Mr. Chairman.
I want to assure the Chairman that I will not take the full
10 minutes, unless you all take it answering two questions. And
I want to apologize to the witnesses for not being here for the
testimony.
Unfortunately, I would much have preferred to have been
here. I was in a hearing about whether we should prohibit
lawsuits against--on behalf of people who get fat against
McDonald's and other fast food providers.
[Laughter.]
No pun intended, a very heavy responsibility.
Just two questions. First of all, I have noted in Mr.
Ferguson's testimony and Mr. Powell's testimony--and I did not
get a chance to look at Mr. Gilleran's testimony. I did not see
anything on it in Mr. Hawke's testimony. At least Mr. Ferguson
and Mr. Powell think that H.R. 2043 could be counterproductive.
I wanted to see if that was the uniform opinion of
everybody on the panel. I have Mr. Ferguson and Mr. Powell.
What about Mr. Hawke?
Mr. Hawke. Congressman Watt, in my oral statement, I said
that while I am sympathetic with the underlying concerns that
led to H.R. 2043, we did not think that it was necessary at
this time. There has been a very collaborative process that has
been followed by the regulators. There are dozens and dozens of
issues that come up, most of which we agree on, some of which
we do not agree on. The need for some external process to force
resolution of issues, I think, is not there.
We have a collaborative process going forward that is going
to involve joint notices of rulemaking and joint publication of
supervisory guidance. I think we are very much together on
these issues going forward.
In addition, there is an executive order that requires
certain kinds of economic analysis to be made in connection
with any rulemaking that would have a substantial effect on the
economy. That is defined to mean an effect of $100 million or
more annually. We will be soliciting comment in our Advance
Notice of Proposed Rulemaking to give us the information to
determine whether this rulemaking will actually have that kind
of impact. And if it does, then much of the same kind of
economic analysis that would be called for in H.R. 2043 would
be provided under that executive order.
So, with great respect, we do not think that legislation of
this sort is needed at this time.
Mr. Watt. Mr. Gilleran?
Mr. Gilleran. As I said in my written testimony, to the
extent that the OTS is mentioned in it, we completely agree
with it, and that is that we be part of the process going
forward. I think that the regulators have shown----
Mr. Watt. Have you not been part of this process?
Mr. Gilleran. We have not been part of the international
process up until this time. We have been part of the working
groups here in the United States. And we will be part of it
going forward, in the sense that we will be a party to the ANPR
that we have put out and the deliberative process that will
take place going forward. So your support in that regard is
welcome.
On the issue of how this decision is made going forward, I
believe that the regulators have shown the ability to
cooperate, to deliberate and come to very, very reasonable
conclusions. So that I believe the process of Basel II, with
your strong oversight and interest, I believe your interest has
made a difference already. And I believe the Senate Banking
Committee's interest has made a difference.
But I believe that the process, going forward, should be
left to the bank regulators.
Mr. Watt. Now while you have the floor, I noticed that when
Ms. Maloney was asking questions, you raised your hand at one
point. And apparently, nobody saw you. I wanted to make sure
you got a chance to make the point, whatever that point was,
that you wanted to make.
Mr. Gilleran. Thank you. Well, I was just going to, on the
point of international competitiveness, I wanted to react to
that. Because in a prior career, I was superintendent of banks
in California and worked with a great number of international
regulators.
And it is my view, as has been already expressed here in
our written documents and in person, that the United States is
the strongest bank regulator, without question. And we have
countries out there where bank regulation is weak and that they
have not applied concepts that we apply here in the United
States correctly.
There are countries out there that have not written off
loans and that are just starting to react to the loans they
have in their bank portfolios now. Their inability to have a
strong international banking system has been to their
detriment.
Because what has happened in those countries that do not
have one is that they have a misallocation of capital within
the country. They keep funding companies that are losing and
not funding new technology.
So I think that they are the biggest losers of not
correctly allocating capital. And I believe that since there
are countries that are not doing it well now, there will be
countries that will be not doing it well in the future.
I do not think it disadvantages the United States or United
States banks because I think we are the winner for strong bank
supervision.
Mr. Watt. Thank you.
Finally, a natural segue from my first question about H.R.
2043 and your responses to the need for that, in general, is
there anything that you can identify that this Subcommittee,
the full Committee or Congress needs to be doing as you keep
going through the schedule that is outlined in your testimony?
And if there are any things that we need to be particularly
aware of, it would be helpful for at least me to know that.
Mr. Hawke. I think, Congressman Watt, that the Financial
Services Committee's involvement has been very healthy for this
process. It has certainly strengthened our hand in the Basel
discussions.
Some of the other countries that are participating in this
process have had their legislatures involved from the very
outset. And some members of the Basel Committee were
constrained in the positions that they could take in the
Committee by their parliaments right from the beginning of the
process. We were not. We have worked together as a group of
regulators and participated in that process.
But I welcome the oversight and the interest of the
Committee in the process. I think the Committee's continued
dialogue with the regulators is important. I think ultimately,
it will strengthen our position vis-a-vis the Basel Committee.
We look forward to it.
Mr. Watt. Mr. Powell, anything else you can think of that
we need to be doing? Mr. Gilleran? I am going to come back to
Mr. Ferguson and give him the last word on this.
Mr. Gilleran. I think you should continue what you are
doing. I think your interest and your oversight is important to
us. I think that we should have a meeting like this sometime in
November or early December, so that we can report back on our
findings and assure you that whatever those findings are, that
we are in a position to go forward.
Mr. Watt. Mr. Ferguson?
Mr. Ferguson. I would echo many of the comments from
Comptroller Hawke. And I would add one other, which is that in
a democracy, it is extremely important, I think, to have these
kinds of hearings, to give some legitimacy to a regulatory
process.
I realize that I and we have all been appointed by the
President and confirmed by the Senate. But to have both sides--
Senate and House--asking tough questions and being educated, I
think gives us a greater sense of legitimacy to the industry
overall because they know that we have had to come here and
deal with some very tough questioning.
And I think, therefore, this kind of oversight is very
useful, not just because of the ability to talk to our
negotiating partners overseas about the messages we are
receiving, but also frankly our ability to talk to each other
and to the U.S. population about the fact that indeed, we have
gone through a full process that has not just the usual
external comment period, but this kind of give and take. So I
do also endorse your interest and thank you for the opportunity
to----
Mr. Watt. Any suggestions about any other things we need to
be doing, other than maybe getting a follow-up report at some
point?
Mr. Ferguson. I would say--well, there are two things that
I am sure you will do. One is I am sure you will keep those
cards and letters coming. And so, by definition, I welcome
that.
And secondly, I think----
Mr. Watt. Only to the extent our banks keep those cards and
letters coming--and constituents keep those cards and letters
coming.
Mr. Ferguson. And I am sure they will because that is what
this is all about. And I would say just asking for feedback in
the form we all collectively think would be appropriate,
obviously is the other thing.
Mr. Watt. Thank you.
Chairman Bachus. Thank you, Mr. Watts. At this time, we
will discharge the first panel. We very much appreciate your
testimony. And I very much agree with you that the Committee's
activity has been productive.
So I appreciate all of your candor and participation in
this important issue. And we are confident that you all will
come to a consensus.
Thank you.
At this time, we will call our second panel. I want to
welcome our second panel. I am actually going to introduce
three of the panelists. And then Ms. Hart is going to introduce
Mr. Elliott.
The first panelist or the second panelist, seeing as Mr.
Elliott is going to be introduced by Ms. Hart, is Dr. Benton
Gup. He is the Chair of Banking at the University of Alabama.
Prior to that, he was the Chair of Banking at both the
University of Virginia and the University of Tulsa.
Prior to that, he was a staff economist for the Federal
Reserve Bank of Cleveland and has been the author of so many
books, it would be impossible to list them, many of them used
widely in the banking industry and also in the university. His
publications have appeared in a number of journals.
So we welcome you, Dr. Gup.
Mr. Gup. Thank you.
Chairman Bachus. Our second panelist or our next panelist
is Micah Green of the Bond Market Institute. And I notice,
between our third and fourth panelists, is that you both have
your doctorate degree from George Washington University, so
both graduates. That is correct, isn't it?
Mr. Green. My law degree. But thank you for the----
Chairman Bachus. Law degree. I consider that a graduate
degree or post-graduate degree. Micah Green is President of the
Bond Market Association. That is an association of 220 member
firms, which collectively account for 95 percent of the
nation's municipal security underwriting and includes all the
primary dealers and other key participants in the U.S.
government and federal agency security market and all major
dealers and municipal and corporate debt securities, mortgage
securities and money market instruments. And you will be
testifying on behalf of the Bond Market Association.
He received his J.D. and bachelor's degree from George
Washington University.
Our final panelist is Ms. Karen Thomas. She is Director of
Regulatory Affairs and Senior Regulatory Counsel for the
Independent Community Bankers of Alabama--not of Alabama, of
America, a national trade association representing 5,000
community banks. She has frequently published articles in the
Wall Street Journal, American Banker and quoted in American
Banker and BNA's Report for Executives and appeared on numerous
TV shows--CNBC, Nightly News, et cetera.
You are a graduate of the College of William and Mary and
received her J.D. with honors from George Washington
University's Law Center. So you are both law graduates from
George Washington.
So I welcome you both.
At this time, I am going to turn the chair over to the
gentlelady from Pennsylvania, Ms. Hart. And we will try to
expedite this hearing. Thank you.
Ms. Hart. [Presiding.] Thank the Chairman also for allowing
me to introduce Mr. Elliott, who is from my area. Steven G.
Elliott is Senior Vice Chairman of Mellon Financial
Corporation. He is responsible for the corporation's asset
servicing and human resources services businesses, including
global security services, securities lending, foreign exchange,
Mellon investor services, Buck Consultants and Mellon HR
Solutions.
The corporation's finance, treasury, technology and real
estate and Mellon's venture capital businesses also report to
Mr. Elliott. And he serves on the Board of Directors of Mellon
Financial Corporation and also on the Board of Directors of
Mellon Bank, N.A.
Mr. Elliott joined Mellon in 1987 as Executive Vice
President and head of the Finance Department. He was named CFO
in 1990, Vice Chairman in 1992 and Senior Vice Chairman in
1998. There was clearly no age requirement for that job.
Previously, Mr. Elliott served in executive positions at
First Commerce Corporation, Crocker National Bank, Continental
Illinois National Bank and First Interstate Bank of California.
He is a member of the American Institute of CPAs, the Financial
Executives Institute and the Financial Services Roundtable.
He also serves on the boards of the Pittsburgh Cultural
Trust and the UPMC Health System. That is the University of
Pittsburgh Medical Center Health System.
He is a native of Delta, Colorado. Mr. Elliott also
received a bachelor's degree in finance from the University of
Houston and a master's in business administration from
Northwestern University's Kellogg School of Management.
I will also add, it is nice to see the reverse migration
from Colorado to Pittsburgh, instead of from Pittsburgh to
Colorado. Thank you for joining us also, Mr. Elliott.
Is that a vote? Okay. We are going to have a vote. But I am
going to let you start, Mr. Elliott. And we may suspend in just
a little while so that members can actually get over to the
vote.
STATEMENT OF STEVEN G. ELLIOTT, SENIOR VICE CHAIRMAN, MELLON
FINANCIAL CORPORATION
Mr. Elliott. Thank you very much, Representative Hart.
Mellon is a financial services company with 22,500
employees in 21 countries. As indicated, we provide
institutional asset management, mutual funds, private wealth
management, asset servicing, human resources and treasury
services. Mellon has approximately $2.9 trillion in assets
under management, administration or custody, including $566
billion under management.
It is indeed a pleasure to appear today before you to
discuss our views on the pending changes to the capital,
supervision and disclosure rules. Although complex, sometimes
very much so, these new rules will have a profound impact on
the competitiveness of U.S. financial services firms and on the
products they provide to American consumers, companies and
investors.
Basel will have a particularly dramatic impact on Mellon's
lines of business, where U.S. banks now have a global
comparative advantage through aggressive investment and leading
edge technology and the sophisticated risk management and
related systems developed to support these activities.
Basel's rules also will have a profound impact on the
global economy. Although the rules are not now scheduled to go
into effect before 2007, they will in fact have a major impact
on financial markets far more quickly. Thus, your review--and
that of other panels in the Congress--is timely and
commendable.
At the outset, I would like to express Mellon's gratitude
to all of the regulators--U.S. and global--that spent literally
thousands of hours crafting these revisions. Of particular note
is the new emphasis on a more balanced approach to bank
regulation--what Basel is calling the Three Pillar Approach.
I strongly agree that capital rules are not the sole
touchstone of bank safety and soundness. Indeed, undue reliance
on capital adequacy can divert attention from latent, serious
problems in internal controls, strategic decision-making and
other key risk areas.
Thus, Basel's decision to look not only at capital, but
also at supervision and disclosure, will result in a far
stronger global financial system going forward. All of the hard
work is also justified by the worthy goal with which Basel
started: an end to regulatory capital arbitrage.
All sophisticated banks and their holding companies--Mellon
included--have gotten better in the past decade at spotting
inconsistencies between the regulatory capital standards that
bind us and the economic ones that are demanded by the broader
markets. Better alignment of regulatory and economic capital
will reduce this dichotomy and ensure that capital requirement
incentives promote the laudable supervisory goal of increased
bank safety and soundness.
Unfortunately, since Basel started, its goals appear to
have changed. As recently stated in a document released by U.S.
regulators, the Basel goals now are improving internal controls
and capital allocation, promoting market discipline and adding
a new capital charge for operational risk.
Mellon strongly supports the first two goals. But the
third--a new one--in fact undermines the first two by creating
perverse incentives to undue risk taking. The operational risk-
based capital requirement could also put U.S. banks at a
serious competitive disadvantage versus non-banks here--and I
want to emphasize versus non-banks here--and non-U.S. financial
services firms around the world.
The U.S. decision not to impose the most flawed operational
risk-based capital proposals does not negate the fact that
these will be mandated elsewhere, with potential serious
safety-and soundness results. Setting operational risk-based
capital as a simple percentage of gross revenue creates
perverse incentives to risk taking, as I have mentioned in my
written testimony. And the U.S. should fight hard against this
in Basel II to ensure that all of the world's large banks are
under a proper regulatory capital regime, not just those here
in the United States.
Systemic risk must be an overriding consideration as Basel
II is finalized. And the operational risk-based capital
proposal thus poses especially serious challenges, in our view.
As requested by the Subcommittee, I shall focus my comments
today on issues of particular importance in the U.S., with a
focus on recommendations for the pending advance notice of
proposed rulemaking to be released by the bank regulators.
I would recommend: first, complete elimination of the
Pillar 1 operational risk capital charge. The goal of promoting
internal controls and capital allocation can far better be
achieved through addressing operational risk-based capital in
Pillar 2; namely, improved bank supervision.
Second, the U.S. should not force all large banks into the
most advanced versions of Basel II, as these are also the most
complex and not necessarily appropriate for all large banks.
Specialized banks like Mellon, for example, which holds less
than $5 billion of loans in our lead bank, do not require the
advanced internal ratings-based approach for our credit book.
The standardized approach for credit risk that will be used by
the European Union appropriately controls regulatory arbitrage
for specialized banks.
Third, there is no need to continue the arbitrary eight to
10 percent capital ratio or the overall leverage capital
standards. To achieve the end of the regulatory arbitrage that
Basel and the U.S. regulators rightly seek, low-risk banks
should hold regulatory capital appropriate to this position,
which could be well below current regulatory levels set in
1988.
On the other hand, high-risk banks should similarly hold
the appropriate amount of capital, likely far more than what
they currently do. A simple, overall capital ratio undermines
the goal for which Basel and the U.S. have worked so hard for
so long.
Finally, operational risk-based capital should not be used
as a Pillar 1 or a Pillar 2 top off to credit risk capital.
Each bank should hold regulatory capital appropriate to its
risk profile, with market forces and the bank's judgment
determining when more than the risk-determined amounts of
capital be held.
Thank you. And I would be pleased to answer any questions.
[The prepared statement of Steven G. Elliott can be found
on page 66 in the appendix.]
Ms. Hart. Thank you, Mr. Elliot. At this time, we are going
to recess the Committee so that the members can vote. And we
are going to reconvene at 1:45, with a pretty long series of
votes. So if the panel wants to maybe grab lunch or something,
feel free to do that.
But we will be back at 1:45.
[Recess.]
Chairman Bachus. [Presiding.] The Subcommittee on Financial
Institutions and Consumer Credit will come back to order. I
apologize to our panelists for the interruption. We had votes
on the floor.
It is my understanding, Mr. Elliot, that you testified.
And Dr. Gup, we look forward to your testimony. And I
recognize you at this time for your testimony.
STATEMENT OF BENTON GUP, CHAIR OF BANKING, UNIVERSITY OF
ALABAMA
Mr. Gup. Mr. Chairman and members of the Committee, thank
you for the opportunity to testify here. I am going to
summarize my written comments that I would like included in the
record.
The 1988 Basel Accord provided a minimum capital standard
of eight percent of risk weighted assets for internationally
active banks to ensure an adequate level of capital and provide
competitive equality. The ``one size fits all'' capital
standard was a good starting point.
But as banks face a growing range of risks and new
technologies, it became clear that the capital requirements had
to be made more risk sensitive. The result is Basel II.
Federal Reserve Vice Chairman Ferguson said on June 10th
that regulators expect to require 10 or more of the largest
banks to use the Basel II Advance Internals Risk-Based approach
for credit risk. Other large banks may elect to use the
Advanced IRB approach. And the remaining banks will continue to
use the 1988 capital standards.
In my written testimony, I said the regulators would
require about 20 banks to meet the new standards. The
difference in the number of banks required to use the advanced
IRB does not affect my conclusions.
The major point is that about 70 large banks, with assets
of $10 billion or more, those banks whose stocks are actively
traded believe that if they want to be considered major league
players by equity analysts and their stockholders must use the
advanced IRB approach. In addition, they must declare that they
are using it in their financial reports.
The advantage to banks using the advanced IRB approach is
that they may have lower capital charges on certain loans than
banks using the 1988 capital standards. This creates
competitive inequality.
The disadvantage is the high cost of implementing Basel II,
which ranges from $10 million to $150 million.
The treatment of real estate loans in Basel II is another
problem because real estate loans constitute a large portion of
the portfolios of large regional banks. The U.S. bank
regulators' perception of risks associated with real estate
loans are based in part on the loss experiences of the late
1980's and early 1990's.
During that period, the losses on real estate loans were
highly concentrated geographically in Texas, Massachusetts and
Connecticut and mostly in small banks. It is important to keep
in mind that this occurred before deregulation and significant
changes in financial technology.
Thus, looking at the 1980's and early 1990's to determine
capital requirements for today is analogous to driving down a
steep, winding mountain road by only looking out the back
window; a crash is inevitable.
Today, real estate lending at large regional banks is
different for the following reasons: banks can expand
geographically and avoid excessive concentration; they can buy
or sell mortgages via securitization; they can hedge with
derivatives; they can have low loan-to-value ratios and they
can use high credit scores, such as FICO scores.
Fannie Mae and Freddie Mac provide examples of how these
tools may be used. In addition, Fannie Mae and Freddie Mac have
only three percent capital requirement.
In conclusion, the Basel II capital requirements create an
uneven playing field, giving an advantage on capital charges to
those banks using the advanced IRB approach. The capital
charges on commercial real estate loans in Basel II are
excessive. A risk weight of 150 percent may mean that a bank
must hold more than eight percent capital on such loans.
However, as noted previously, banks can manage their
portfolios using the same tools as Fannie Mae and Freddie Mac.
And these government-sponsored entities have only three percent
capital requirement.
The bottom line is that there will be competitive
inequality in bank capital under Basel II.
Thank you very much. And I will be glad to answer any
questions.
[The prepared statement of Benton E. Gup can be found on
page 128 in the appendix.]
Chairman Bachus. Appreciate that.
Mr. Green?
STATEMENT OF MICAH S. GREEN, PRESIDENT, THE BOND MARKET
ASSOCIATION
Mr. Green. Thank you, Chairman Bachus, for the opportunity
to testify today on Basel II.
As you indicated earlier, the Bond Market Association
represents the U.S. and global bond markets. Together with our
affiliates, the American and European securitization forums, we
also represent many of the major participants in the growing
securitization markets in the United States and Europe.
The following comments focus on those issues related to
Basel II that are most important to our membership. First, let
me say the association supports the Basel Committee's overall
goal of rationalizing the current risk-based capital regime and
aligning regulatory capital requirements more closely to actual
risk.
We are grateful to the Federal Reserve Board in particular,
Vice Chairman Roger Ferguson and other U.S. bank regulatory
agencies for working with us to address the issues presented by
the proposed capital accord revisions that are important to our
membership. We are still concerned, however, that if not
amended, Basel II will diminish the economic benefits derived
from large and growing sectors of the capital markets, benefits
which accrue to consumers, as well as businesses.
And I also want to congratulate you, Mr. Chairman, and
Chairman Oxley and Congressman Frank, for bringing this
Committee hearing together today. It really has been important
to the process of elevating the dialogue between regulators,
the Congress and the affected parties. And I think it is a very
positive development.
I will first make one general comment on the direction of
Basel II and then focus on two areas of most importance to us--
securitization and the repurchase agreement and securities
lending market.
With regard to Basel II broadly, we believe it is important
that this agreement not be viewed as the last word on
regulatory capital. Risk management techniques are continually
evolving. And the financial markets need a regulatory capital
accord that evolves with them.
Basel II must therefore be crafted in a way that ensures it
can better adapt to changing market products and development.
Ultimately, the global financial community will need to move
toward a broader reliance on internal risk models to determine
appropriate capital levels.
On securitization, which is a process of converting
illiquid financial assets, like loans or other receivables,
into securities which can be traded in the capital markets, it
is a large and growing marketplace, with tremendous economic
benefits for consumers and businesses.
Securitization lowers borrowing costs for consumers and
others, improves risk management, draws new sources of capital
to the lending markets. Consumers benefit from these
efficiencies with lower interest rates; in a sense, bringing
the high finance, the technology of finance down to the
consumer level through lower cost home mortgage.
To give you an example of the size of the markets, in the
last 7 years, the U.S. securitization market has grown fivefold
to $2.7 trillion. In Europe, it has grown twentyfold--to a
smaller level--but twentyfold to $151 billion. And in Asia,
where the securitization market is just getting started, it has
grown in the last 7 years 510-fold to $51 billion.
Financial institutions participate in this marketplace as
issuers and investors and as part of their risk management
functions. For securitization generally under Basel II, the
proposed risk weights for securitization positions held by
banks are simply too high in light of the actual credit risk
presented by these products.
The proposed rules use unrealistically conservative
assumptions that cumulatively would require financial
institutions to set aside excessive levels of capital.
Considering who ultimately benefits from a vibrant
securitization market--home and car buyers--this is very
important.
These concerns must be addressed. And they are addressed
fully in our written testimony.
Lastly, repo and securities lending transactions, although
little known outside the wholesale financial markets, are vital
to our capital markets' liquidity and efficiency. Repo and
securities lending transactions allow market participants to
finance and hedge trading positions safely, cheaply and
efficiently. In fact, the Federal Reserve uses this marketplace
to implement monetary policy.
Basel II may require banks to take capital charges
inconsistent with the actual level of risk present in repo and
securities lending transactions. Financial institutions should
have greater flexibility to employ supervisory-approved
internal risk models created to assess counter party risk in
order to accurately reflect risks present in these
transactions. These issues are also dealt with in more detail
in my written testimony.
And finally, we agree completely that the current
regulatory scheme for bank capital--Basel I--needs significant
revision. The current regulations are outdated and inflexible.
Updating the regime can produce significant benefits,
including the promotion of fair global competition, incentives
for better internal risk management and an economically
efficient allocation of capital. Getting it wrong, however, and
implementing capital regulations which do not reflect modern
practices or true credit risks on banks' balance sheets will
diminish or eliminate market efficiencies that benefit
everyone.
The Basel Committee is on the right track in developing new
capital standards. But significant work still needs to be done.
In order to preserve the efficiency of our capital markets,
the treatment of securitization, repo and securities lending
products, it needs to be amended. We intend to continue our
active dialogue with U.S. and international bank regulators on
the issues addressed above. We have every hope that these
issues can and will be resolved before Basel II becomes final.
Thank you for the opportunity to testify, Mr. Chairman.
[The prepared statement of Micah S. Green can be found on
page 122 in the appendix.]
Chairman Bachus. Thank you. I would say this, Mr. Green,
securitization, which we also are hearing that a lot in our
FCRA hearings, because with many auto loans, as well as
mortgage loans and in consumer loans, securitized, it is
important that we have a national uniform credit reporting
system too.
And I had heard, in those hearings we have been conducting,
amazing testimony on how much that does bring down interest
rates. It is quite amazing. So I just point that out. I
appreciate that.
Ms. Thomas?
STATEMENT OF KAREN M. THOMAS, DIRECTOR OF REGULATORY AFFAIRS
AND SENIOR REGULATORY COUNSEL, INDEPENDENT COMMUNITY BANKERS OF
AMERICA
Ms. Thomas. Mr. Chairman, thank you very much. I am pleased
to appear today on behalf of the Independent Community Bankers
of America, to discuss Basel II and its implications for
community banks in the United States.
First and foremost, ICBA applauds the U.S. regulators for
their announced intention to limit the scope of application of
Basel II in the U.S. and not to require it for second-tier and
community banks. Capital adequacy rules must be appropriate to
the size and complexity of operations of the bank.
The Basel I Accord has worked well for community banks and
generally remains well suited to assess capital adequacy for
these banks. The significant and far-reaching changes to the
capital adequacy framework contemplated by Basel II are unduly
complex and costly for U.S. community banks and would be
unnecessarily burdensome.
Stated simply, Basel II is overkill for non-complex
community banks. And the cost and burdens of adhering to Basel
II would outweigh the benefits--if any--of moving to the new
accord.
The internal ratings-based approach is simply infeasible
for community banks. Community banks do not have the resources
to use costly, sophisticated internal risk rating models.
A community bank is not likely to have a sufficient volume
of credits to maintain a sophisticated, statistically valid
model with sufficiently meaningful risk refinement to justify
the high cost of extensive data collection, recordkeeping and
model maintenance.
The standardized approach, despite its additional
complexity over Basel I, may not materially affect a non-
complex bank's minimum capital requirements once the additional
charge for operational risk under Basel II is taken into
account. But as with any change, the standardized approach
would present the burden of learning and mastering a new
scheme, changing systems and software, and retraining
management, boards and employees with little corresponding
benefit to justify the cost for community banks.
Even though we are pleased with the decision regarding the
scope of application of Basel II in the U.S., that does not
mean we do not have some concerns about the impact of Basel II
on community banks. In particular, we are concerned that Basel
II may place community banks at a competitive disadvantage.
Basel II will yield lower capital requirements for retail
credit, including mortgages and other loans to individuals and
small businesses. These are the very credits where community
banks compete with large banks.
Regulatory capital is a key factor in profitability and
return on equity. There is a cost to a bank for maintaining
capital. The lower capital requirements for retail credits may
result in a cost advantage and correspondingly, a pricing
advantage for large banks that are subject to Basel II.
Our concern is heightened by the Quantitative Impact Study
3, which compares the average risk weights and capital charges
under Basel I and Basel II. Total retail credit capital charges
under the advanced IRB approach are estimated to decrease by 50
percent, including 60 percent for mortgages and 41 percent for
non-mortgages.
ICBA urges U.S. regulators to examine the question of
competitive impact on Basel I banks closely. Small and medium-
sized institutions play an important role in the economy by
providing credit to consumers and small and medium-sized
businesses.
For this reason, it is imperative to consider the
competitive impact and implications Basel II will have for
second-tier and community banks, as well as for their
customers. To balance any competitive inequities, regulators
may have to consider making appropriate adjustments for Basel I
banks, such as additional risk buckets or changes in risk
weights to increase risk sensitivity.
In addition, regulators should consider whether to allow
second-tier banks and community banks the option to apply the
Basel II standardized approach in order to avail themselves of
its lower risk weights for retail credit. Problems with the
operational risk charge under a standardized approach would
have to be addressed, however.
In sum, ICBA supports limiting the scope of application of
Basel II in the U.S. At the same time, the concerns about
competitive equity between Basel I and Basel II banks must be
carefully examined and addressed.
Thank you for the opportunity to appear before you today. I
would be happy to respond to your questions.
[The prepared statement of Karen M. Thomas can be found on
page 182 in the appendix.]
Chairman Bachus. Thank you. I am going to ask the first two
questions of the entire panel. And I will start with Mr.
Elliott and answer in order. And you do not have to, if you do
not want to respond to either one of these two questions, you
do not have to.
First, would you share with the Committee your
organization's involvement in the development of the Basel
Capital Accords and the third consultative paper, if at all.
Did you meet with all the regulators involved? Or only with
some of them? And do you feel that the concerns you raised were
properly addressed in the third paper?
Mr. Elliott. At Mellon, we have been very actively involved
in not only the most recent paper, but all of the previous
papers as well. I had a number of dialogues with the
regulators. For us, our primary regulators are the Comptroller
of the Currency and the Federal Reserve Board.
Not only have they visited us at our headquarters in
Pittsburgh, but we have gone to a series of outreach meetings
that they have conducted. And there has been a lot of ability
to be part of the process.
So I think from a process perspective, Mellon is
comfortable that the regulators have been giving us adequate
opportunity to have our views heard.
Chairman Bachus. Were your concerns addressed?
Mr. Elliott. No. We still have a major concern as it
relates to the operational risk charge. Part of it obviously is
with our mix of businesses, where we do very little lending
directly. And thus, the operational risk issue becomes larger.
And the one in which we have difficulty is that most of our
competitors, many of them are non-banks and would not be
subject to the same type of capital requirements, not only
here, but also globally. And a lot of the risks that are
currently part of Pillar 2 supervisory, like interest rate
risk, liquidity risk, strategic risk, these will continue to be
dealt with in Pillar 2.
And we are puzzled, if you will, as to why operational risk
by itself is being singled out for an explicit capital charge.
Our view is that it should be back in Pillar 2, along with
these other major type of risks that affect all institutions.
Chairman Bachus. So you feel like this could actually put
you at a competitive disadvantage?
Mr. Elliott. Yes, we do.
Chairman Bachus. Dr. Gup, I do not guess--you have not
actually been part of the process?
Mr. Gup. Well, the University of Alabama has no direct
interest in this.
Chairman Bachus. Sure.
Mr. Gup. I have a research interest in this. I am working
on a book of selected readings and invited articles by myself
and others on the subject of Basel. We will have a panel that
presented some of this in a meeting last week in Ireland,
dealing with Pillar 3, which has not been discussed here.
At the Financial Management meeting in Denver in October,
we are having a panel of government regulators, academics and
others, practitioners, discussing Basel II. The following year
in Zurich, we are having another panel on this.
So we are presenting a wide variety of views. I will be
presenting some of my views also to the Australian Institute of
Banking and Finance, which is like the American Bankers'
Association Down Under, later this summer. So we are getting a
global perspective. And I am trying to get some research input
into this area.
Chairman Bachus. You said that you talked to your
colleagues in Europe about Basel II when you were in Ireland?
Mr. Gup. Asia, all over. Yes, sir.
Chairman Bachus. What can you share with the Committee
about what you learned over there in Ireland?
Mr. Gup. I could not find anybody that likes it. Everybody
seems to agree that Basel I is outdated and we have to move
forward. But the degree of complexity is a major disadvantage
of using Basel II. It has a lot of problems.
It is a good starting point. It is a work in progress.
Chairman Bachus. So the Europeans have some of the same
concerns?
Mr. Gup. Absolutely.
Chairman Bachus. Okay.
Mr. Green?
Mr. Green. Mr. Chairman, the Bond Market Association, since
our principal focus--not our sole focus, but our principal
focus--has been around the product areas I mentioned, has been
deeply involved for a long time, particularly in the United
States, working with the Federal Reserve, as well as the New
York Fed, where President McDonough was so deeply involved in
the Basel Committee for many years. And there has been very
good dialogue over that period of time.
Also, since the U.S. securitization market was so well
formed already, there was a sense that the European
participants in Basel may not be fully aware of the impact that
would have on the European securitization market. And our
affiliate organization, the European Securitization Forum,
which is a purely European-based organization, has had regular
ongoing dialogues with European regulators to try to ensure
that they have a full and complete understanding of that
market. And together, we have also had discussions with them on
the repurchase agreement side.
Also, the Bond Market Association, both through its office
London but also in its membership in the International Council
of Securities Association, which is made up of 25 or 26 various
associations and self-regulatory organizations from around the
world, meets a couple of times a year. And Basel has been a
subject matter of discussion for many years to ensure that, at
the association representational level, there is some degree of
coordination.
Are we there yet? I am not sure we would be here
testifying, saying that it needs improvement, if we were fully
satisfied with the Third Consultative Paper.
Our hope is that on the issues that we have talked about on
securitization and repurchase agreements, that between Third
Consultative Paper and the final Basel agreement, there will be
continued improvement to address those issues. Because the
issues that we feel are our focus affect real people and
consumers who need to buy homes and buy cars and need access to
capital.
In fact, the University of Alabama may, in fact, care about
that. And we would hope that before Basel is complete, these
issues can be addressed.
Chairman Bachus. If the Basel Accord went into effect, as
presently constituted, and there are no more changes with
regard to securitization, what will be the impact on the
securitization market?
And number two, will the Bond Market Association support
Basel II, even if the changes you have suggested are not
adopted or included?
Mr. Green. Answering your second question first, there is
unanimity among the market participants in our organization
that Basel I is outdated and inflexible. And therefore, the
status quo is not good.
The general direction of Basel II is very promising. And
the specifics--in a sense, the details--need improving. But the
general direction is an improvement upon the status quo, which
is why we are supportive of the general direction of Basel II.
If the issues that we have raised are not fixed, the impact
would be focusing on securitization. Financial institutions, if
they have to charge more risk capital on their balance sheet
than what is appropriate, based on the actual risk, then their
ability to participate in that marketplace will be hampered.
The depth of liquidity in that marketplace will be
hampered. That affects the pricing in that marketplace.
And since that marketplace is where home mortgages and car
loans and credit card receivables are securitized, when you
adversely affect the pricing in that market, it will raise the
cost of borrowing in that market, which then gets down to the
consumer level.
So I am not going to say the sky is going to fall out of
the sky. But pure market logic would have it that if you
inhibit their ability to participate and you inhibit liquidity,
you change pricing and you increase the cost of capital, which
affects consumers.
So that will happen. And that is why we are here today. And
we appreciate the opportunity.
Chairman Bachus. Yeah, thank you. Well, that would not only
maybe drive up the loans, it would also--would it affect the
amount of funds available to make loans?
Mr. Green. Absolutely because one of the principal purposes
of the securitization marketplace is to ensure that on
financial institutions' balance sheets are not loans that are
just stagnant. And they can get rid of those loans on their
balance sheet and get fresh capital.
They can also, in a very sophisticated way, manage their
risks and match their assets with their liabilities much
better. So by inhibiting their ability to participate in that
marketplace, it will in fact lower the supply of lendable
capital.
Chairman Bachus. And that would, I think, affect your lower
and middle income families probably disproportionately.
Mr. Green. Certainly, as any consumer who needs a car or a
house or a refinanced mortgage or a credit card, yes.
Chairman Bachus. Okay. Thank you.
Ms. Thomas, do you recall the original question?
Ms. Thomas. Yes, I do.
[Laughter.]
Chairman Bachus. Would you like to respond?
Ms. Thomas. Certainly. ICBA has had a number of
opportunities and a variety of opportunities to meet and talk
with the regulators about Basel II. This has included a number
of our banker members as well.
We have met with individual agencies on an informal basis.
We have met with all the agencies on an interagency basis
together, as well. We have participated in the comment letter
process regularly on this issue.
And we know that the regulators' door is always open to us
if we have any questions. If we need to be briefed, if we have
any concerns we want to express, we know well that we can do
that.
The other thing I would like to mention is that ICBA was
the only U.S. trade association that participated in a meeting
with the Basel Committee itself in July 2001. The Committee
convened a meeting of representatives of small and medium-sized
banking institutions around the world to hear our concerns.
So we had an unprecedented opportunity to speak directly to
the Basel Committee itself. And it was there that the U.S.
regulators first signaled their intention not to apply Basel II
to community banks.
And at that point, that was our major concern. We saw
incredible increase in regulatory burden, if that were the
case. Our concerns were certainly addressed there, as the
agencies have announced that they do not intend to do that.
I think now one of the main issues that we see is the
competitive impact. And I think you heard from the first panel
that they intend to take a close look at that issue.
And they have been looking at it. And they intend to look
at it closely, moving forward, particularly in the ANPR
process.
Chairman Bachus. And that is on small lending, mortgage
lending and residential mortgage----
Ms. Thomas. For our bankers, we are concerned about those
retail credits, which are defined as mortgages and other loans
to individuals and small businesses.
Chairman Bachus. Okay. And even though the agreement does
not specifically apply to you, it would wash over and could
affect your competitiveness on that market?
Ms. Thomas. Yes. We see that the Basel II banks, they plan
on using the changes in Basel II to more finely price their
products and services. They want the ability to price according
to economic, as opposed to regulatory capital, try to match the
economic capital more to regulatory capital.
Our concern is that smaller banks, not being subject to
Basel II, are going to have higher capital requirements for
those same loans and credits. And all other things being equal,
a larger institution will be able to price something lower but
still achieve the same return on capital as the smaller bank,
which has to price it at a higher level.
So we are concerned about the competitive impact there.
Some of the larger community banks that are publicly traded,
they compete in the capital markets for capital. And they need
to realize certain returns on equity in order to be
competitive.
And so we do see that as an issue. And one of the answers
may be to make some additional adjustments for Basel I banks to
address those inequities.
Chairman Bachus. Have you suggested any change in Basel II
to address your concern about these business lines?
Ms. Thomas. Not so much in the Basel II. I think we think
that it will be more appropriate to make an adjustment for the
Basel I banks.
Chairman Bachus. All right. Thank you.
Ms. Maloney?
Mrs. Maloney. Thank you very much. My biggest concern with
Basel II is the impact on the competitiveness of the U.S.
financial services industry. And I understand some banks
support it and some have questions.
But as a whole, I think this competitiveness issue is the
most important to address before the accord is implemented. And
I want to be clear that I am not looking for an American
advantage. I just want to make sure that our industry does not
face a disadvantage.
With this as a priority, I worked with the Chairman to
introduce H.R. 2043. And one of the primary aspects of the bill
establishes an interagency Committee, made up of the Treasury
Secretary, the Federal Reserve, OCC and FDIC, to develop a
uniform position on issues before the accord, before Basel II.
If the members of the interagency Committee could not agree
on apposition, the position of the Secretary of the Treasury
would be the determinative position. It also requires a report
to Congress before a decision is made; not that we could stop
any decision, but at least we would be informed of what it is.
And I was particularly concerned about not having any
concrete evidence on the fact that our financial institutions
were not disadvantaged. I would like to ask any of the
panelists if they would like to comment on the legislation, if
you think it is necessary or not.
Mr. Elliott. One place where this may be into the
competitiveness issue that you are referring to is that Basel
II, as designed, really is only on the banking institution
component of financial services. There are many parts of
financial services here in the U.S., as well as globally, that
Basel II would not apply to.
And an institution like Mellon that I am associated with,
many of our competitors are non-bank financial institution
competitors. And here is where we feel the real inequality of
the proposal.
Our hope would be that, from a regulatory perspective, the
regulators would be able to come to an agreement that would not
penalize the banking sector, if you will, of financial services
and that hopefully legislation would not be required.
But having said that, at the same time, we are looking very
much in terms of how competitive we can be. If our capital is
higher, that means our return on equity is lower. That means
our stock to investors is not viewed as attractively.
And our ability then to access the capital markets to, in
essence, grow the institution, is in essence hindered. In many
ways, many of these risks we have been talking about, earnings,
current earnings basically cover all of the risks. And we think
that is a part of the dimension that they really have not
addressed.
Mrs. Maloney. Well, Mr. Elliott, just following up on it,
we had quite a discussion earlier with the regulators. And they
seem to be in agreement now on the Pillar 1 approach to
operational risk.
And I want to know, on a daily basis, what do you do to
manage operational risk? And how will a Pillar 1 approach lead
to greater transparency? Or will it not?
Could you--if you heard that earlier comment on operational
risk.
Mr. Elliott. Yes, I did. Obviously, risk management for any
financial institution has to be a core competency at the end of
the day. And if you were to look in terms of not only the human
capital that we put against it--you know the human intellect--
as well as our internal systems, this is something that we are
constantly enhancing and spending a great deal of money on, on
a current basis.
And we do not feel an explicit capital charge is going to
enhance that process. In fact, if you think about it, it is
really paying for it twice. You are paying for it in capital.
And you are paying for it through earnings by having a very
robust risk management system.
So our view would be that disclosure, which is part of the
Pillar 3, which we really have not talked about a whole lot
today. This transparency issue, we think, is very important. We
are very willing. And we think frankly that most financial
institutions are leaders in transparency.
The tradeoff in transparency is if you have too much, in
essence, there is too much overload possibilities of all your
disclosures. So they do have to be focused. They do have to be
on the relevant things.
Obviously, from a regulatory perspective, the regulators
have access to all of our internal systems, all of our internal
ways of looking at risk, be it either operational risk or
interest rate or liquidity. And our view is that the strength
of the regulatory system basically is the way that you address
this, as opposed to a capital charge that is difficult, if not
impossible, to calculate and then compare from institution to
institution.
Mrs. Maloney. Thank you.
Would Mr. Green like to comment on the legislation?
Mr. Green. Congresswoman Maloney, while we appreciate the
spirit with which the legislation was introduced, we do not
have a formal position on it. I would just comment, and again,
from our relatively narrow markets' perspective, but I would
just comment, thinking about the last 2 days. I testified at
the Senate hearing yesterday.
And the combination of these two hearings has probably done
a great deal to achieve the underlying purpose, and that is
developing a dialogue with the regulators, sending a signal to
the regulators, allowing those affected by Basel II to have a
forum to speak and have the regulators and legislators hear
that. And I think we are all coming from these hearings with a
clearer direction of what needs to happen between the Third
Consultative Paper, the final Basel Accord and then the
ultimate national implementation of it.
So we applaud what you have done to this date. And for that
reason, in our narrow market's perspective, we do not have a
position on the legislation.
Mrs. Maloney. Would anyone else like to comment? And the
Chairman has informed me that we need to get ready for the next
hearing.
They gave us additional time on this incredibly important
issue. And I thank the Chairman.
If anyone else would like to comment, fine.
Chairman Bachus. Thank you. I would make just one final
comment.
Dr. Gup, I notice that you mentioned that some of our banks
that do not participate in Basel II could be competitively
disadvantaged. And Ms. Thomas, I think you have some of the
same concerns.
And I did note--and I do not know whether it was in the
Senate testimony or in the submitted testimony today--that
Director Gilleran, actually one of the concerns he expressed is
that this may result in a wave of acquisitions, which is
obviously a concern.
That could even happen to a larger institution that was
maybe, like Mellon Bank, that your business model was such that
it caused you to be non-competitive. And you might actually,
you know, your one alternative would be to be acquired, I would
think. I am not sure that would happen.
The other thing I would say, Mr. Elliott, the Federal
Reserve or the regulators have never expressed any concern over
how you address operational risk today, I would not think. Have
they? Not to a great extent.
Mr. Elliott. Mr. Chairman, I am not sure I understand your
question.
Chairman Bachus. Okay, have you--maybe I will ask another
way. Have you ever had a problem or a concern with your
management of operational risk? Or have they ever had a problem
or concern?
Mr. Elliott. With respect to our organization, no, they
have had no concerns as to either our management of operational
risk or how we would invest in the risk process. We get very
high scores with respect to how we manage that aspect of our
business.
Chairman Bachus. Right. And yet, under this agreement, they
would substitute basically, with a complex and costly formula,
for how you presently manage that risk.
Mr. Elliott. And part of the costliness would be adding a
capital charge to our organization that, in essence, we would
have to pass on to our customers or, in essence, be
uncompetitive against our competition that would not have such
a charge.
Chairman Bachus. Certainly, the description that this will
simply bring some of our larger banks in is simply a reflection
of what they are already doing. That is certainly not the case
with Mellon.
Mr. Elliott. That is correct, yes.
Chairman Bachus. Thank you.
If there are no further questions, I thank the second panel
for your testimony. And you are discharged at this time. Thank
you.
[Whereupon, at 2:35 p.m., the Subcommittee was adjourned.]
A P P E N D I X
June 19, 2003
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