Statement by Thomas Hoenig: Basel III Capital Interim Final Rule and Notice of Proposed Rulemaking

I wish to thank the many individuals from the U.S. and international communities involved in the Basel process for their efforts to improve the capital standard: its definition, measures of risk, and levels of protection. I am particularly aware that our FDIC staff shared a heavy burden in the work, and they deserve our thanks.

Despite this impressive effort, I am able to support only one of the two proposals before us today.

It is often suggested that Basel III provides more and better capital than earlier versions of the Basel standards. However, this is not a worthy standard of comparison given Basel II's contribution to the last crisis. To compare nearly any standard to Basel II will show improvement.

I support more and better capital; however, the Basel III standard without a binding leverage constraint remains inadequate to the task of assuring the American public, who paid a high price for the financial crisis, that our capital standards are adequate to contribute to financial stability. A capital standard, to be useful, must be understandable and enforceable and must be sufficient to absorb unexpected loss. Unfortunately, the Basel III interim final rule, as proposed, fails to fully meet these criteria.

The interim final rule continues the disparity in capital requirements between and among banks, and affects operational and competitive positions within the financial industry. This disparity has been confirmed as recently as last week in a study released by the Basel Committee.

While Basel III strengthens the definition of capital, its primary reliance on a risk-weighted asset standard employs the same techniques as Basel II with ratios that remain unduly complex, difficult to compute and requiring a vast number of calculations just begging to be gamed. This result is well illustrated when considering that the percentage of risk-weighted assets to total assets for the world's largest banks has systematically declined almost since the introduction of the Basel standards. The result has been confusion instead of clarity among the public and among bank directors who have a responsibility to oversee these firms.

The supervisory world has been made aware through a growing body of research that risk-weighted capital measures correlate poorly with actual future losses, reflecting the reality that complexity does not assure predictability nor enable individuals to know in advance how risks will shift among assets. Despite these flaws, the interim final rule continues to rely on risk-based measures, ignoring the usefulness of the leverage ratio to constrain excess risk taking for the largest, most complex institutions.

To that point, Basel III provides for a 3 percent supplemental leverage ratio applicable to advanced approach firms. This ratio measures capital against total assets and a portion of off-balance sheet exposures. It is important to know that just prior to the crisis these firms held tangible capital averaging just under 3 percent of assets, an amount that proved woefully inadequate. That a 3 percent leverage ratio is too low was appropriately noted by the Board of Governors during its July 2 discussions of this topic.

Also, a wide variety of studies and data accumulated during the comment period provide further evidence of the significant contribution that a stronger leverage ratio would bring to these firms' balance sheets. Thus, failure to include an adequate leverage ratio in the interim final rule leaves a gaping hole in the Basel III standard that has been pointed out to policymakers for months.

Moreover, nothing is accomplished by acting now and failing to wait an extra 60 or 90 days to receive comment and then implement a complete rule with a stronger leverage ratio. All of the largest, most complex U.S. firms currently meet the requirements of the interim final rule. It does nothing in the interim to strengthen the balance sheets of U.S. banks. Thus, by separating the implementation of Basel III from the supplemental leverage ratio proposal, we gain little and risk a stronger leverage ratio being delayed, or worse, not being adopted.

In summary, I support the FDIC's leadership in proposing to raise the supplemental leverage ratio for the eight largest financial holding companies in the U.S. to 6 percent for the banks and 5 percent for the holding company. I also would encourage comment on whether these capital levels are sufficient. I cannot support the interim final rule because without a binding leverage ratio, it is incomplete and inadequate. You cannot have a strong capital standard without an adequate leverage ratio, and it should be part of any rule we adopt, even on an interim basis.

Finally, I have voiced my concerns with the inadequacies of Basel III and have advocated for a stronger leverage ratio over the past year in hopes of creating a capital program that serves the broader economy. My divided vote today signals my continued concern for what is left undone. I remain fully committed to engaging with my colleagues to strengthen U.S. capital standards and to ensure that promised improvements are realized.

Capitalization ratios for GSIBs: http://www.fdic.gov/about/learn/board/hoenig/capitalizationratios.pdf - PDF (PDF Help)