Bies, Susan Schmidt and Board of Governors of the Federal Reserve System (U.S.), 1935- "An Update on Regulatory Issues." Speech at the Banking Institute, Charlotte, North Carolina, March 31, 2006, https://fraser.stlouisfed.org/title/955/item/37183, accessed on April 23, 2025.

Title: An Update on Regulatory Issues : Speech at the Banking Institute, Charlotte, North Carolina

Date: March 31, 2006
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image-container-0 Speech Governor Susan Schmidt Bies At the Banking Institute, Charlotte, North Carolina March 31, 2006 An Update on Regulatory Issues Thank you for the invitation to speak here at the Banking Institute. I want to discuss with you today some recent and ongoing regulatory issues that are likely of interest to this audience. These issues include efforts to enhance our regulatory capital regime, compliance risk management, and consumer protection. Proposed Revisions to Regulatory Capital Regime First of all, you probably heard the good news yesterday that the Federal Reserve Board reviewed and in an open Board meeting approved a draft of the interagency notice of proposed rulemaking (NPR) on the Basel II capital framework. The draft NPR was made available on the Board's website as well as some statements made at the public meeting. The final NPR is expected to be issued in the Federal Register once all of the U.S. banking agencies have completed their review and approval processes, at which time it will then be "officially" out for comment. We are very pleased that the substantial time spent on this effort has culminated in this agreement among the agencies. We also recognize the significance of this development to the industry, the Congress, and others who have waited for greater specificity on the proposed revisions. We look forward to comments on the NPR; they will be an important contribution to the assessment of Basel II objectives and implementation of the framework. In some areas, the agencies are still grappling with what the correct approach is. For this reason, the NPR contains a number of requests for feedback on specific topics. All of this will help us as we continue to develop the framework. But before commenting further on the NPR and the U.S. Basel II process, I would like to reiterate our rationale for pursuing Basel II. Reasons for Pursuing Basel II The current Basel I capital framework, adopted nearly twenty years ago, has served us well, but has become increasingly inadequate for large, internationally active banks that are offering ever-more complex and sophisticated products and services. We need a revised capital framework for these large, internationally active banks, and we believe that Basel II is such a framework. One of the major improvements in Basel II is the closer linking of capital requirements and risk. The current Basel I measures are not very risk-sensitive and do not provide bankers, supervisors, or the marketplace with meaningful measures of risk at large, complex organizations. Under Basel I, it is possible for two banks with dramatically different risk profiles in their commercial loan portfolio to have the same regulatory capital requirement, and a bank's capital requirement does not reflect deterioration in asset quality. In addition, the balance-sheet focus of Basel I does not adequately capture risks of certain off-balance-sheet transactions and fee-based activity--for example, the operational risk embedded in many of the services from which many large U.S. institutions generate a good portion of their revenues. In addition to enhancing the meaningfulness of regulatory capital measures, Basel II should make the financial system safer by substantially improving risk management at banks. Basel II builds on the risk-management approaches of well-managed banks and creates incentives for banks to move toward leading risk-measurement and risk-management practices. By providing a consistent framework for all banks to use, supervisors will more readily be able to identify portfolios and
image-container-1 banks whose risk management and risk levels are significantly different from the range seen in other banks. By communicating these differences to banks, management will be able to benchmark their risk assessments, models, and processes in a more detailed and regular manner. We have already seen some progress in risk management at many institutions in the United States and around the globe as a result of preparations for Basel II. The new framework is also much more consistent with the internal capital measures that institutions use to manage their business. Basel II can also provide supervisors with a more conceptually consistent and more transparent framework for assessing the link between risk and capital over time at our most complex institutions; identifying which institutions have deficiencies; and evaluating systemic risk in the banking system through credit cycles. Therefore, Basel II establishes a more coherent relationship between how supervisors assess regulatory capital and how they supervise the banks, enabling examiners to better evaluate whether banks are holding prudent capital levels, given their risk profiles, and to better understand differences among institutions. As a central bank and supervisor of banks, bank holdings companies, and financial holding companies, the Federal Reserve is committed to ensuring that the Basel II framework delivers a strong and risk-sensitive base of capital. That is why we support safeguards to ensure strong capital levels during the transition to Basel II, and will remain vigilant in monitoring Basel II's impact on an ongoing basis. This means that during and after the transition to Basel II, supervisors will rely upon ongoing, detailed analysis to continuously evaluate the results of the new framework and ensure prudent levels of capital. To be quite clear, the Federal Reserve believes that strong capital is critical to the health of our banking system and we believe that Basel II will help us continue to ensure that U.S. banks maintain capital levels that serve as an appropriate cushion against risk-taking. As we have mentioned before, we will continue to use existing prudential measures to complement Basel II. For example, the current leverage ratio requirement--a ratio of capital to total assets--will remain unchanged for all banks, whether or not they are subject to the Basel II framework. Also, supervisors will continue to enforce existing prompt-corrective-action rules in response to declines in capital. Both the leverage ratio and prompt-corrective-action are fully consistent with Basel II. Basel II NPR I will not try to summarize the NPR here today. We want all of you to read it and come to your own judgments. I would, however, like to highlight a few key points. As you know, the U.S. Basel II NPR is based on the 2004 framework issued by the Basel Committee and adheres to the main elements of that framework. But the U.S. agencies, just as their counterparts in other countries, have exercised national discretion and tailored the Basel II framework to fit the U.S. banking system and U.S. financial environment. For example, the U.S. agencies continue to propose that we implement only the advanced approaches of Basel II, namely the advanced internal-ratings-based approach (AIRB) for credit risk and the advanced measurement approaches (AMA) for operational risk. The U.S. agencies also included in the NPR a timetable and set of transition safeguards that are more rigorous than those set forth in the 2004 Basel II framework. For instance, the U.S. agencies are proposing three transition floors, below which minimum required capital under Basel II will not be permitted to fall, relative to the general risk-based capital rules. The first transition period would have a floor of 95 percent, the second 90 percent, and the third 85 percent. Part of the justification for implementing more rigorous floors stemmed from the lessons we learned from the fourth quantitative impact study (QIS4) conducted in the United States in 2004. As I have said before, QIS4 was not intended to reflect the ultimate impact of Basel II on U.S. institutions--particularly since it was not based on a complete proposal and bank inputs to QIS4 were not based on fully developed systems or full supervisory guidance. Rather, it was conducted on a "best-efforts basis" to provide a snapshot for gauging progress toward implementation of Basel II and to give the U.S. agencies a better sense of how to structure the NPR. One of the key areas in the NPR influenced by QIS4 pertains to banks' estimates of loss given
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Date: March 31, 2006
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