Basel
ii in the United States of America
From the
Basel ii
Compliance Professionals Association (BCPA),
the largest association of Basel ii Professionals in the
world
Final Rule, USA: Risk-Based Capital Standards:
Advanced Capital Adequacy Framework — Basel II
Executive Summary of the Final Rule
I.
On
September 25, 2006, the agencies issued a joint notice
of proposed rulemaking (proposed rule or proposal) (71
FR 55830) seeking public comment on a
new risk-based
regulatory capital framework for
banks.
The
agencies previously issued an advance notice of proposed
rulemaking (ANPR) related to the new risk-based
regulatory capital framework (68 FR 45900, August
4, 2003).
The
proposed rule was based on a
series of releases from the Basel Committee on Banking
Supervision (BCBS), culminating in the BCBS's
comprehensive June 2006 release entitled ``International
Convergence of Capital Measurement and Capital
Standards: A Revised Framework'' (New Accord).
The New Accord sets forth a ``three pillar'' framework
encompassing risk-based capital requirements for credit
risk, market risk, and operational risk (Pillar 1);
supervisory review of capital adequacy (Pillar 2); and
market discipline through enhanced public disclosures
(Pillar 3).
The New
Accord includes several methodologies for determining a
bank's risk-based capital requirements for credit,
market, and operational risk.
The proposed rule included the advanced capital
methodologies from the New Accord, including the
advanced internal ratings-based (IRB) approach for
credit risk and the advanced measurement approaches
(AMA) for operational risk (together, the advanced
approaches).
The IRB approach uses risk parameters determined by a
bank's internal systems in the calculation of the bank's
credit risk capital requirements.
The AMA relies on a bank's internal estimates of its
operational risks to generate an operational risk
capital requirement for the bank.
The agencies now are adopting this final rule
implementing a new risk-based regulatory capital
framework, based on the New Accord, that is mandatory
for some U.S. banks and optional for others.
While the New Accord includes several methodologies for
determining risk-based capital requirements, the
agencies are adopting only the advanced approaches at
this time.
The agencies received approximately 90 public comments
on the proposed rule from banking organizations, trade
associations representing the banking or financial
services industry, supervisory authorities, and other
interested parties.
This section of the preamble highlights several
fundamental issues that commenters raised about the
agencies' proposal and briefly describes how the
agencies have responded to those issues in the final
rule.
More detail is provided in the preamble sections below.
Overall, commenters supported the development of the
framework and the move to more risk-sensitive
capital requirements.
One overarching issue, however, was the areas
where the proposal differed from the New Accord.
Commenters said the divergences generally created
competitive problems,
raised home-host
issues, entailed extra cost and regulatory burden, and
did not necessarily improve the overall safety and
soundness of banks subject to the rule.
Commenters also generally disagreed with the agencies'
proposal to adopt only the advanced approaches from the
New Accord.
Further, commenters objected to the agencies' retention
of the leverage ratio, the transitional arrangements in
the proposal, and the 10 percent numerical benchmark for
identifying material aggregate reductions in
risk-based capital requirements to be used for
evaluating and responding to capital outcomes during the
parallel run and transitional floor periods (discussed
below).
Commenters also noted numerous technical issues with the
proposed rule.
As noted in an interagency press release issued July 20,
2007 (Banking Agencies Reach Agreement on Basel II
Implementation), the agencies have agreed to eliminate
the language from [[Page 69290]] the preamble concerning
a 10 percent limitation on aggregate reductions in
risk-based capital requirements.
The press release also stated that the agencies are
retaining intact the transitional floor periods (see
preamble sections I.E. and III.A.2.).
In addition, while not specifically mentioned in the
press release, the agencies are retaining the leverage
ratio and the prompt corrective action (PCA) regulations
without modification.
The final rule adopts without change the proposed
criteria for identifying core banks (banks required to
apply the advanced approaches) and continues to permit
other banks (opt-in banks) to adopt the advanced
approaches if they meet the applicable qualification
requirements.
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.
A depository institution (DI) also is a core bank if it
is a subsidiary of another DI or bank holding company
that uses the advanced approaches.
The final rule also provides that a bank's primary
Federal supervisor may determine that application of the
final rule is not appropriate in light of the bank's
asset size, level of complexity, risk profile, or scope
of operations (see preamble sections II.A. and B.).
As noted above,
the final rule includes only the
advanced approaches.
The July 2007 interagency press release stated that the
agencies have agreed to issue a proposed rule that would
provide non-core banks with the option to adopt an
approach consistent with the standardized approach
included in the New Accord.
This new proposal (the standardized proposal) will
replace the earlier proposal to adopt the so-called
Basel IA option (Basel 1A proposal).
The press release also noted the agencies' intention to
finalize the standardized proposal before core banks
begin the first transitional floor period under this
final rule.
In response to commenters' concerns that some aspects of
the proposed rule would result in excessive regulatory
burden without commensurate safety and soundness
enhancements, the agencies included a
principle of conservatism in the final rule.
In general, under this principle, in limited situations,
a bank may choose not to apply a provision of the rule
to one or more exposures if the bank can demonstrate on
an ongoing basis to the satisfaction of its primary
Federal supervisor that not applying the provision
would, in all circumstances, unambiguously generate a
risk-based capital requirement for each such exposure
that is greater than that which would otherwise
be required under the regulation, and the bank meets
other specified requirements (see preamble section II.D.).
In the proposal, the agencies modified the definition of
default for wholesale exposures from that in the New
Accord to address issues commenters had raised on the
ANPR.
Commenters objected to the agencies' modified definition
of default for wholesale exposures, however,
asserting that a definition different from the New
Accord would result in competitive inequities and
significant implementation burden without associated
supervisory benefit.
In response to these concerns,
the agencies have adopted
a definition of default for wholesale exposures
that is consistent with the New Accord
(see preamble
section III.B.2.).
For retail exposures, the final rule retains the
proposed definition of default and clarifies that,
subject to certain considerations, a foreign subsidiary
of a U.S. bank may, in its consolidated risk-based
capital calculations, use the applicable host
jurisdiction definition of default for retail exposures
of the foreign subsidiary in that jurisdiction (see
preamble section III.B.2.).
Another concept introduced in the proposal that was not
in the New Accord was the expected loss given default (ELGD)
risk parameter.
ELGD had four functions in the proposed rule--as a
component of the calculation of expected credit loss (ECL)
in the numerator of the risk-based capital ratios; in
the expected loss (EL) component of the IRB
risk-based capital formulas; as a floor on the value of
the loss given default (LGD) risk parameter; and as an
input into a supervisory mapping function.
Many commenters objected to the inclusion of ELGD as a
departure from the New Accord that would create
regulatory burden and competitive inequity.
Many commenters also objected to the supervisory mapping
function, which the agencies intended as an alternative
for banks that were not able to estimate reliably the
LGD risk parameter.
The agencies have eliminated ELGD from the final rule.
Banks are required to estimate only the LGD risk
parameter, which reflects economic downturn conditions
(see preamble section III.B.3.).
The supervisory mapping function also has been
eliminated from the rule.
Commenters also objected to the agencies' decision not
to include a distinct risk weight function for exposures
to small- and medium-size enterprises (SMEs) as provided
in the New Accord.
In the proposal, the agencies noted they were not aware
of compelling evidence that smaller firms with the same
probability of default (PD) and LGD as larger firms are
subject to less systemic risk than is already reflected
in the wholesale risk-based capital functions.
The agencies continue to believe an SME-specific risk
weight function is not supported by sufficient evidence
and might give rise to competitive inequities across
U.S. banks, and have not adopted such a function in the
final rule (see preamble section V.A.1.)
With regard to the proposed treatment for securitization
exposures, commenters raised a number of technical
issues.
Many objected to the proposed definition of a
securitization exposure, which included exposures to
investment funds with material liabilities (including
exposures to hedge funds).
The agencies agree with commenters that
the proposed
definition for securitization exposures was quite broad
and captured some exposures that would more
appropriately be treated under the wholesale or equity
frameworks.
To limit the scope of the IRB securitization framework,
the agencies have modified the definition of
traditional securitization in the final rule as
described in preamble section V.A.3. Technical issues
related to securitization exposures are discussed in
preamble sections V.A.3. and V.E.
For equity exposures, commenters focused on the
proposal's lack of a grandfathering period.
The New Accord provides national discretion for each
implementing jurisdiction to adopt a grandfather period
for equity exposures.
Commenters asserted that this omission would result in
competitive inequity for U.S. banks as compared to other
internationally active institutions.
The agencies believe that, overall, the proposal's
approach to equity exposures results in a competitive
risk-based capital requirement.
The final rule does not include a grandfathering
provision, and the agencies have adopted the proposed
treatment for equity exposures without significant
change (see preamble section V.F.).
A number of commenters raised issues related to
operational risk.
Most significantly, commenters noted that activities
besides securities processing and
credit card fraud have
highly predictable and reasonably stable losses and
should be considered for operational risk offsets.
The agencies believe that the proposed definition of
eligible operational risk offsets allows
for the consideration of other activities in a flexible
and prudent manner and, thus, are retaining the proposed
definition in the final rule.
Commenters also noted that the proposal appeared to
place limits on the use of operational risk mitigants.
The agencies have provided flexibility in this regard
and under the final rule will take into consideration
whether a particular operational risk mitigant covers
potential operational losses in a manner equivalent to
holding regulatory capital (see preamble sections
III.B.5. and V.I.).
Many commenters expressed concern that the proposed
public disclosures were excessive and would hinder,
rather than facilitate, market discipline by requiring
banks to disclose information that would not be well
understood by or useful to the market.
Commenters also expressed concern about
possible
disclosure of proprietary information.
The agencies believe that it is important to retain the
vast majority of the proposed disclosures, which are
consistent with the New Accord.
These disclosures will enable market participants to
gain key insights regarding a bank's capital structure,
risk exposures, risk assessment processes, and,
ultimately, capital adequacy.
The agencies have modified the final rule to provide
flexibility regarding proprietary information.
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