November 3, 2003
Mr. John D. Hawke, Jr.
Office of the Comptroller of the Currency
250 E Street, SW, Washington, DC 20219
Attention: Docket No. 03-14
Ms. Jennifer J. Johnson, Secretary,
Board of Governors of the Federal Reserve System
20th Street and Constitution Avenue, NW, Washington, DC 20551
Attention: Docket No. R-1154
Mr. Robert E. Feldman, Executive Secretary
Federal Deposit Insurance Corporation |
550 17th Street, NW, Washington, DC 20429
Attention: Comments, FDIC
Regulation Comments, Chief Counsel's Office,
Office of Thrift Supervision
1700 G Street, NW, Washington, DC 20552
Attention: No. 2003-27
Re: Advance Notice of Proposed Rulemaking: Implementation of
New Basel Capital Accord (Docket Nos. R-1154
(Federal Reserve
Board), 03-14 (OCC), 2003-27 (OTS))
Ladies and Gentlemen:
The Institute of International Bankers (the “Institute”) appreciates
this opportunity to comment on the advance notice of proposed rulemaking
(the “ANPR”) published by the U.S. federal banking agencies relating to
their proposed framework for implementing the New Basel Capital Accord
(“Basel II”). The Institute represents internationally headquartered
banking/financial institutions that conduct banking operations in the
United States through branches, agencies, commercial lending company
subsidiaries, Edge corporations and/or U.S. bank subsidiaries.
The Institute strongly supports the decision by the U.S. banking
agencies to issue an ANPR in order to solicit public comments early in
the rulemaking process. In view of the major policy issues and potential
economic effects of Basel II, we commend the transparency that has
characterized the agencies’ implementation efforts to date. Recognizing
that Basel II remains a work in progress,1 we believe the
ANPR is a productive step in the ongoing dialogue between the industry
and bank supervisory authorities regarding Basel II.
The Institute supports the Basel Committee’s efforts to develop a new
capital framework that facilitates a more comprehensive and
risk-sensitive approach to setting minimum capital requirements and
permits the allocation of capital on the basis of a banking
institution’s internal risk assessments. We thus broadly support the
U.S. banking agencies’ implementation of these reforms. Our comments
regarding the ANPR relate to an issue that we believe has not been
sufficiently addressed either in the Basel Committee’s publications
concerning Basel II or the ANPR: the need for clear international
standards for cross-border implementation of Basel II to ensure the
primacy of the home country supervisor’s role in supervising the capital
adequacy of internationally active banking institutions under Basel II.
I. Introduction
One of the core principles underlying the original Basel Capital
Accord (“Basel I”) and informing the development of Basel II is the
importance of harmonized capital adequacy standards for internationally
active banking institutions. In addition, beyond the context of
risk-based capital requirements, the Basel Committee has articulated
international standards relating to the supervision of cross-border
establishments of banking institutions, including in the Basel Concordat
and the Core Principles for Effective Banking Supervision (the “Core
Principles”). These international standards assign primary
responsibility for supervision of a banking organization’s safety and
soundness to the relevant home country supervisor.
In furtherance of the objectives of Basel II and the Basel
Committee’s international standards for cross-border bank supervision,
we have urged the Basel Committee to articulate in the final Basel II
documentation clear standards for the cross-border implementation of
Basel II—not only for banks that operate branches in multiple countries
but also for banks that operate locally incorporated bank subsidiaries
in multiple countries. In this regard, we have commended the Basel
Committee’s formation of the Basel Accord Implementation Group (the “AIG”),
which is considering cross-border implementation issues, and we support
the call for cross-border coordination among banking supervisors
reflected in the Basel Committee’s “High-Level Principles for the
Cross-Border Implementation of the New Accord” (the “High-Level
Principles”), published in August. At the same time, we continue to
believe that the development of clearer standards in this area is
crucial.
In the Institute’s view, the complexity of Basel II’s advanced
approaches to credit and operational risk, combined with Basel II’s
reliance on supervisory discretion (both to approve a bank’s
implementation of those approaches and to supervise capital adequacy
more generally under Pillar 2), underscores the need for international
standards and procedures for cross-border coordination. The more complex
and discretionary the Basel capital framework becomes, the more likely
supervisors are to reach differing good faith judgments regarding a
particular bank’s implementation of the framework. This potential is
illustrated clearly by the experience of many internationally active
banks which use value-at-risk methodologies to calculate a market risk
capital charge. It is not uncommon for home and host country supervisors
to reach reasonable but conflicting determinations regarding the
adequacy of a bank’s market risk models, back-testing results, etc. At
times, these differences have been mitigated through coordination
between regulators on a bilateral basis. However, given the materiality
and scope of the Basel II reforms, we believe more structured guidance
is required to minimize the instances of conflicting demands by home and
host country supervisors. In the absence of international standards and
procedures for coordination, internationally active banks potentially
face the impossible task of satisfying many different bank supervisors
regarding the adequacy of their implementation of Basel II capital
standards.
We believe these issues become particularly acute in jurisdictions
such as the United States which propose to implement Basel II only for
their largest internationally active institutions. The ANPR outlines
proposed criteria for defining the banking organizations that will be
required to use the Advanced Internal Ratings-Based (“A-IRB”) approach
to credit risk and the Advanced Measurement Approach (“AMA”) to
operational risk. However, the Institute believes that it is inevitable
that U.S. capital standards implementing Basel II will differ from those
of other countries as the Basel Committee’s international standards are
adapted to local banking practices, laws and regulations and accounting
standards. Indeed, international variation of capital adequacy standards
exists today under the considerably simpler Basel I framework, and the
potential for such variation under Basel II is magnified significantly
by the complexity of Basel II and its reliance on supervisory
discretion.
In our July 31, 2003 comment letter to the Basel Committee regarding
its Third Consultative Document (see attached), we articulated certain
broad principles regarding home-host country coordination that we
believe should inform the Basel Committee’s further development of Basel
II and, in turn, all countries’ implementation of Basel II. We do not
repeat those principles here, although we believe they are particularly
relevant to the U.S. banking agencies’ implementation of Basel II.
Instead, this comment letter focuses on certain specific issues relating
to the U.S. banking agencies’ supervision of the capital adequacy of
international banks in light of historical U.S. practices and issues
raised in the ANPR.
II. Achieving an Appropriate Balance Between Home and Host Country
Roles in the U.S. Banking Agencies’ Supervision of International Banks’
Capital Adequacy
There are two principal areas in which the Institute believes the
roles of U.S. banking agencies as host country supervisors should be
more clearly defined: (1) the supervision of the capital adequacy of
international banks’ separately incorporated U.S. bank and/or thrift
subsidiaries; and (2) the supervision of international banks’
consolidated capital adequacy, including for purposes of determining the
eligibility of international banks for “financial holding company” (“FHC”)
status under the Gramm-Leach-Bliley Act (the “GLBA”).
A. U.S. Bank and Thrift Subsidiaries of International Banks
The ANPR suggests that U.S. bank and thrift subsidiaries of
international banks would be required to comply with U.S. regulatory
capital requirements applied to U.S. banks, regardless of which Basel II
approach the international bank uses on a consolidated basis.2
While this requirement essentially mirrors the approach used today by
the U.S. (and many non-U.S.) bank supervisors under Basel I standards,
the choice of approaches available under Basel II creates additional
complications for internationally active banks. This is particularly
true in the United States, where, as articulated in the ANPR, only a
select few institutions will be required (or permitted) to use the A-IRB
approach to credit risk and the AMA for operational risk. All other U.S.
institutions will continue to use Basel I-based standards. The U.S.
banking agencies’ decision not to implement the less sophisticated Basel
II approaches means that virtually all international banks with one or
more U.S. bank or thrift subsidiaries will be required to manage such
subsidiaries to Basel I-based standards while managing their
consolidated organizations (including their U.S. subsidiaries) to home
country Basel II-based standards.
Imposing dual capital adequacy requirements on international banks in
this regard will impose burdensome implementation costs on international
banks. In the Institute’s view, an international bank should not be
effectively penalized for adopting one of the Basel II approaches (which
the Basel Committee has determined represent an improvement over current
standards) on a consolidated basis because the United States has
determined not to implement that approach.
In his June 2003 speech to the Institute, Vice Chairman Ferguson of
the Board of Governors of the Federal Reserve System (the “FRB”)
recognized that difficult problems will arise if a U.S. bank subsidiary
of an international bank is compelled to remain on Basel I-based rules
while its parent bank adopts the foundation internal ratings-based
approach to credit risk. Vice Chairman Ferguson indicated that U.S.
supervisors recognize the burdens this will impose on international
banks and suggested that U.S. supervisors would work with U.S.
subsidiaries to develop the inputs necessary to feed into the parent
bank’s consolidated capital calculations.3
While the Institute supports the willingness of U.S. supervisors to
be flexible in this regard, and appreciates Vice Chairman Ferguson’s
suggestions of possible transition arrangements to deal with these
issues4, we would respectfully submit that flexibility and transition
arrangements will not fully address the undue burdens that will be
imposed on international banks. Instead, we believe an international
bank should be permitted to adopt a Basel II-based approach uniformly
throughout its consolidated organization, subject to host country
approval of local bank subsidiaries’ qualifications to use those
approaches. Assuming the relevant U.S. bank supervisor determines that a
locally incorporated subsidiary meets the relevant criteria to use one
of the less sophisticated Basel II-based approaches, the subsidiary
should be permitted to use that approach regardless of whether the
United States elects to adopt the approach for internationally active
U.S. banking organizations.
In this regard, we would further suggest that U.S. bank supervisors
adopt a flexible approach in determining whether a locally-incorporated
subsidiary meets the relevant criteria to use a Basel II-based approach.
In making such a determination, U.S. bank supervisors should take into
account the interrelationships between the subsidiary and the global
banking institution of which it is a part and accord due deference to
the home country supervisor’s judgments relating to the consolidated
banking organization.
For example, the determination of whether a locally-chartered U.S.
depository institution subsidiary of an international bank is eligible
to use one of the advanced approaches under Basel II should take into
consideration whether the subsidiary has implemented elements of the
systems and procedures utilized by the parent institution in connection
with the risk management of its global operations, regardless of whether
they are the same as those utilized by domestic institutions that are
permitted to use the advanced approaches. If the locally-chartered
subsidiary has done so, and if the parent institution’s systems and
procedures have been approved and are reviewed by the institution’s home
country supervisor (and the home country supervisor oversees the
operations of the institution on a consolidated basis in accordance with
international standards), then the relevant U.S. supervisor generally
should accept the validity of the institution’s systems and procedures
as applied by the subsidiary and not require the subsidiary to implement
the IRB approach in the same manner expected of domestic institutions.
We believe such an approach is consistent with the High-Level
Principles.
B. International Banks that Operate in the United States Through Branches and Agencies
In the Institute’s view, deference to determinations on capital by a
banking institution’s home country supervisor is especially appropriate
where the institution operates in the United States through branches or
agencies and does not control any locally-chartered depository
institution subsidiary. As an integral part of the banking institution
itself, the operations of a branch or agency are supported by the
capital of the institution as a whole, which is allocated by the bank’s
management in accordance with its global strategy. We recognize that
U.S. banking supervisors, in their proper exercise of supervisory and
examination powers over branches and agencies of international banks,
strive to understand and evaluate the institution’s risk management
processes and systems as they relate to the operations of the branch in
the United States. However, assessing the consolidated capital adequacy
of the institution and conducting a supervisory review of the
institution’s management, systems and controls for allocating capital on
the basis of its global risks should be matters generally within the
supervisory oversight of the home country authority.
C. Compliance with Capital Standards in Excess of Home Country Minimum Requirements
As a general principle, the Institute believes that the determination
of whether a banking institution’s capital should be greater than the
minimum required under Basel II (and, if so, what that greater amount
should be) is the primary responsibility of the home country supervisor.
Nevertheless, we recognize that U.S. banking supervisors operate under
U.S. statutory standards that require them to make such determinations
with respect to international banks. The principal example of such a
determination arises under the GLBA, under which an international bank
with U.S. banking operations must be “well-capitalized” in order to
qualify as an FHC and engage in expanded financial activities in the
United States (such as securities underwriting, insurance underwriting
and merchant banking). Under applicable FRB regulations implementing the
GLBA, international banks from countries that have adopted Basel I
capital standards generally must have Tier 1 and total risk-based
capital ratios of at least 6% and 10% and must have capital that is
“comparable” to the capital required for a U.S. banking organization
under the GLBA.
In his June 2003 speech to the Institute, Vice Chairman Ferguson
indicated that the Federal Reserve Board would accept whichever of the
Basel II approaches an international bank adopts under home country
standards for purposes of evaluating FHC well-capitalized criteria. The
Institute strongly supports the approach articulated by Vice Chairman
Ferguson. Nevertheless, there are lingering concerns among many
international banks that their qualifications for the advanced
approaches under Basel II, including the integrity of the home country
approval process, home country Pillar 2 standards and home country
Pillar 3 requirements and practices, will be independently reviewed in
the context of evaluations of the bank’s compliance with FHC
well-capitalized criteria. We would therefore strongly encourage the FRB
to reflect in its next Basel II rulemaking release the policy
articulated by Vice Chairman Ferguson in his speech to the Institute.
* * *
Please contact the Institute if we can provide any further
assistance.
Very truly yours,
Lawrence R. Uhlick
Executive Director and General Counsel
Institute of International Bankers
New York, NY
____________________________
