Opening Statement: Basel III and Improved Capital Measurement; FDIC Board Meeting; June 12, 2012
I would like to start by thanking the staff for their efforts and dedication towards the challenging task of developing a system to implement the Basel framework and improved capital measurement rules for the U.S. banking system. I support moving forward with the three Notices of Proposed Rulemaking for a 90-day comment period.
In my view, it is important to consider the historical context through which we consider the three Notices of Proposed Rulemaking (“NPRs”). In 2005, the Basel Committee on Banking Supervision (BCBS) agreed upon a plan for implementing the new regulatory capital framework for financial institutions. These rules, known as Basel II, were implemented in other countries; however, progress on implementation stalled in the U.S. as stress in the financial markets began in earnest during 2007.
Instead, the U.S. taxpayer stood behind the financial system through a number of unprecedented actions and programs in 2008 and 2009. The list is long and not necessary to go through today; however, it is clear that equity holders, creditors, and counterparties of financial institutions benefited greatly from various U.S. Government actions, programs, and initiatives. In considering the events of 2008 and 2009, we should not only keep in mind the actual losses suffered by financial institutions, but also the magnitude of losses avoided because of the various Government assistance measures. With this perspective, I believe it is critically important that the Banking Agencies implement a new regulatory capital framework that can better withstand stress in the financial markets and future economic downturns.
The three Notices of Proposed Rulemaking: Basel III, the Standardized Approaches, and the Advanced Approaches are all the product of negotiation both internationally at the Basel Committee on Banking Supervision and domestically in a joint process between the FDIC, Federal Reserve, and the OCC. Despite being a product of a multilateral, multifaceted, and multilayered negotiation, taken together, I believe the final products could offer U.S. policymakers a Pareto improvement. However, I think that the collective product put forward today could benefit from additional consideration and comment to ensure that the final rules provide meaningful improvement to the existing Basel I and Basel II capital measures.
Regulatory Capital Minimums
With regard to regulatory capital minimums, I am most encouraged by the fact that these rules provide for significantly more common equity in the numerator. At the same time, I am concerned that, especially for the largest and most complex institutions, the 7.0% Common Equity Tier 1 Ratio might not be sufficiently high given the risks some entities pose to the system inextremis.
The effectiveness of the Basel capital minimums is highly reliant upon the risk weighting of assets in the denominator. A great deal of the work at the Basel Committee has been focused on an effort to come up with credible risk weightings for assets and exposures. I remain concerned that the risk weightings for certain assets and exposures do not reflect sufficiently the inherent risk of default and loss given default.
Importantly, the Basel III agreement does implement a leverage ratio on a global basis for the first time. However, I would be particularly interested in receiving comments about the merits of instituting a stronger regulatory framework in the U.S. based upon a Common Equity Tier 1 to average total assets or a tangible common equity to tangible assets leverage ratio. A regulatory capital framework that provides a more balanced consideration of risk-based capital ratios and a common equity leverage ratio could mitigate potential shortcomings associated with the Basel agreement.
The Basel III and Standardized Approaches NPRs would also apply to community banks, and I encourage industry participants and other interested parties to comment on the merits of these proposed rules. In my view, the comment period provides for an appropriate venue to question whether or not these rules for community banks will result in a more effective measure of capital for their business models.
Again, I would like to thank staff for their efforts and look forward to the presentation today.