Risk-Based Capital
New Basel II Rules Reduced Certain Competitive Concerns, but Bank Regulators Should Address Remaining Uncertainties Gao ID: GAO-08-953 September 12, 2008Basel II, the new risk-based capital framework based on an international accord, is being adopted by individual countries. It includes standardized and advanced approaches to estimating capital requirements. In the United States, bank regulators have finalized an advanced approaches rule that will be required for some of the largest, most internationally active banks (core banks) and proposed an optional standardized approach rule for non-core banks that will also have the option to remain on existing capital rules. In light of possible competitive effects of the capital rules, GAO was asked to examine (1) the markets in which banks compete, (2) how new capital rules address U.S. banks' competitive concerns, and (3) actions regulators are taking to address competitive and other potential negative effects during implementation. Among other things, GAO analyzed data on bank products and services and the final and proposed capital rules; interviewed U.S. and foreign bank regulators, officials from U.S. and foreign banks; and computed capital requirements under varying capital rules.
Large and internationally active U.S.-based banks (core banks) that will adopt the Basel II advanced approaches compete among themselves and in some markets with U.S.-based non-core banks, investment firms, and foreign-based banks. Non-core banks compete with core banks in retail markets, but in wholesale markets core banks often compete with investment firms and foreign-based banks. Because holding capital is costly for banks, differences in regulatory capital requirements could influence costs, prices, and profitability for banks competing under different capital requirements. The new U.S. capital rules addressed some earlier competitive concerns of banks; however, other concerns remain. By better aligning the advanced approaches rule with the international accord and proposing an optional standardized approach rule, U.S. regulators reduced some competitive concerns for both core and non-core banks. For example, the U.S. wholesale definition of default for the advanced approaches is now similar to the accord's. Core banks continue to be concerned about the leverage requirement (a simple capital to assets calculation), which they believe places them at a competitive disadvantage relative to firms not subject to a similar requirement. Foreign regulators have been working with U.S. regulators to coordinate Basel II implementation for U.S. banks with foreign operations. The proposed standardized approach addresses some concerns non-core banks raised by providing a more risk sensitive approach to calculating regulatory requirements. But other factors likely will reduce differences in capital for banks competing in the United States; for example, the leverage requirement establishes a floor that may exceed the capital required under the advanced and standardized approaches. Many factors have affected the pace of Basel II implementation in the United States and, while the gradual implementation is allowing regulators to consider changes in the rules and reassess banks' risk-management systems, regulators have not yet taken action to address areas of uncertainty that could have competitive implications. For example, the final rule provides regulators with considerable flexibility and leaves open questions such as which banks may be exempted from the advanced approaches. Although the rule provides that core banks can apply for exemptions and regulators should consider these in light of some broad categories, such as asset size or portfolio mix, the rule does not further define the criteria for exemptions. Some industry participants we spoke with said that uncertainties about the implementation of the advanced approaches have been a problem for them. Moreover, regulators have not fully developed plans for a required study of the impacts of Basel II before full implementation. Lack of specificity in criteria, scope, methodology, and timing will affect the quality and extent of information that regulators will have to help assess competitive and other impacts, determine whether there are any material deficiencies requiring future changes in the rules, and determine whether to permit core banks to fully implement Basel II.
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Director: Team: Phone:GAO-08-953, Risk-Based Capital: New Basel II Rules Reduced Certain Competitive Concerns, but Bank Regulators Should Address Remaining Uncertainties
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Report to the Subcommittee on Financial Institutions and Consumer
Credit, Committee on Financial Services, House of Representatives:
United States Government Accountability Office:
GAO:
September 2008:
Risk-Based Capital:
New Basel II Rules Reduced Certain Competitive Concerns, but Bank
Regulators Should Address Remaining Uncertainties:
GAO-08-953:
GAO Highlights:
Highlights of GAO-08-953, a report to the Subcommittee on Financial
Institutions and Consumer Credit, Committee on Financial Services,
House of Representatives.
Why GAO Did This Study:
Basel II, the new risk-based capital framework based on an
international accord, is being adopted by individual countries. It
includes standardized and advanced approaches to estimating capital
requirements. In the United States, bank regulators have finalized an
advanced approaches rule that will be required for some of the largest,
most internationally active banks (core banks) and proposed an optional
standardized approach rule for non-core banks that will also have the
option to remain on existing capital rules. In light of possible
competitive effects of the capital rules, GAO was asked to examine (1)
the markets in which banks compete, (2) how new capital rules address
U.S. banks‘ competitive concerns, and (3) actions regulators are taking
to address competitive and other potential negative effects during
implementation. Among other things, GAO analyzed data on bank products
and services and the final and proposed capital rules; interviewed U.S.
and foreign bank regulators, officials from U.S. and foreign banks; and
computed capital requirements under varying capital rules.
What GAO Found:
Large and internationally active U.S.-based banks (core banks) that
will adopt the Basel II advanced approaches compete among themselves
and in some markets with U.S.-based non-core banks, investment firms,
and foreign-based banks. Non-core banks compete with core banks in
retail markets, but in wholesale markets core banks often compete with
investment firms and foreign-based banks. Because holding capital is
costly for banks, differences in regulatory capital requirements could
influence costs, prices, and profitability for banks competing under
different capital requirements.
The new U.S. capital rules addressed some earlier competitive concerns
of banks; however, other concerns remain. By better aligning the
advanced approaches rule with the international accord and proposing an
optional standardized approach rule, U.S. regulators reduced some
competitive concerns for both core and non-core banks. For example, the
U.S. wholesale definition of default for the advanced approaches is now
similar to the accord‘s. Core banks continue to be concerned about the
leverage requirement (a simple capital to assets calculation), which
they believe places them at a competitive disadvantage relative to
firms not subject to a similar requirement. Foreign regulators have
been working with U.S. regulators to coordinate Basel II implementation
for U.S. banks with foreign operations. The proposed standardized
approach addresses some concerns non-core banks raised by providing a
more risk sensitive approach to calculating regulatory requirements.
But other factors likely will reduce differences in capital for banks
competing in the United States; for example, the leverage requirement
establishes a floor that may exceed the capital required under the
advanced and standardized approaches.
Many factors have affected the pace of Basel II implementation in the
United States and, while the gradual implementation is allowing
regulators to consider changes in the rules and reassess banks‘ risk-
management systems, regulators have not yet taken action to address
areas of uncertainty that could have competitive implications. For
example, the final rule provides regulators with considerable
flexibility and leaves open questions such as which banks may be
exempted from the advanced approaches. Although the rule provides that
core banks can apply for exemptions and regulators should consider
these in light of some broad categories, such as asset size or
portfolio mix, the rule does not further define the criteria for
exemptions. Some industry participants we spoke with said that
uncertainties about the implementation of the advanced approaches have
been a problem for them. Moreover, regulators have not fully developed
plans for a required study of the impacts of Basel II before full
implementation. Lack of specificity in criteria, scope, methodology,
and timing will affect the quality and extent of information that
regulators will have to help assess competitive and other impacts,
determine whether there are any material deficiencies requiring future
changes in the rules, and determine whether to permit core banks to
fully implement Basel II.
What GAO Recommends:
GAO recommends that the U.S. bank regulators (1) clarify how they will
use regulatory flexibility built into the rules and (2) fully develop
plans, on a joint basis, for the required study of the impacts of Basel
II. The bank regulators generally agreed with our recommendations in a
joint response to this report.
To view the full product, including the scope and methodology, click on
[hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-08-953]. For more
information, contact Orice M. Williams at (202) 512-8678 or
williamso@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Core Banks Compete among Themselves and with Other Financial Entities
That Will Operate under Different Capital Regimes:
New U.S. Capital Rules Have Reduced Some Competitive Concerns about
Basel II:
Bank Regulators Have Taken Limited Actions to Address Additional
Competitive Effects of Basel II Implementation on U.S. Banking
Organizations:
Conclusions:
Recommendations:
Agency Comments and Our Evaluation:
Appendix I: Objectives, Scope, and Methodology:
Appendix II: Three Pillars of the Advanced Approaches:
Appendix III: Basel II Timeline:
Appendix IV: Comments from Federal Banking Regulators:
Appendix V: GAO Contact and Staff Acknowledgments:
Related GAO Products:
Tables:
Table 1: Percentage of Selected Assets of Core Banks in Certain Retail
and Wholesale Markets, December 31, 2007:
Table 2: Percentage of Total Assets in Selected Classes, by Bank
Holding Company Size, December 31, 2007:
Table 3: Significant Technical Differences between the U.S. NPR on
Advanced Approaches and the New Basel Accord, and the Treatment of
These Differences in the U.S. Final Rule on Advanced Approaches:
Figures:
Figure 1: The Three Pillars of Basel II:
Figure 2: Foreign Exposures of U.S.-based Core Banks, as of December
31, 2007:
Figure 3: Required Capital for Short-term Corporate Loans under the
Advanced Approach and Bank Holding Company Leverage Requirement, by
Probability of Default:
Figure 4: Risk Sensitivity of Proposed Standardized Approach vs.
Prudently Underwritten Residential Mortgages under Basel I, by LTV:
Figure 5: Required Capital for Externally Rated Corporate Loans under
Basel I, Proposed Standardized Approach, and Advanced Approach, by
Rating:
Figure 6: Required Capital for Externally-rated Corporate Loans under
the Advanced Approach and Depository Institution Leverage Requirement,
by Rating:
Figure 7: Computation of Wholesale and Retail Capital Requirements
under the Advanced Internal Ratings-based Approach for Credit Risk:
Abbreviations:
A-IRB: advanced internal ratings-based approach:
AMA: advanced measurement approaches:
CSE: consolidated supervised entity:
EAD: exposure at default:
FDIC: Federal Deposit Insurance Corporation:
FFIEC: Federal Financial Institutions Examination Council:
LTV: loan-to-value:
LGD: loss given default:
M: maturity of the exposure:
MRA: market risk amendment:
NPR: Notice of Proposed Rulemaking:
OCC: Office of the Comptroller of the Currency:
OMB: Office of Management and Budget:
OTS: Office of Thrift Supervision:
PCA: prompt corrective action:
PD: probability of default:
QIS-4: fourth quantitative impact study:
SEC: Securities and Exchange Commission:
SME: small-and medium-sized enterprise:
United States Government Accountability Office:
Washington, DC 20548:
September 12, 2008:
The Honorable Carolyn B. Maloney:
Chair:
The Honorable Judy Biggert:
Ranking Member:
Subcommittee on Financial Institutions and Consumer Credit:
Committee on Financial Services:
House of Representatives:
Ensuring that banks maintain adequate capital is essential to the
safety and soundness of the banking system.[Footnote 1] Basel II, the
newly revised risk-based capital framework, aims to better align
minimum capital requirements with enhanced risk-measurement techniques
and to encourage banks to develop a more disciplined approach to risk
management. Basel II rests on an international accord (the New Basel
Accord) adopted by the Basel Committee on Banking Supervision (Basel
Committee) in June 2004.[Footnote 2] The New Basel Accord includes a
standardized approach and advanced approaches, more complex approaches
that large, internationally active banks are encouraged to use. U.S.
federal banking regulators have been working to finalize capital rules
based on this accord. Since our February 2007 report on Basel II, U.S.
federal banking regulators have finalized the advanced approaches rules
that are required for some of the largest and most internationally
active banking organizations (core banks), which account for about half
of U.S. banking assets.[Footnote 3] Some other banks may choose to
comply with the advanced approaches rule as well. These rules lay out a
phased implementation schedule, which generally requires core banks to
have Basel II implementation plans approved by their boards of
directors by October 1, 2008. In addition, in July 2008, U.S. banking
regulators published for comment a proposed rule on the standardized
approach, a simpler version of the new regulatory capital framework
that could be adopted by banks that were not required to adopt the
advanced approaches (non-core banks).
Though the goal of Basel II was to improve the safety and soundness of
the banking system through better risk management and create a level
playing field for internationally active banks, the development of
Basel II has generated concerns among banks, banking regulators, and
other interested parties that potentially different capital
requirements and implementation costs for various categories of U.S.
and foreign banks could have competitive effects.[Footnote 4] These
concerns arose, in part, because U.S. banks that all have been
operating under the same risk-based capital rules--known as Basel I--
may be operating under different capital rules in the future--Basel II
advanced approaches, Basel II standardized approach, or Basel I. In
addition, because the New Basel Accord identified certain areas for
national discretion, the capital regimes being adopted in various
countries differ from that being implemented in the United States.
The risk-management systems for financial institutions and the
information systems on which they rest have been called into question
by the failure of some of these systems during the market turbulence
that began with subprime mortgages in 2007. While this turmoil is not
the focus of this report, it is an important factor that is leading
banking organizations and their regulators to reassess capital
requirements and other aspects of bank regulation and
supervision.[Footnote 5] These assessments could lead to changes in the
Basel II rules or could influence the implementation of those rules in
the United States. In addition, as a result of concerns about the
ability of U.S. financial institutions to compete with institutions
based in foreign countries, the U.S. Department of the Treasury has
proposed a restructuring of the complex U.S. regulatory
system.[Footnote 6] Various congressional committees have held hearings
that addressed this issue and in the past, we have recommended that the
U.S. regulatory system be restructured.[Footnote 7]
In light of concerns about possible competitive effects, you requested
that we review the competitive implications of Basel II for non-core
U.S. banks in comparison to core banks adopting the advanced approaches
and how differences in the implementation of Basel II in foreign
countries might affect the competitiveness of internationally active
banks operating in the United States. Specifically, this report
examines (1) the nature of the competitive environment in which U.S.
banking organizations operate, (2) the extent to which the new capital
rules address competitive concerns of U.S. banking organizations
internationally and domestically, and (3) actions regulators are taking
to address competitive and other potential negative effects of the new
capital rules during implementation.
To meet our objectives, we reviewed the New Basel Accord, the U.S.
proposed rules on the advanced approaches and standardized approach,
the U.S. final advanced approaches rule, supervisory guidance, and
related materials. In addition, we reviewed research related to the
impact of Basel II in the United States and the European Union. We
interviewed officials at the federal bank regulatory agencies
responsible for implementing Basel II, including examination and policy
staff. We also interviewed officials from all of the core banks and
other domestic and foreign banks with operations in the United States.
In addition, we interviewed officials from several foreign bank
regulatory agencies; domestic and foreign trade associations; credit
rating agencies; and several academics and consultants with banking
expertise. To describe the competitive environment in which U.S.
banking organizations operate, we analyzed various data sources on the
products and services that U.S. and foreign banking organizations offer
domestically and internationally. To assess the competitive impact of
the different capital rules on U.S. banks, we computed capital
requirements for certain products under the varying rules and reviewed
academic and other studies of the impact of regulatory capital on bank
behavior.
We conducted this performance audit from May 2007 to September 2008 in
accordance with generally accepted government auditing standards. Those
standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe that
the evidence obtained provides a reasonable basis for our findings and
conclusions based on our audit objectives. Appendix I discusses our
scope and methodology in further detail.
Results in Brief:
Core banks--large and internationally active U.S. banks that will be
required to adopt the advanced approaches for Basel II--compete with
other core banks and in some markets with non-core U.S.-based banks,
other financial institutions, and foreign-based banks. Core banks that
will adopt the advanced approaches have varying business models such
that some focus on domestic retail banking activities such as
residential mortgages, some focus on wholesale activities such as
lending to large corporate clients domestically and abroad, and others
are engaged in the full range of these activities. In retail markets
such as those for residential mortgages, core banks often compete with
smaller non-core banks that are not likely to adopt the advanced
approaches. In wholesale markets, core banks often compete with
investment firms. Core banks compete globally with investment firms and
also with foreign-based banks. In addition, banks that are subsidiaries
or branches of foreign-based banks are active in U.S. markets at both
the retail and wholesale levels. While Basel II likely will apply to
foreign-based banks in their home countries, the specifics of the rules
and their implementation in other countries will differ from those in
the United States, in part, because the New Basel Accord identified a
number of areas for national discretion. Because holding capital is
costly for banks, differences in regulatory capital requirements could
influence costs, prices, and profitability for banks competing under
different capital requirements.
U.S. regulators addressed some of the banking industry's competitive
concerns with the advanced approaches rule for core banks and the
proposal of an optional standardized approach rule for other banks.
However, some of the industry's competitive concerns about the U.S.
capital framework remain. In developing the rules, regulators analyzed
some competitive issues raised by banks. By adopting a final advanced
approaches rule that is closer to the New Basel Accord, U.S. regulators
reduced the differences between the U.S. rule as originally proposed
and the New Basel Accord that had the potential to lead to greater
implementation costs. For example, in the final advanced approaches
rule banks will use a single wholesale definition of default for both
their U.S. and foreign operations, thus reducing the cost of operating
in multiple countries. Nonetheless, core banks are concerned about
continuing to be subject to the leverage requirement, which they
believe could place them at a competitive disadvantage relative to
certain foreign-based banks and investment firms, which do not have a
similar requirement. In efforts to mitigate other differences, U.S.
regulators have been working with foreign regulators, bilaterally and
as members of international bodies, to coordinate Basel II
implementation for U.S.-based internationally active banks. The
proposed standardized approach rule issued by U.S. regulators in July
2008 addresses some concerns raised by non-core banks--those banks not
required to adopt the advanced approaches. These banks were concerned
that core banks would have a competitive advantage because they would
be able to hold less capital for some assets. The proposed standardized
approach would allow for additional risk-sensitivity-over Basel I with
respect to the capital treatment for certain assets, including
residential mortgages. Among other factors, the leverage requirement
may reduce differences in capital among banks competing in the United
States because it establishes a floor that may exceed capital required
under the advanced or standardized approaches for certain low-risk
assets.
Since we last reported on Basel II in February 2007, the regulators
have made significant progress by jointly issuing the advanced
approaches rule and a proposed rule for an optional standardized
approach. However, while the gradual implementation is allowing
regulators to consider changes in the rules and reassess banks' risk
management systems, regulators have not taken action to address some
areas of uncertainty that could have competitive implications or other
negative effects. For example, the regulatory flexibility that the
advanced approaches rule provides will help regulators deal with the
rule's unforeseen consequences, but leaves uncertainties such as which
banks will ultimately be exempted from using the advanced approaches.
While the regulators have stated that they may exempt some core banks
from using the advanced approaches, they have only provided broad
categories such as asset size and portfolio mix rather than specific
criteria for making these decisions. And, in the proposed standardized
approach rule, regulators have asked for comments on the question of
whether large and internationally active core banks should be able to
use the proposed standardized approach. These uncertainties may
continue to reflect the difficulties that resulted from the differing
perspectives the regulators brought to negotiations during the
development of Basel II. In addition, some industry participants we
spoke with said that uncertainty about the implementation of the
advanced approaches rule has been a problem for them. Finally,
regulators have undertaken some planning for a study of the impact of
the advanced approaches, but plans are not fully developed. The
advanced approaches rule called for a study of the rule's impact to
determine whether major changes in the rule needed to be made before
banks would be permitted to fully implement the new rule. However, the
regulators have not developed criteria by which to assess Basel II,
have not specified whether the scope of the study will go beyond core
banks to consider, for example, investment firms, or developed a
methodology to analyze opportunities for regulatory arbitrage. Lack of
development or specificity in criteria, scope, methodologies, and
timing will affect the quality and extent of information that
regulators will use to help assess competitive and other impacts,
determine whether there are any material deficiencies that require
changes in the rules, and determine whether core banks should fully
implement Basel II.
To further limit any potential negative effects and to reduce the
uncertainty about Basel II implementation, we are making two
recommendations to the heads of the Federal Deposit Insurance
Corporation (FDIC), Board of Governors of the Federal Reserve System
(Federal Reserve), Office of the Comptroller of the Currency (OCC), and
Office of Thrift Supervision (OTS). Specifically, where possible, these
regulators should reduce the uncertainty built into the Basel II rules
by better clarifying the use of certain regulatory flexibilities,
particularly with regard to how they will exercise exemptions from the
advanced approaches requirements and the extent to which core banks
will be allowed to adopt the standardized approach. In addition, to
improve understanding of potential competitive effects, we recommend
that the regulators fully develop plans, on a joint basis, for the
required study of the impacts of Basel II.
We requested comment on a draft of this report from the heads of the
Federal Reserve, FDIC, OCC, OTS, Securities and Exchange Commission
(SEC), and Department of the Treasury. We received written comments
from the Federal Reserve, FDIC, OCC, and OTS, who provided a joint
letter, which is reprinted in appendix IV. In their joint letter, the
banking regulators said that they were in general agreement with our
recommendations. Specifically, the regulators said that they will work
together to resolve, at the earliest possible time, the question posed
for comment in the proposed standardized approach rule regarding
whether and to what extent core banks should be able to use the
standardized approach. With regard to clarifying certain regulatory
flexibilities, the regulators said they will continue to make decisions
concerning the exemption of core banks from the advanced approaches
based on the specifics of a bank's request; they have already commenced
discussions to ensure a clear and consistent interpretation of these
provisions is conveyed to U.S. banks. In addition, regarding the need
to jointly plan the required study, the regulators said that they will
begin to prepare more formal plans for the study once they have a
firmer picture of banks implementation plans. The banking regulators
also provided technical comments, which we incorporated in the report
where appropriate. We did not receive comments from SEC or the
Department of the Treasury.
Background:
Basel II rests on the New Basel Accord, which established a more risk-
sensitive regulatory framework that was intended to be sufficiently
consistent internationally but that also took into account individual
countries' existing regulatory and accounting systems. The U.S. bank
regulators have been adapting the New Basel Accord for use by U.S.
banks.
The New Basel Accord:
The New Basel Accord sets forth minimum requirements, which regulators
may complement with additional capital requirements, such as a leverage
ratio. The New Basel Accord also identifies a number of areas for
national discretion, thus requiring regulators from different countries
to work together to understand how each country is implementing the New
Basel Accord and to ensure broad consistency in the application of the
regulatory framework across jurisdictions. The New Basel Accord
consists of three pillars: (1) minimum capital requirements, (2)
supervisory review of an institution's internal assessment process and
capital adequacy, and (3) effective use of disclosure to strengthen
market discipline as a complement to supervisory efforts.[Footnote 8]
As shown in figure 1, Pillar 1 establishes several approaches (of
increasing complexity) to measuring credit and operational
risks.[Footnote 9] The advanced approach for credit risk (also known as
the advanced internal ratings-based approach) uses risk parameters
determined by a bank's internal systems as inputs into a formula
developed by supervisors for calculating minimum regulatory capital. In
addition, banks with significant trading assets--assets banks use to
hedge risks or to speculate on price changes in markets for themselves
or their customers--must calculate capital requirements for market risk
under Pillar 1.[Footnote 10] Pillar 2 explicitly recognizes the role of
supervisory review, which includes assessments of capital adequacy
relative to a bank's overall risk profile and early supervisory
intervention that are already part of U.S. regulatory practices. Pillar
3 establishes disclosure requirements that aim to inform market
participants about banks' capital adequacy in a consistent framework
that enhances comparability. See appendix II for more information on
the three pillars of the advanced approaches.
Figure 1: The Three Pillars of Basel II:
This figure is a chart showing the three pillars of Base II: millennium
capital requirements, supervisory review, and market discipline (via
disclosure).
[See PDF for image]
Source: GAO.
[End of figure]
After extensive discussions and consultation that included issuing an
advanced notice of proposed rulemaking in 2003 and a Notice of Proposed
Rulemaking (NPR) in 2006, the U.S. banking regulators issued a final
rule on the advanced approaches that became effective on April 1,
2008.[Footnote 11] Under the rule, only certain banks--core banks--will
be required to adopt the advanced approaches for credit and operational
risk. Core banks are those with consolidated total assets (excluding
assets held by an insurance underwriting subsidiary of a bank holding
company) of $250 billion or more or with consolidated total on-balance
sheet foreign exposure of $10 billion or more. Publicly available
information shows that, as of July 2008, 12 banks met the rule's basic
criteria for being a core bank. A depository institution also is a core
bank if it is a subsidiary of another bank that uses the advanced
approaches. Under the rule, a core bank's primary federal regulator may
determine that application of the advanced approaches is not
appropriate in light of a core bank's asset size, level of complexity,
risk profile, or scope of operations. In addition, banks that are not
required to adopt the advanced approaches, but meet certain
qualifications, may voluntarily choose to comply with the advanced
approaches. Generally, core banks had or will have from April 2008
until April 2010 to begin the four phases that lead to the full
implementation of Basel II.[Footnote 12] As a result, core banks could
be ready for full implementation between April 2012 and April 2014. By
January 1, 2008, banks in the European Union, Canada, and Japan had
moved off of Basel I and begun implementing some version of the New
Basel Accord's advanced approaches or standardized approach for all of
their banks. Banks located in the European Union, Canada, and Japan
expect to have fully implemented Basel II sometime in 2010.
Non-core banks--those that do not meet the definition of a core bank--
will have the option of adopting the advanced approaches, a
standardized approach when finalized, or remaining on Basel I. The
proposed standardized approach rule, published in July 2008, provides
for a more risk-sensitive approach than Basel I by classifying banks'
assets into more risk categories and assessing different capital
requirements according to the riskiness of the category.[Footnote 13]
While Basel I has 5 risk categories, the proposed standardized approach
rule includes 16 categories. In contrast to the advanced approaches,
the standardized approach relies more on external risk assessments--
conducted by rating agencies--than on a bank's own assessments of a
certain product's or borrower's risk. The proposed U.S. standardized
approach generally is consistent with the standardized approach
outlined in the New Basel Accord, but diverges from the New Basel
Accord to incorporate more risk sensitive treatment, most notably in
the approaches for residential mortgages and equities held by banks.
Additional U.S. Capital Requirements:
The U.S. regulatory capital framework also includes minimum leverage
capital requirements. Banks, thrifts, and bank holding companies are
subject to minimum leverage standards, measured as a ratio of Tier 1
capital to total assets. The minimum leverage requirement is either 3
or 4 percent, depending on the type of institution and a regulatory
assessment of the strength of its management and controls.[Footnote 14]
Leverage ratios are a commonly used financial measure of risk. Greater
financial leverage, as measured by lower proportions of capital
relative to assets, increases the riskiness of a firm, all other things
being equal. If the leverage capital requirement is greater than the
risk-based level required then the leverage requirement would be the
binding overall minimum requirement on an institution. Depository
institutions also are subject to the Federal Deposit Insurance
Corporation Improvement Act of 1991, which created a new supervisory
framework known as prompt corrective action (PCA) that links
supervisory actions closely to these banks' capital ratios. PCA, which
applies only to depository institutions and not bank holding companies,
requires regulators to take increasingly stringent forms of corrective
action against banks as their leverage and risk-based capital ratios
decline.[Footnote 15] Under this rule, regulators also can require
banks to hold more than minimum levels of capital to engage in certain
activities. In addition, under the Bank Holding Company Act, the
Federal Reserve can require that bank holding companies hold additional
capital to engage in certain activities.
U.S. Regulators Responsible for Implementing Basel II:
In the United States, the four federal bank regulators oversee the
implementation of Basel II for banks and SEC oversees the
implementation of Basel capital rules for investment firms. The
financial institutions that will be involved in the implementation of
Basel II are organized as bank holding companies, thrift holding
companies, or consolidated supervised entities (CSE). At a consolidated
level the Federal Reserve supervises bank holding companies that are
subject to Basel capital requirements, OTS supervises thrift holding
companies that are not subject to Basel capital requirements, and SEC
supervises CSEs that voluntarily choose to be subject to consolidated
oversight including Basel capital reporting requirements.[Footnote 16]
Each of these types of holding companies has subsidiaries that are
depository institutions that could be required to adopt Basel II. Each
of these banking institutions is regulated by a primary federal
regulator according to the rules under which it is chartered.
* FDIC serves as the primary federal regulator of state chartered banks
that are not members of the Federal Reserve System (state nonmember
banks). It is also the deposit insurer for all banks and thrifts and
has backup supervisory authority for all banks it insures.
* The Federal Reserve serves as the primary federal regulator for state
chartered banks that are members of the Federal Reserve System (state
member banks).
* OCC serves as the primary federal regulator for national (i.e.,
federally chartered) banks. Many of the nation's largest banks are
federally chartered.
* OTS serves as the primary federal regulator for all federally insured
thrifts.
Under the dual federal and state banking system, state chartered banks
are supervised by state regulatory agencies in addition to a primary
federal regulator.
In 2004, SEC established a voluntary, alternative net capital rule for
broker-dealers whose ultimate holding company consents to groupwide
supervision by SEC as a CSE. This alternative net capital rule permits
the use of statistical models for regulatory capital purposes. At the
holding company level, CSEs are required to compute and report to SEC
capital adequacy measures consistent with the standards in the Basel
Accord, and SEC expects them to maintain certain capital ratios, though
they are not required to do so. According to SEC, all CSEs have
implemented Basel II. Primary U.S. broker-dealers affiliated with CSEs
are required to comply with a capital requirement that SEC says is not
identical to the Basel standards but makes use of statistical models in
its computation. Depository institutions within the CSEs are subject to
the same requirements as other banks of similar sizes and exposures
including risk-based capital requirements, the leverage ratio, and PCA;
however, there is no leverage requirement at the consolidated level for
CSEs.
Core Banks Compete among Themselves and with Other Financial Entities
That Will Operate under Different Capital Regimes:
Core banks face a range of competitors including non-core U.S. banks,
other financial institutions, and foreign-based banks. Core banks that
have varying business models--some focus on domestic retail banking
activities, some on wholesale activities, and others are engaged in the
full range of these activities--are overseen by a number of different
bank regulators. Banks of different sizes that are likely to be under
different capital regimes are more likely to compete with each other in
retail markets, where they offer products such as residential mortgages
to the same customers, than in wholesale markets. In certain wholesale
markets, core banks often compete with U.S. investment firms. U.S.-
based core banks also compete with foreign-based banks in foreign
markets and in U.S. markets where foreign-based banks are very active.
Since core banks compete with other financial institutions across
various product and geographic markets, differences in capital rules or
the implementation of those rules may have competitive effects by
influencing such things as the amount of capital institutions hold, how
banks price loans, and the cost of implementing capital regulations.
Core Banks Compete with Other Core and Non-core Banks:
Core banking organizations--those that meet the requirements in terms
of asset size and foreign exposure for mandatory adoption of the Basel
II advanced approaches--have adopted a variety of business models, but
all compete with some other core banks. Some of the core banks are
active in retail markets, some in wholesale markets, and some in the
full range of banking activities. As illustrated in table 1, which is
based on publicly available information, five core banking
organizations--including one that is foreign-based--have at least 25
percent of their assets in retail markets and one of these, the only
thrift that is a core banking organization (Washington Mutual Bank),
has more than 60 percent of its assets in retail markets, while a few
institutions have almost no activity in these markets. In addition, two
core banks that appear less active in retail markets--with about 15
percent of their assets in these markets--may still have a major
presence there because of their overall size. In wholesale markets,
table 1 shows that some banks are active in making commercial and
industrial loans while others hold a larger percentage of their assets
as trading assets--assets held to hedge risks or speculate on price
changes for the bank or its customers. However, the thrift institution
has very little activity in these markets. The three smaller U.S.-based
core banks, which are classified as core banks because they have large
foreign exposures, engage primarily in custodial activities where they
manage the funds of their clients. In this area they compete with the
largest U.S. banks that are also engaged in these activities.
Table 1: Percentage of Selected Assets of Core Banks in Certain Retail
and Wholesale Markets, December 31, 2007:
(Dollars in millions):
Institution: Top level parent based in the United States: Citigroup
Inc;
Total assets: Top level parent based in the United States: $2,187,631;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 11.1%;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 4.0%;
Trading assets: Top level parent based in the United States: 24.6%;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 9.4%;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 1.0%;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 8.8%.
Institution: Top level parent based in the United States: Bank of
America Corp;
Total assets: Top level parent based in the United States: 1,720,688;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 23.0;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 4.7;
Trading assets: Top level parent based in the United States: 11.7;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 10.3;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 6.0;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 13.9.
Institution: Top level parent based in the United States: JPMorgan
Chase & Co;
Total assets: Top level parent based in the United States: 1,562,147;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 11.0;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 4.9;
Trading assets: Top level parent based in the United States: 29.3;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 9.0;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 1.6;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 5.2.
Institution: Top level parent based in the United States: Wachovia
Corp;
Total assets: Top level parent based in the United States: 782,896;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 30.0;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 0.3;
Trading assets: Top level parent based in the United States: 7.1;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 10.5;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 9.9;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 14.6.
Institution: Top level parent based in the United States: Wells Fargo &
Co;
Total assets: Top level parent based in the United States: 575,442;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 30.1;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 3.4;
Trading assets: Top level parent based in the United States: 1.3;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 13.8;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 9.7;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 12.7.
Institution: Top level parent based in the United States: Washington
Mutual Bank[A];
Total assets: Top level parent based in the United States: 325,809;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 59.5;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 3.0;
Trading assets: Top level parent based in the United States: 0.8;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 1.0;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 13.5;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 10.6.
Institution: Top level parent based in the United States: Bank of New
York Mellon Corp;
Total assets: Top level parent based in the United States: 197,839;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 2.3;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 0;
Trading assets: Top level parent based in the United States: 3.3;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 3.4;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 1.3;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 24.5.
Institution: Top level parent based in the United States: State Street
Corp;
Total assets: Top level parent based in the United States: 142,937;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 0;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 0;
Trading assets: Top level parent based in the United States: 3.5;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 0.1;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 0;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 52.2.
Institution: Top level parent based in the United States: Northern
Trust Corp;
Total assets: Top level parent based in the United States: 67,611;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 13.6;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 0.0;
Trading assets: Top level parent based in the United States: 1.3;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 9.6;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 3.4;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 12.6.
Institution: Top level parent based in a foreign country: Taunus Corp.
(Germany);
Total assets: Top level parent based in the United States: 668,199;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 3.2;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 0.4;
Trading assets: Top level parent based in the United States: 30.1;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 1.4;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 1.2;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 0.5.
Institution: Top level parent based in a foreign country: HSBC North
America Holding Inc. (United Kingdom);
Total assets: Top level parent based in the United States: 487,755;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 24.6;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 10.5;
Trading assets: Top level parent based in the United States: 11.7;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 8.2;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 1.7;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 6.5.
Institution: Top level parent based in a foreign country: Barclays
Group US (United Kingdom);
Total assets: Top level parent based in the United States: 343,736;
Certain retail products as percent of assets: Mortgages: Top level
parent based in the United States: 3.9;
Certain retail products as percent of assets: Credit cards: Top level
parent based in the United States: 1.9;
Trading assets: Top level parent based in the United States: 15.1;
Certain wholesale products as percent of assets: Commercial &
industrial loans: Top level parent based in the United States: 0;
Certain wholesale products as percent of assets: Commercial real
estate: Top level parent based in the United States: 3.3;
Certain wholesale products as percent of assets: Securities available
for sale or held to maturity[B]: Top level parent based in the United
States: 0.2.
Source: GAO analysis of publicly available Federal Reserve and OTS
data.
[A] Data are for the federal savings bank rather than the consolidated
entity. The federal savings bank comprises 99.4 percent of the
consolidated entity's total assets.
[B] Securities available for sale or held to maturity include mortgage-
backed securities, asset-backed securities, and others.
[End of table]
Core banks are in some ways similar to non-core banks. For example,
banks of all sizes continue to participate in some activities
historically associated with banking-, such as taking deposits and
making loans. As table 2 shows, bank holding companies of different
sizes hold similar proportions of certain loans such as residential
mortgages and commercial and industrial loans.
Table 2: Percentage of Total Assets in Selected Classes, by Bank
Holding Company Size, December 31, 2007:
(Dollars in millions):
Size category by assets: Core bank holding companies;
Number of bank holding companies: 11;
Total assets: $8,736,881;
Certain retail products as percent of assets: Mortgages: 15.9%;
Certain retail products as percent of assets: Credit cards: 3.7%;
Certain wholesale products as percent of assets: 18.1%;
Certain wholesale products as percent of assets: Commercial &
industrial loans: 8.6%;
Certain wholesale products as percent of assets: Commercial real
estate: 3.6%;
Certain wholesale products as percent of assets: Securities held for
sale or until maturity[A]: 9.9%.
Size category by assets: Non-core bank holding companies;
Total assets: [Empty];
Certain retail products as percent of assets: Mortgages: [Empty];
Certain retail products as percent of assets: Credit cards: [Empty];
Certain wholesale products as percent of assets: [Empty];
Certain wholesale products as percent of assets: Commercial &
industrial loans: [Empty];
Certain wholesale products as percent of assets: Commercial real
estate: [Empty];
Certain wholesale products as percent of assets: Securities held for
sale or until maturity[A]: [Empty].
Size category by assets: Consolidated assets between $100 billion and
$250 billion;
Number of bank holding companies: 9;
Total assets: 1,402,048;
Certain retail products as percent of assets: Mortgages: 23.1;
Certain retail products as percent of assets: Credit cards: 2.4;
Certain wholesale products as percent of assets: 1.5;
Certain wholesale products as percent of assets: Commercial &
industrial loans: 14.1;
Certain wholesale products as percent of assets: Commercial real
estate: 15.4;
Certain wholesale products as percent of assets: Securities held for
sale or until maturity[A]: 13.8.
Size category by assets: Consolidated assets between $10 billion and
$100 billion;
Number of bank holding companies: 48;
Total assets: 1,431,394;
Certain retail products as percent of assets: Mortgages: 15.6;
Certain retail products as percent of assets: Credit cards: 0.5;
Certain wholesale products as percent of assets: 0.9;
Certain wholesale products as percent of assets: Commercial &
industrial loans: 15.0;
Certain wholesale products as percent of assets: Commercial real
estate: 25.3;
Certain wholesale products as percent of assets: Securities held for
sale or until maturity[A]: 18.3.
Size category by assets: Consolidated assets between $3 billion and $10
billion;
Number of bank holding companies: 100;
Total assets: 558,077;
Certain retail products as percent of assets: Mortgages: 16.7;
Certain retail products as percent of assets: Credit cards: 0.2;
Certain wholesale products as percent of assets: 0.4;
Certain wholesale products as percent of assets: Commercial &
industrial loans: 11.9;
Certain wholesale products as percent of assets: Commercial real
estate: 29.9;
Certain wholesale products as percent of assets: Securities held for
sale or until maturity[A]: 21.2.
Size category by assets: Consolidated assets between $1 billion and $3
billion;
Number of bank holding companies: 283;
Total assets: 468,831;
Certain retail products as percent of assets: Mortgages: 15.5;
Certain retail products as percent of assets: Credit cards: 0.3;
Certain wholesale products as percent of assets: 0.2;
Certain wholesale products as percent of assets: Commercial &
industrial loans: 10.5;
Certain wholesale products as percent of assets: Commercial real
estate: 39.6;
Certain wholesale products as percent of assets: Securities held for
sale or until maturity[A]: 17.4.
Size category by assets: Consolidated assets between $500 million and
$1 billion;
Number of bank holding companies: 465;
Total assets: 325,611;
Certain retail products as percent of assets: Mortgages: 17.2;
Certain retail products as percent of assets: Credit cards: 0.2;
Certain wholesale products as percent of assets: 0.1;
Certain wholesale products as percent of assets: Commercial &
industrial loans: 10.4;
Certain wholesale products as percent of assets: Commercial real
estate: 39.0;
Certain wholesale products as percent of assets: Securities held for
sale or until maturity[A]: 17.3.
Size category by assets: Consolidated assets less than $500 million;
Number of bank holding companies: 4,148;
Total assets: 649,948;
Certain retail products as percent of assets: Mortgages: 17.4;
Certain retail products as percent of assets: Credit cards: 0.1;
Certain wholesale products as percent of assets: 0.1;
Certain wholesale products as percent of assets: Commercial &
industrial loans: 2.9;
Certain wholesale products as percent of assets: Commercial real
estate: 32.4;
Certain wholesale products as percent of assets: Securities held for
sale or until maturity[A]: 19.6.
Source: GAO analysis of publicly available Federal Reserve data.
Note: Metropolitan Life Insurance Company is excluded from the table
because, while it is large enough to be a core bank, it is involved
primarily in insurance activities. For 4,103 of the smaller bank
holding companies, consolidated data is not reported to the Federal
Reserve. For those bank holding companies we grouped the banks in the
holding company and reported that data instead. Bank holding companies
that do not have to report asset distributions at the holding company
level generally do not engage in activities outside of their banks.
This table also does not include thrifts or thrift holding companies
that are active in banking markets especially in retail areas.
[A] Securities available for sale or held to maturity include mortgage-
backed securities, asset-backed securities, and others.
[End of table]
According to research conducted by Federal Reserve staff and other
experts, banks of different sizes compete with each other for retail
products such as residential mortgages.[Footnote 17] As illustrated in
table 2, bank holding companies in all size ranges hold a relatively
large percentage of their assets--from 15.5 to 23.1 percent--in
residential mortgages. Customers can obtain mortgages from banks across
the United States and generally can obtain pricing information from
brokers or directly through the Internet or financial publications. For
small thrifts, which make up a portion of the small non-core banking
institutions in the United States but are not included in table 2, the
proportion of mortgages is much higher.[Footnote 18] Unlike residential
mortgages, only a few banks, including several core banks, are active
in the credit card market, but some non-core banks are active in this
market as well; and all credit card issuers generally compete for the
same customers.[Footnote 19]
For wholesale products, the competitive landscape is more complex. As
table 2 illustrates, in some areas core banks differ substantially from
non-core banks and are thus not likely to compete with them in those
markets. For example, non-core banks hold a very small percentage of
their assets as trading assets, an area where some core banks are very
active, and core banks hold a relatively small proportion of their
assets in commercial real estate, an area where non-core banks are very
active. While table 2 shows that core and non-core banks are both
active in the commercial and industrial loan markets, the market for
loans from large banks may be quite different from those for smaller
banks. According to a bank official and other experts, larger banks do
not price commercial and industrial loans individually; instead, these
loans generally are part of a package of products and services offered
to major corporate clients. Financial market experts told us that often
these loans are discounted to establish a relationship with the
customer. Because smaller banks do not offer a full range of products
and services, they likely are not competing for the same customers as
larger banks. In addition, we and others have shown that smaller banks
tend to serve the needs of smaller businesses with which they can
establish a personal relationship.[Footnote 20] Because obtaining
credit information on small businesses is difficult, community banks
often have an advantage with these customers in that they may have
better information about small businesses in their local market than do
large national or internationally active banks. As a result, the
largest banks are unlikely to be competing with community banks in
these markets. At the same time, research conducted by Federal Reserve
staff has shown that large non-core banks may compete with core banks
for corporate customers.[Footnote 21]
In Some Markets, Core Banks Compete with Other U.S. Financial
Institutions:
Core banks are much more likely than smaller or regional non-core banks
to participate in activities often associated with investment banking.
For example, core banks are much more likely to hold trading assets
that typically are used to hedge risks or speculate on certain market
changes either for the banking organization or its customers (see table
2).
In addition, core banks are involved in international activities where
they often provide investment banking products and services in the
major capital markets around the world. In the United States and
abroad, U.S.-based core banks, especially Citigroup and JPMorgan Chase,
compete with the four major U.S. investment firms---Goldman Sachs,
Merrill Lynch, Morgan Stanley, and Lehman Brothers. The core banks also
are involved in custodial and asset management activities domestically
and internationally. In this capacity, core U.S.-based banks compete
with foreign-based banks, with investment firms, and with asset
management firms that do not own depository institutions and are not
subject to regulatory capital requirements.
U.S.-Based Banks Compete with Foreign-Based Banks in Foreign and U.S.
Markets:
Basel capital requirements were established, in large part, to limit
competitive advantages or disadvantages due to differences in capital
requirements across countries; however, the New Basel Accord allows for
certain areas of national discretion and this could create competitive
advantages or disadvantages for banks competing in various countries.
In addition, because a major part of Basel II involves direct
supervision of the risk management processes of individual banks,
further opportunities exist for differences across countries to develop
as the new rules are implemented.
While all but one of the core banks has some foreign exposure, some of
the nine U.S.-based core banks have foreign exposures that are large
relative to the size of the institution (see fig. 2). As noted above,
most of these banks are engaged in asset management and investment
banking activities globally. In addition, one of the banks is heavily
engaged in retail banking activities in a wide range of countries where
each country likely comprises a separate market. To the extent that
U.S.-based banking institutions that have subsidiaries in foreign
countries face more stringent capital requirements for the parent
institution at home, U.S.-based banks could be disadvantaged in foreign
markets.
Figure 2: Foreign Exposures of U.S.-based Core Banks, as of December
31, 2007:
This figure is a map with a chart showing foreign exposures of U.S.-
based core banks, as of December 31, 2007.
Citigroup: $971.4;
JP Morgan Chase & Co.: $486.4;
Bank of America Corp.: $125.2;
Wachovia Corp.: $72.3;
Bank of New York Mellon Corp.: $61.7;
Northern Trust Corp.: $27.5;
State Street Corp.: $19.8;
Wells Fargo & Co.: $9.4;
Washington Mutual Bank: $0.0.
Country (number of U.S.-based core banks operating subsidiaries):
United Kingdom: 7;
Ireland: 7;
Luxembourg: 6;
Germany: 5;
Netherlands: 5;
France: 3;
Italy: 3;
Belgium: 2.
[See PDF for image]
Source: GAO analysis of SEC Form 10-ka and information from Mergent
Online; Map Resources (map).
[End of figure]
Much of the competition between U.S.-and foreign-based banks takes
place in the United States, where foreign based-banks are very active
through their subsidiaries, branches, and offices. Foreign-based banks
account for about $2.8 trillion of the approximately $15 trillion of
U.S. banking assets and subsidiaries of those banks account for 11 of
the 50 largest U.S. bank holding companies. Further, as noted in table
1, three of the core banks in the United States are subsidiaries of
foreign-based banks. Two of these operate primarily in wholesale
markets, while the third, HSBC, is active in both retail and wholesale
banking markets in the United States. In addition, some large U.S. non-
core banks that are subsidiaries of foreign-based banks are likely to
adopt the advanced approaches in the United States.
The extent to which differences in capital requirements will affect
competition in the United States between U.S.-based and foreign-based
banks will depend, in part, on how the U.S. activities of the foreign-
based banks are organized. For capital purposes, although foreign-based
banks with U.S. subsidiaries will likely follow the Basel II rules in
their home countries, the U.S. subsidiaries are regulated as U.S. banks
within the United States and will follow U.S. rules. However, branches
of foreign banks are not required to meet the U.S. rules. As a result,
some foreign-based banks that have substantial U.S. operations, but
conduct their banking activities in the United States through branches,
will be following the Basel II rules in their home country rather than
in the United States.
Differences in Capital Requirements Have the Potential to Create
Competitive Disparities:
Because holding capital is costly for banks, differences in regulatory
capital requirements could influence costs, prices, and profitability
for banks competing under different capital frameworks. If regulatory
capital requirements increase the amount of capital banks hold relative
to what they would hold in the absence of regulation, then the
requirements would increase banks' costs and reduce their
profitability.[Footnote 22] Depending on the structure of markets,
these higher costs could be passed on to bank customers in the form of
higher prices--interest rates on loans or fees for services--or
absorbed as reduced lending and profits. For example, higher capital
costs driven by higher capital requirements could result in a
competitive disadvantage for banks that compete for similar customers
with banks subject to different capital rules. Conversely, lower
capital requirements that allow banks to reduce the capital they hold
for a particular asset could allow them to price those assets more
aggressively, thereby increasing market share or earning higher returns
at existing prices.
Bank officials with whom we spoke and some empirical evidence we
reviewed suggested that regulatory capital requirements are one of
several key factors banks consider in deciding how much capital to
hold. Other factors include management views on the amount of capital
the firm needs internally and market expectations.[Footnote 23] These
multiple and overlapping motivations for holding capital make it
difficult to isolate the impact of regulatory capital on the amount of
capital banks hold.[Footnote 24] Nevertheless, there is some evidence
that banks hold more than the minimum required capital--a buffer--in
part to reduce the risk of breaching that minimum requirement. For
example, one study of United Kingdom banks found that an increase in
required capital was followed by an increase in actual capital,
although the increase was only about half the size of the increase in
required capital.[Footnote 25] Thus, changes in minimum required
capital could cause banks to change the amount of capital they hold to
maintain a similar buffer of capital, consistent with the other goals
of the bank. The study also found that banks with small buffers reacted
more to a given change in individual capital requirements--and banks
with larger buffers reacted little, if at all--supporting the view that
the capital buffer is a form of insurance against falling below
regulatory minimums.
Differences in the implementation costs of capital requirements also
could have competitive effects. In principle, higher implementation
costs could lead to a one-time increase in costs or ongoing costs
associated with compliance. One-time costs would influence
profitability directly, while ongoing costs also could influence the
cost of lending for banks in the same way that higher capital costs
could influence pricing and profitability. Significant implementation
costs are likely to be easier to bear the larger the institution--the
costs of implementing regulation are on average higher (as measured by
cost per employee) for smaller firms.[Footnote 26]
The possible effects of differences in regulatory capital requirements
on implementation and capital costs also could influence incentives for
consolidation by making acquisitions more or less advantageous for
banks operating under different capital rules. Such advantages would
imply that those banks under a given capital regime might be able to
use the capital resources of banks under a different regime more
effectively, making it profitable for the former banks to acquire the
latter ones. Conversely, if implementation costs for a capital regime
imposed on larger banks were high, this might discourage some banks
from merging because they would become large enough to be required to
adopt a capital regime with high implementation costs.
New U.S. Capital Rules Have Reduced Some Competitive Concerns about
Basel II:
The new U.S. capital rules address some competitive concerns of banks;
however, other concerns remain. Regulators analyzed some competitive
issues raised by banks during the development of the Basel II rules in
the United States. In the final rule for the advanced approaches, the
regulators addressed concerns about differences between the NPR and the
New Basel Accord that could have led to greater implementation costs.
For example, in the final rule they harmonized the definition of
wholesale loan default with the accord, thus responding to banks'
concerns that differences in the definition of wholesale loan default
between the NPR and the accord could have led to increased costs of
operating in multiple countries. However, core banks remain concerned
that the leverage requirement will affect their ability to compete with
both foreign-and some U.S.-based competitors. The coordination between
U.S. and foreign regulators on implementation issues for core banks may
address some competitive concerns of internationally active core banks.
For non-core banks, the proposed standardized approach rule may address
some concerns--for example, that core banks could hold less capital for
similar assets. The proposed rule is more risk sensitive than Basel I,
providing non-core banks with the possibility of lower regulatory
capital minimums for certain assets or activities. Other factors, such
as the leverage requirement, may reduce differences in capital for
banks competing in the United States.
U.S. Regulators Recognized Some Competitive Concerns during the
Development of the Rules:
As a result of the potential for large banks to hold less capital under
Basel II, at least for certain assets, researchers, primarily at the
Federal Reserve, conducted studies of the potential impact of Basel II
on specific markets and on aspects of the rule, including the impact on
residential mortgages, credit cards, operational risk, and mergers and
acquisitions. These studies were limited by the availability of data
and by a lack of information on the impact regulatory capital has on
bank behavior. Nonetheless, the studies identified that there could be
competitive impacts in the residential mortgage market and helped to
lead to the development of alternatives to Basel I for non-core banks.
OCC and OTS provided the Office of Management and Budget (OMB) with
regulatory impact analyses that included examination of the impact of
the rules on domestic competition.[Footnote 27] In addressing
competitive issues in this analysis, OCC relied primarily on the
studies conducted at the Federal Reserve. In its regulatory impact
analysis, OTS incorporated OCC's analysis adding appropriate material
specifically related to the thrift industry. For example, OTS noted
that because thrifts have high concentrations of assets in residential
mortgages, the leverage requirement would be more likely to impose
greater capital requirements on these firms than would the Basel II
requirements and, as a result, would have a negative impact on the
ability of thrifts to compete with other banking organizations. OTS
also pointed out that interest rate risk for those mortgage-related
assets that a bank is planning to hold rather than trade is
particularly important to thrifts. However, the adequacy of capital
held for these risks is being assessed in Pillar 2 rather than in
Pillar 1, where the risks associated with changes in interest rates on
mortgage related assets that are being actively traded are assessed.
Since there is more regulatory flexibility in Pillar 2 than in Pillar
1, OTS expressed concern that thrifts could be disadvantaged if
different regulatory agencies did not implement Pillar 2 consistently.
The regulators did less analysis regarding the international
competitive impact of the new rules. At the time that the capital rules
were being developed, OMB provided little guidance on analyzing the
international impact of U.S. rules and the agencies did not discuss
international competition issues in their analyses. Alternatively,
European Union guidance for regulatory impact analyses includes a more
detailed evaluation of impacts on international trade and investment,
and OMB is considering including more explicit guidance on the analysis
of the impact on international trade and investment in the United
States.[Footnote 28] During the development of Basel II, U.S. banks
raised concerns about being disadvantaged internationally by certain
aspects of the U.S. rules.
U.S. Final Rule on the Advanced Approaches Addresses Some Competitive
Concerns Raised by Banks, but the Leverage Ratio Continues to Be a
Concern:
Although regulators have harmonized some aspects of the advanced
approaches final rule with the New Basel Accord, concerns remain about
remaining differences in the final rule and other issues such as the
leverage requirement that could have competitive effects. The final
rule removed an important technical difference in the definition of
default for wholesale products that existed between the U.S. NPR and
the New Basel Accord. However, other differences were retained, such as
the U.S. implementation schedule and the amount by which regulatory
capital could decrease during a bank's transition to the final rule.
Core banks are specifically concerned that the leverage requirement
will have negative effects on their ability to compete with CSEs and
foreign-based banks.
Final Rule Eliminated Some Technical Differences That Raised Concerns
about Competitive Effects, but Other Differences Remain:
U.S. banking regulators harmonized certain aspects of the U.S. final
rule on the advanced approaches with the New Basel Accord, reducing
some concerns of core banks. For example, one of the major concerns of
U.S. core banks was that the proposed rule included a different
definition of default for wholesale products, which could lead to
increased implementation costs through the need to maintain separate
systems for data in the United States and in those foreign countries
where U.S. core banks were required to adopt Basel II. The definition
of default for wholesale products in the final rule now closely
resembles the New Basel Accord's definitions for these types of
products, thus limiting the potential for higher implementation costs
for core banks. Other technical differences that have been diminished
for core banks include how core banks have to estimate their losses
after a borrower has defaulted on a loan. Table 3 outlines several key
technical differences between the earlier proposed U.S. rules and the
New Basel Accord and highlights where U.S. regulators diminished or
retained differences in the final rule.
Table 3: Significant Technical Differences between the U.S. NPR on
Advanced Approaches and the New Basel Accord, and the Treatment of
These Differences in the U.S. Final Rule on Advanced Approaches:
Significant technical differences: Wholesale definition of default;
U.S. NPR on the Advanced Approaches: Based on whether:
* the bank places any exposure to the borrower on non-accrual status,;
* the bank incurs full or partial charge offs on any exposure to the
borrower, or;
* the bank incurs a credit-related loss of 5 percent or more on the
sale of any exposure to the borrower or transfer of any exposure to the
borrower to the held-for-sale, available-for-sale, trading account, or
other reporting category;
New Basel Accord: Based on whether:
* the bank considers a borrower unlikely to pay in full without
recourse to bank actions, or;
* a borrower's payment on principal or interest is more than 90 days
past due;
* Includes non-accrual status and material credit-related loss on sale
as elements indicating unlikeliness to pay. However, the accord does
not specify the threshold of 5 percent for credit-related losses upon
sale or transfer, and other countries' definitions do not generally
include non-accrual status;
U.S. Final Rule on Advanced Approaches: Based on whether:
* the bank considers that the borrower is unlikely to pay its credit
obligations to the bank in full, without recourse by the bank to
actions such as realizing collateral (if held), or;
* the borrower is past due more than 90 days on any material credit
obligation to the bank;
* Includes nonaccrual and material credit-related loss on sale as
elements indicating unlikeliness to pay.
Significant technical differences: Retail definition of default;
U.S. NPR on the Advanced Approaches: Occurs when an exposure reaches
120 or 180 days past due, depending on exposure type, or when the bank
incurs a full or partial charge off or write-down on principal for
credit- related reasons;
New Basel Accord: Occurs when an exposure reaches a past due threshold
between 90 and 180 days, set by the national supervisor, or when the
bank considers a borrower unlikely to pay in full without recourse to
bank actions;
U.S. Final Rule on Advanced Approaches: * Occurs when an exposure
reaches 120 or 180 days past due, depending on exposure type, or when
the bank incurs a full or partial charge-off or write-down on principal
for credit-related reasons;
* Banks can adopt the definition of default of host countries for
foreign subsidiaries subject to prior approval of their primary federal
supervisor.
Significant technical differences: Small-and medium-sized enterprise
(SME) lending;
U.S. NPR on the Advanced Approaches: Does not include an adjustment
that would result in a lower capital requirement for loans to SMEs
compared to other business loans under the framework;
New Basel Accord: Includes such an adjustment;
U.S. Final Rule on Advanced Approaches: Does not include an adjustment
that would result in a lower capital requirement or loans to SMEs
compared to other business loans.
Significant technical differences: Loss given default (LGD);
U.S. NPR on the Advanced Approaches: * A bank may use its own LGD
estimates upon obtaining supervisory approval, which is based in part
on whether the estimates are reliable and sufficiently reflective of
economic downturn conditions;
* A bank that does not qualify to use its own internal LGD estimates
must instead compute LGD using a supervisory formula that some bank
officials have described as overly conservative;
New Basel Accord: * Requires banks to estimate losses from default that
would occur during economic downturn conditions, which may result in
higher regulatory required capital for some exposures under the
framework;
* Does not identify an explicit supervisory formula for estimating LGD
when a bank's internal LGD estimates do not meet minimum requirements;
* Instead, if a bank is unable to estimate LGD for any material
portfolio, it would not qualify for the A-IRB approach;
U.S. Final Rule on Advanced Approaches: Bank's LGD estimate must be
reliable and sufficiently reflective of economic downturn data and
should have rigorous and well-documented policies and procedures for
(1) identifying economic downturn conditions for each exposure
subcategory, (2) identifying changes in material adverse relationships
between the relevant drivers of default rates and loss rates given
default, and (3) incorporating identified relationships into LGD
estimates.
Source: GAO.
[End of table]
One technical difference that remains between the U.S. final rule on
advanced approaches and the New Basel Accord is the treatment of SME
loans. U.S. regulators believe that an adjustment to lower the capital
charge for such business loans is not substantiated by sufficient
empirical evidence. In other words, this suggests that, all other
things equal, SME loans have risks comparable to those posed by larger
corporate loans. U.S. regulators also noted that the SME treatment in
the Accord might give rise to a domestic competitive inequity between
core banks and banks subject to other regulatory capital rules, such as
Basel I. Officials at one rating agency with whom we spoke said that a
lower capital requirement for SME loans in the New Basel Accord was not
reflective of the risk for these exposures, and the rating agency did
not treat these loans differently from other business loans in their
own assessments of capital adequacy. In addition, several experts with
whom we spoke noted that this difference in capital requirements for
SME loans would likely not have any immediate or major impact on
competition between U.S. and foreign banks.
In addition to the technical differences discussed above, the final
rule addressed one concern related to a prudential safeguard U.S.
regulators introduced in the 2006 NPR, but some core banks remain
concerned about the implementation schedule. The NPR contained a
benchmark--a 10 percent reduction in aggregate minimum capital among
core banks--that would have been viewed as a material reduction in
capital requirements that warranted modification in the rule. Core
banks had commented that this safeguard could affect them negatively
because of the uncertainty surrounding its application. In the final
rule, U.S. regulators eliminated the benchmark. However, retention of
the implementation schedule proposed in the 2006 NPR continues to raise
concerns for some core banks because it will lead to a longer
transition period in the United States than in other countries and
delay any possible capital reductions. European banks and most Canadian
banks on the advanced approaches most likely will exit their
transitional periods by January 2010. In contrast, U.S. core banks
cannot exit their transitional periods before April 2012 and could do
so in 2014 or later. Furthermore, European banks will be able to reduce
capital to 90 percent of Basel I requirements in 2008 and to 80 percent
of Basel I requirements in 2009 while Canadian banks will be able to
apply for approval to reduce their capital by similar amounts under the
same timeframes. Under the final rule, U.S. core banks will have three
distinct transitional periods during which required risk-based capital
may be reduced to only 95 percent, 90 percent, and 85 percent of Basel
I requirements respectively.[Footnote 29] The different implementation
schedules and maximum capital reductions may provide foreign
competitors of U.S. core banks an earlier opportunity to make use of
any decreases in capital costs associated with lower required capital
for certain assets or activities. Therefore, by making the transition
to Basel II lengthier for U.S. core banks, foreign competitors may be
able to take better advantage of strategic opportunities, such as a
mergers or acquisitions. Though several core bank officials with whom
we spoke remained concerned about the time difference, officials at one
core bank explained that the current market environment may limit the
competitive implications of that difference.
Several core bank officials with whom we spoke mentioned that they
would have wanted to have the option to select the standardized
approach with some officials suggesting that the lack of a choice may
lead to higher implementation costs. In the United States, the final
rule requires all core banks to adopt the advanced approaches for both
credit and operational risk, but affords opportunities for the primary
federal supervisor to exercise some flexibility when applying the final
rule to core banks. The advanced approaches rule specifically allows
for the exemption of subsidiary depository institutions from
implementing the advanced approaches, and, under the reservation of
authority, the primary federal regulator can require a different risk
weighted asset amount for one or more credit risk exposures, or for
operational risk, if the regulators determine that the requirement
under the advanced approaches is not commensurate with risk. However,
some U.S. regulatory officials with whom we spoke noted the potential
risk of a piecemeal approach and emphasized that they do not want banks
to apply the advanced approach for credit risk to their least risky
portfolios and to apply Basel I or the proposed standardized approach
for their riskier portfolios.
In contrast, some foreign banks have not been explicitly required to
adopt the advanced approaches for credit and operational risk. For
example, Canadian regulators told us that they have an expectation for
their domestic banks with significant global operations to move to the
advanced approach for credit risk and that there is no such expectation
for domestic banks to use the advanced approach for operational risk.
Furthermore, all other banks in Canada can decide to adopt the advanced
approaches with the condition that the bank must adopt the advanced
approach for credit risk before adopting the advanced approach for
operational risk. In addition, regulatory officials from the United
Kingdom told us that all banks were required to adopt the standardized
approach in 2007, but some banks applied for a waiver to allow them to
adopt the advanced approaches for determining capital requirements for
credit risk or for operational risk. Moreover, officials from one
European bank told us that they entered their first transitional year
in their country with approximately three-quarters of their portfolios
on the advanced approach for credit risk.
Retention of Leverage Requirement Has Raised Concerns of Core Banks
about Competitive Effects:
Officials from some of the core banks with whom we spoke expressed
concerns that they may be at a competitive disadvantage due to the
retention of the U.S. leverage requirement, which applies to all
depository institutions and U.S.-based bank holding companies. Foreign
banks based in other industrialized countries are generally not subject
to a leverage requirement.[Footnote 30] Some U.S.-based core banks are
concerned about the impact of the leverage requirement for bank holding
companies on their operations abroad. That is, in meeting the leverage
requirement, a U.S. bank holding company must include the assets of its
foreign operations, potentially increasing the amount of required
regulatory capital in comparison with the regulatory capital
requirements for foreign-based bank holding companies. For example, the
additional capital needed to meet the leverage requirement may exceed
the additional capital required under the advanced approaches for
certain corporate loans that are estimated by banks to be relatively
low-risk, as demonstrated in figure 3. Most core bank officials with
whom we spoke also said that by maintaining the leverage requirement,
U.S. regulators were preserving a regulatory capital requirement that
was not aligned with the improved risk-management practices promulgated
by the final rule on the advanced approaches. Officials from one trade
association said that because the leverage requirement does not require
additional capital as risk increases, banks may have an incentive to
increase their return on equity by holding assets with higher risk and
return, but no additional capital required by the leverage requirement.
In contrast, regulatory officials have stated that risk-based and
leverage requirements serve complementary functions in which the
leverage requirement can be seen as offsetting potential weaknesses or
supplementing the risk-based capital requirements.
Figure 3: Required Capital for Short-term Corporate Loans under the
Advanced Approach and Bank Holding Company Leverage Requirement, by
Probability of Default:
This figure is a line and bar combination graph showing required
capital for short-term corporate loans under the advances approach and
bank holding company leverage requirement, by probability of default.
The X represents the annual probability of default, and the Y axis
represents the required capital (percentage).
Annual probability of default: 0.05%;
Advanced approach: 0.76%.
Annual probability of default: 0.15%;
Advanced approach: 1.67%.
Annual probability of default: 0.25%;
Advanced approach: 2.34%.
Annual probability of default: 0.35%;
Advanced approach: 2.87%.
Annual probability of default: 0.45%;
Advanced approach: 3.32%.
Annual probability of default: 0.55%;
Advanced approach: 3.70%.
Annual probability of default: 0.65%;
Advanced approach: 4.04%.
Annual probability of default: 0.75%;
Advanced approach: 4.33%.
Annual probability of default: 0.85%;
Advanced approach: 4.59%.
Annual probability of default: 0.95%;
Advanced approach: 4.83%.
Annual probability of default: 1.05%;
Advanced approach: 5.05%.
Annual probability of default: 1.15%;
Advanced approach: 5.24%.
Annual probability of default: 1.25%;
Advanced approach: 5.42%.
Annual probability of default: 1.35%;
Advanced approach: 5.59%.
Annual probability of default: 1.45%;
Advanced approach: 5.75%.
Annual probability of default: 1.55%;
Advanced approach: 5.89%.
Annual probability of default: 1.65%;
Advanced approach: 6.03%.
Annual probability of default: 1.75%;
Advanced approach: 6.16%.
Annual probability of default: 1.85%;
Advanced approach: 6.28%.
Annual probability of default: 1.95%;
Advanced approach: 6.40%.
Annual probability of default: 2.05%;
Advanced approach: 6.51%.
[See PDF for image]
Source: GAO analysis of the advanced approaches rule. Federal Reserve
regulation, and data from the QIS-4 summary.
Note: Estimates of the capital required under the advanced approaches
in the figure assume an LGD of 35.8 percent (adjusted for downturn
conditions using the supervisory formula from the advanced approaches
NPR, based on mean LGD for corporate, bank, and sovereign exposures
from the fourth quantitative impact study (QIS-4 ) of 30.2 percent),
and a maturity of 1 year. The leverage requirement of 3 percent for
bank holding companies subject to the market risk amendment is measured
in tier 1 capital, while the Basel II credit risk requirement is
measured in total capital. The estimates of required capital under the
advanced approach do not include any increase in the operational risk
capital requirement that could come from holding additional assets.
[End of figure]
In terms of potential competitive effects domestically, some core bank
officials with whom we spoke expressed concerns that certain financial
firms, primarily the CSEs, offer similar wholesale products but lack
similar regulatory capital requirements, while other core bank
officials were no longer concerned. As noted previously, CSEs are
required to compute and report to SEC capital adequacy measures
consistent with the standards in the New Basel Accord, and SEC expects
them to maintain certain capital ratios, though they are not required
to do so. SEC has said that it will make modifications in light of the
final rule adopted by U.S. bank regulators and subsequent
interpretations. In addition, bank holding companies are subject to a
leverage requirement, but CSEs do not have a similar requirement. For
example, in December 2007, the leverage ratio for core bank holding
companies ranged from about 4.0 percent to about 6.8 percent and for
CSEs ranged from about 3 percent to 3.8 percent.
International Coordination among Regulators Has Contributed to Reducing
Competitive Concerns for Core Banks:
U.S. regulators and their foreign counterparts are coordinating in ways
that contribute to reducing the potential for adverse competitive
effects on U.S. banks operating abroad. These efforts aim to resolve
some issues that develop between regulators in a bank's home country
and those in other countries where the bank operates, usually referred
to as home-host issues. Handling home-host issues is an essential
element of the New Basel Accord framework because it allows for
national discretion in a number of areas.[Footnote 31] Several foreign
regulators with whom we spoke discussed how well U.S. regulators have
been able to collaborate with their foreign counterparts on a variety
of supervisory issues. Specific to Basel II implementation, U.S.
regulators have been able to provide needed information to foreign bank
supervisors that could limit the compliance costs of subsidiaries of
U.S. banks operating abroad. For example, OCC examiners explained to us
how they assisted a foreign regulator in better understanding some of
the information a core bank was using in estimating credit risk for a
certain loan portfolio. In another instance of collaboration, foreign
regulators explained to us that they waived the requirement for a core
bank to adopt the advanced approaches for its foreign-owned subsidiary
until the core bank adopted the advanced approaches in the United
States.
Over the years, the U.S. regulators have entered into various
information-sharing agreements that facilitate cooperation with their
foreign counterparts. These agreements are intended to expedite the
meeting of requests posed by foreign regulators for supervisory
information from U.S. regulators. As of July 2008, OCC and Federal
Reserve officials explained that they had some form of an information-
sharing agreement with 25 and 16 foreign jurisdictions respectively.
Likewise, FDIC and OTS officials both described good working
relationships with their foreign counterparts as they related to U.S.
banks with international operations that they supervise.
U.S. regulators have been and continue to be active members in the
Basel Committee and its various subcommittees, including the Accord
Implementation Group. In addition, U.S. regulators participate in
colleges of supervisors and other international bodies, such as the
Joint Forum.[Footnote 32] Participation in such entities further
provides U.S. regulators information on how U.S. banks may be treated
by foreign regulators, thus allowing for more dialogue among regulators
to preemptively address any home-host issues. The Accord Implementation
Group's purpose is to exchange views on approaches to implementation of
Basel II, and thereby to promote consistency in the application of the
New Basel Accord. Colleges of supervisors are meetings at which
regulators from various countries discuss supervisory matters that
relate to a specific bank that has global operations. Officials from
the Federal Reserve stated that the colleges are more often better for
sharing information among regulators than for addressing a specific
regulatory issue. Though regulators from various countries are sharing
information, several core banks expressed concerns to us that their
foreign regulators have been implementing Basel II differently.
Proposed Standardized Approach May Reduce Competitive Concerns of Non-
core Banks, as May Other Factors:
As discussed earlier, because non-core banks compete with core banks in
some markets, non-core banks were concerned that core banks would be
able to hold less capital than non-core banks were holding under Basel
I for the same assets. Part of this concern came from the April 2005
results of the fourth quantitative impact study (QIS-4), which
estimated that Basel II could result in material reductions in
aggregate minimum required risk-based capital among potential core
banks.[Footnote 33] By holding less capital for certain products, such
as residential mortgages, core banks might charge less for these
products than non-core banks. Two studies of the potential impact of
Basel II on the market for residential mortgages have disagreed as to
the magnitude of any competitive impact--one suggested a potentially
significant shift in income from mortgages toward banks on the advanced
approaches, while the other argued that any competitive impact was
unlikely.[Footnote 34] In addition, U.S. regulators have recognized
that some banks were concerned about core banks being required to hold
less capital overall, thus making it advantageous to acquire non-core
banks. The proposed standardized approach rule should address some of
the competitive concerns non-core banks expressed in the early 2000s,
while several other factors, including the leverage requirement, also
may reduce differences in capital between core and non-core banks.
Proposed Standardized Approach Provides a More Risk-sensitive Option
for Non-core Banks:
U.S. regulators have proposed the standardized approach in part to
mitigate potential competitive differences between core and non-core
banks.[Footnote 35] The U.S. version of the standardized approach
features more risk-sensitive capital requirements than Basel I. In
particular, it adds risk sensitivity for mortgages based on their loan-
to-value (LTV) ratios and has lower capital requirements than Basel I
for some lower-risk (lower LTV) mortgages (see fig. 4).
Figure 4: Risk Sensitivity of Proposed Standardized Approach vs.
Prudently Underwritten Residential Mortgages under Basel I, by LTV:
This figure is a combination bar graph showing risk sensitivity of
proposed standardized approach vs. prudently underwritten residential
mortgages under Basel I, by LTV. One bar shows Base I, and the other
shows Proposed U.S. standardized approach.
Loan-to-value (LTV) ratio: LTV
