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SOVEREIGN BANK
November 3, 2003
Ms. Jennifer J. Johnson,
Secretary
Board of Governors of the Federal Reserve System
Twentieth Street and Constitution Avenue, NW
Washington, DC 20551
Attention: Docket No. R-1154
Office of the Comptroller of the Currency
250 E Street, SW
Public Information Room,
Mail Stop 1-5
Washington D.C. 20219
Attention: Docket No. 03-14
Regulations Comments
Chief Counsel's Office
Office of Thrift Supervision
1700 G Street, NW
Washington, DC 20552
Attention: No. 2003-27
Robert E. Feldman,
Executive Secretary
Federal Deposit Insurance Corporation
550 17th Street, NW
Washington, DC 20429
Attention: Comments
Re: No. 2003-27 - Advanced Notice of Proposed Rulemaking - New
Basel Capital Accord
No. 2003-28 - Draft Supervisory Guidance - New Basel Capital Accord
CEO Memorandum #177 - Basel Capital Accord
Dear Sir or Madam:
Sovereign Bank is pleased to submit this letter presenting our
comments related to the New Basel Capital Accord (Basel II). Listed
below are our comments on the Advanced Notice of Proposed Rulemaking (ANPR)
and the Draft Supervisory Guidance, which were published in the Federal
Register on August 4, 2003. Additionally, we have provided comments on
the five questions posed by the Office of Thrift Supervision (OTS) in
the CEO letter # 177 published on July 11, 2003.
Sovereign Bank is one of the 25 largest banking organizations in the
United States, with assets of more than $41 billion at September 30,
2003. Sovereign has over 530 community banking offices, and more than
8,000 team members in Connecticut, Massachusetts, New Hampshire, New
Jersey, New York, Pennsylvania, and Rhode Island.
Our responses to these publications are detailed below in three
parts:
• Comments on the Advanced Notice of Proposed Rulemaking
• Comments on the Draft Supervisory Guidance
• Comments on the OTS CEO Memorandum #177
Our comments for each of these documents are preliminary in nature,
and do not yet reflect our final positions as we are still in the
process of assessing the impact of Basel II on Sovereign Bank.
Advanced Notice of Proposed Rulemakinq (ANPR) (No. 2003-27)
Comments on the Advanced Approaches
We believe that the implementation of Basel II in the United States
will be a significant undertaking for financial institutions as well as
the regulatory agencies (the Agencies). We support the Agencies' efforts
in proposing the Basel II rules, and appreciate the opportunity to
comment. Additionally, we believe that the US implementation proposed in
the ANPR and Draft Supervisory guidance is well conceived and thorough.
However, we believe, as discussed further below, the requirements for
Core and Opt-In banks are too restrictive.
• Mandatory Application of Advanced Internal Ratings Based (A-IRB)
Approach - Generally, we agree with the Agencies' emphasis on the A-IRB
approach as the most thorough methodology for calculating a capital
charge for credit risk. The ANPR indicates that the A-IRB should be
implemented at the same time across all material portfolios, business
lines, and geographic regions. The proposed rules also indicate that the
Agencies will allow, with supervisory approval, exemptions from the A-IRB
for exposures in non-significant business units and asset classes that
are immaterial in terms of size and perceived risk. However, it appears
based on the commentary in the ANPR, that the Agencies view deviations
from the advanced approach will be the exception rather than the rule.
We think the expectation that institutions can apply the A-IRS to all
material portfolios is too restrictive.
Most banking organizations hold certain portfolios of seasoned loans,
which do not have sufficient data to apply the A-IRB. While these
portfolios have sufficient data to manage them under current systems and
procedures, they lack the detailed information necessary to apply the
enhanced risk management techniques necessary for the A-IRB. These
portfolios are commonly held by US banking organizations and may have
maturities that extend well beyond the proposed implementation date of
January 2007.
Another impediment to applying the A-IRB approach uniformly will be
non-compliant information systems. There are many loan application
systems which may not be Basel II compliant by the January 2007
implementation. Likewise, loan servicers will also need to be Basel II compliant. The
servicers will have to provide the supporting information
to calculate capital under the new rules. Accordingly, banking
organizations which adopt Basel II will have to convert to information
systems or servicers which are Basel II compliant, or exclude those
portfolios housed on the non-compliant systems or servicers from the
application of the A-IRB approach.
Therefore, we strongly suggest that the Agencies consider additional
flexibility in applying the A-IRB. The ANPR suggests that any exemptions
from the A-IRB would revert back to the appropriate risk weight category
under the old capital rules, and thus lose any benefits obtained through
the new risk sensitive calculation. However, we believe that the
Agencies should consider other alternatives to the A-IRB. The
international version of the accord allows for the use of the Foundation
Internal Ratings Based Approach (F-IRB), and the Basic Indicator
Approach (Basic). We suggest that the Agencies reconsider the F-IRB and
the Basic approaches for use by US banking organizations. In doing so,
banking organizations can choose the method that matches the level of
sophistication of the information system or data availability for the
various portfolios which they hold.
Furthermore, we would acknowledge that allowing options other than
the A-IRB model necessarily places additional responsibilities on
banking organizations. It will be incumbent on management to demonstrate
to its Board of Directors and the Agencies that deviations in
application of the A-IRB approach are appropriate. This can only be
accomplished by development of an integrated capital assessment process
coupled with a comprehensive program to continually evaluate, monitor,
and report risk data and loss information.
The Agencies have invited comment on what thresholds might be
appropriate for determining whether a portfolio, business line, or
geographic region is material enough to require the A-IRS method. As
described above, we believe that there will be significant portfolios,
which will not allow for the use of the A-IRB method. Consequently, we
have suggested more flexibility in applying the different methods for
calculating credit risk and operational risk within Basel II.
In addition, we believe that a threshold for not applying any of the
Basel II methods (and thus defaulting to the existing capital rules) is
also warranted. Accordingly, we believe that for Sovereign Bank, the
costs would exceed the benefits of applying any of the Basel II methods
to portfolios less than $250 million. This number represents
approximately 1% of our loans outstanding at September 30, 2003.
Comments on a Bifurcated Capital Framework
The proposed rules anticipate a bifurcated capital framework. We
believe that this would be a significant change to the US banking
system, and believe that it would be preferable to have a single risk
based capital framework. Our detailed comments are as follows:
Bifurcated Capital Framework - In the ANPR, the agencies invite
comment on the pros and cons of a bifurcated capital framework. In
concept, we believe that it would be preferable to have a single capital
framework (See also Comments on the CEO Memorandum - Question # 2
below.)
One negative aspect of a bifurcated capital framework is that it will
make comparability of capital levels and capital adequacy among
institutions difficult. It has been suggested that Basel II institutions
may have less required capital than other banks. However, advanced
credit risk approaches and operational risks are not considered in the
existing capital standards. Consequently, it is possible, that selected
institutions which compute capital under the current system will be
required to hold more capital than Basel Il institutions which have a
higher risk profile. This lack in comparability will provide a challenge
to analysts and investors. It is probable that analysts will develop
models, or other tools, in an attempt to create a capital comparability
metric. In addition, some analysts have already indicated that they may
disregard "capital savings" which may accrue from Basel II.
The US banking system has flourished under the current single capital
framework. The US implementation of the original Basel Accord in 1988,
resulted in a single framework that has had extremely positive results.
It has strengthened capital levels and fostered consistency and
coordination, not only in the United States, but internationally as
well. We believe that maintaining a single capital model in implementing
Basel II will provide the most optimal structure for institutions, as
well as their customers, investors and the banking industry as a whole.
However, it is unreasonable to assume that all institutions in the
US, in particular small community banks and thrifts, will be able to
make the investment in people, processes, and systems necessary to
implement the advanced approaches across all material portfolios
currently mandated by Basel II. As such, we believe there is a need for
an alternative to the proposed bifurcated capital framework. (See
Alternative to a Bifurcated Capital framework below)
Additionally, we would again emphasize the desire to have additional
flexibility for the Opt-In banks in applying credit risk and operational
risk methods other than the advanced approaches. More flexibility might
increase the number of banking organizations that would opt-in to Basel
II.
Alternative to a Bifurcated Capital Framework - The Agencies have
invited comment on whether changes should be made to the existing
capital rules to enhance risk sensitivity. We believe that changing the
existing capital rules might mitigate the potential disadvantage of a
bifurcated capital framework.
Changing the existing capital rules to be more risk sensitive might
bring them more in line with the new capital rules under Basel II. This
might be accomplished through giving additional capital relief for low
risk assets. For example, by lowering the risk weighting for mortgages
with low current LTV ratios (less than 70%) from the 50% category to the
20% category, the banking organization gets credit for the lower loss
given default (LGD). Another example would be to allow a lower risk
weighting for high quality auto loans with high FICO scores. The risk
weighting for auto loans, which have a FICO score above a certain
threshold, could be lowered from the 100% category to the 50% category.
Changes like these would allow the General Banks to also benefit from
a capital framework that is more risk sensitive. If the Agencies pursue
this avenue, we would suggest that any adjusted capital framework be
submitted for public comment.
Modifying the existing capital rules should narrow the differences
between Basel II institutions and the banks which remain subject to the
1988 Basel Accord. Since the new rules are based upon a very
sophisticated calculation, simple conventions applied to the old rules
will never duplicate the same capital charges as those calculated under
the A-IRB. However, if there must be a bifurcated capital framework, any
attempt to mitigate the differences between the two methods would be
beneficial.
(For more on this topic, see Comments on the OTS CEO Memorandum
(Question #2) below)
Comments regarding Opt-In Banks
• Which Banks Would "Opt-In" to Basel II - The Agencies have invited
comment on whether institutions would be compelled for competitive
reasons to opt-in to Basel II. Since Sovereign is considering
“opting-in” we believe our comments in this area to be relevant. Based
upon our analysis to date, there may be competitive advantages for most
banking organizations which adopt Basel II.
A potential significant benefit of adopting Basel II would be a lower
capital requirement If an organization has reduced its required capital
from the implementation of Basel II, that capital can be invested in
other earning assets. The reinvested capital may increase earnings per
share and return on equity. (It should be noted that the ability to
reinvest Basel II capital savings is contingent upon the target capital
ratios for 'well-capitalized" institutions to remain the same.)
Another potential significant advantage of adopting Basel II is the
expected improvement in risk management practices. Although we realize
that organizations can implement these practices without "opting-in" to
Basel II, we believe that Basel II can act as a catalyst to accelerate
the evolution of a comprehensive risk management program for an
institution. The risk management program required by Basel II will
create significant value to an organization in terms of reduced losses,
a stronger internal control environment, operational efficiencies, and
improved deployment of capital.
Finally, another possible benefit will be the perception of the
markets. The more sophisticated credit risk and operational risk
management techniques associated with Basel II should give an additional
measure of perceived safety from the perspectives of stockholders,
investors, analysts, and customers.
There are many possible competitive benefits. However, these benefits
come at the cost of enhancing the credit risk and operational risk
processes and systems. Accordingly, the decision to Opt-in, like many
strategies employed by businesses, becomes one of a cost benefit
analysis. If the benefits of Basel II out weigh the costs, an
institution would "opt-in." At Sovereign Bank, we are continuing our
analysis of the costs and benefits of adoption.
See also our Comments on the OTS CEO Memorandum (See Question # 1 below)
Comments on the Advanced Internal Ratings Based (A-IRB) Approach
We have reviewed the formulas for the calculation of the capital
requirements under the A-IRB approach as they are described in the ANPR.
Based on our review, we have noted the following concerns with
parameters and assumptions used in these formulas:
• Retail - Mortgage - The Asset Value Correlation ratio (AVC) is set
too high at 15% for this category, which includes both first and
subsequent lien loans (including home equity lines) secured by 1-4
family residences. This level is 1.5 times the industry median. Also,
the Loss given default (LGD) floor of 10% is inappropriate for loans
with low loan-to-value (LTV) ratios. This may unduly penalize
institutions with seasoned residential mortgage portfolios. The Agencies
should also note that, in the United States, the process of title
tracking and recording of property data is superior to that of other
nations. This fact, coupled with the industry standard of obtaining
credit reports, credit risk weightings, such as FICO scores, title
insurance, and hazard insurance makes loss, due to reasons other than
borrower default, relatively negligible. Secondly, many subordinate lien
mortgage loans are in fact first lien position. Based on these factors,
we believe the higher AVC ratios proposed will inappropriately penalize
many institutions.
• Retail - Qualifying Revolving Exposures (ORE) - This category
includes credit cards and overdraft lines. We believe the AVC ratios for
the QRE loans are also set too high. The top ends of the range at 11 %
and 17% are in excess of industry norms. We urge the Agencies to
reconsider these parameters. Also, we look forward to an updated
proposal which eliminates the expected loss component of the QRE
formula.
• Retail - Other Retail (Installment) - We are concerned with one of
the basic assumptions in this category which includes auto loans,
student loans, consumer installment loans (other than home equity), and
some SME loans. The ANPR describes the inverse relationship between the
AVC and the Probability of Default (PD). Under this assumption, high
quality auto loans will have higher capital charge due to the low AVC.
We
believe that this assumption will unfairly penalize institutions with
high quality auto loan portfolios. Additionally, for reasons already
noted above, the United States has a more sophisticated industry in
determining credit risk compared to other industrialized nations, which
makes default other than borrower relatively negligible.
• Securitizations - We are encouraged about recent news on the BCBS
decision to drop the "supervisory formula" for calculating capital
requirements for securitized assets. We urge the Agencies to also
support simplicity in calculating the capital requirement for
securitizations.
Some of our other concerns include the capital requirements for
senior positions held by originating banks. The requirement to deduct
senior positions originated, which are in excess of K-IRB, contradicts
the treatment for senior positions purchased. We also believe banks
should be allowed to use external ratings.
• High Volatility Commercial Real Estate (HVCRE) - The ANPR has
indicated that all Acquisition, Development, and Construction (ADC)
loans should be treated as HVCRE. An exception is allowed for ADC loans
with substantial equity, or which are sufficiently pre-sold. However, we
believe that, even with this exception, the definition of HVCRE is too
broad. We believe that the residential construction component does not
belong in the HVCRE category.
Comments on Disclosure Requirements
We generally support increased disclosure that provides relevant
information to our customers, investors, analysts, regulators, and other
constituents. However, we have several essential issues that must be
considered in developing the disclosure framework for Basel II.
• A balance must be determined as to the frequency, timing, and
amount of disclosure, which considers the cost to organizations and
materiality, as well as competitive conditions in the market Disclosure
of competitive information that could damage institutions must be
avoided.
• The Agencies must make a final determination as to whether a
bifurcated capital system will exist. We would be very concerned if
there were different rules with respect to disclosure for Basel II
institutions, as compared to banking organizations which do not adopt
Basel II.
• Any disclosure requirements should consider the existing standards
under generally accepted accounting principles (GAAP), as well as
regulatory disclosures mandated by the Agencies, the Securities and
Exchange Commission, etc. We would strongly endorse harmonizing the
financial disclosures required by local GAAP, where applicable, with any
guidelines implemented under Basel II.
Draft Supervisory Guidance (No. 2003-28)
Comments on the Draft Supervisory Guidance on the A-IRB Approach for
Corporate Credit
In our Comments on the Advanced Approaches above, we noted certain
concerns regarding implementation of the A-IRB approach, which were
presented in the ANPR. The following comments are on the supervisory
expectations of an Internal Ratings Based System (IRB) which were
presented in the Draft Supervisory Guidance in the Federal Register. Our
comments cite our concerns with the Agencies' expectations of IRB
systems which Basel II institutions are required to develop.
• Ratings for IRB Systems - Sovereign Bank expects to introduce an
expanded risk rating system that increases granularity of obligor risk
ratings and introduces a facility risk rating dimension. We are
concerned that supervisory oversight of this risk rating system and its
implementation appropriately will take. into account that the rollout
would be occurring concurrent with development of the bank's IRB system.
Therefore the PD and LGD calibration and validation will not take place
until after the IRB system is in place
• Quantification of IRB System/Data Maintenance - We are concerned
with the suggested timeframes for reference data; 5 years (PD) and 7
years (LGD). There are obstacles to the availability and integrity of
loan data from prior years. When the events underlying historical data
occurred, we did not contemplate the granularity and format of data
required by Basel II. Many of our loan portfolios have been assembled
from multiple bank acquisitions. Accordingly, histories are not as
neatly or easily obtained. We believe that the obstacles we anticipate
in obtaining the suggested data will also be experienced by other banks.
For certain wholesale portfolios, the PD sample requirement for 5 years
of data does not satisfy the additional requirement that the reference
data set must include periods of economic stress where default rates
were relatively high. For instance, CRE portfolios in our markets have
not experienced high default stress for over 10 years.
• Control and Oversight Mechanisms - Implementing the IRB System
places an increased burden and related costs on the governance and
oversight resources of the bank. Just as the bank must develop andlor
acquire the staffing expertise and technology to satisfy the standards
of an acceptable IRB system, the oversight functions of the bank,
including loan review, internal audit, and the board of directors, must
also invest in developing the expertise to handle oversight and control
of this new activity.
Comments on the Draft Supervisory Guidance on the AMA for
Operational Risk
Implementation
The framework for the AMA presented in the Draft Supervisory
guidance, as well as guidance provided by the Bank of International
Settlements (BIS), provides a general structure for developing an
operational risk system. However, many aspects of the framework require
more specific guidance.
We believe that the requirement that Core Banks and Opt-In Banks use
only the AMA approach is too restrictive. We suggest that the Agencies
consider allowing use of the Basic and Standard approaches until such a
time that the AMA has been more dearly defined and codified. We believe
it should be desirable to migrate towards utilization of the most
advanced approaches. Organizations should have a documented plan in
place to migrate toward the AMA method over a defined period.
Advanced Management Approach
The main impediment with applying the AMA is that a significant
amount of relevant data and a thorough understanding of that data are
required to produce sound quantitative results. The proposed legislation
requires precision and validation, even though the modeling of
operational risks is not a mature practice. The following are certain
concerns regarding application of the AMA approach:
• For most banks, current operating risk data will not be sufficient
for sound modeling. As such, more detailed data accumulation techniques
and systems will be required to implement the AMA.
• Each type of operational risks may have its own loss distribution
subject to business area and risk management practices. Other concerns
on loss distributions include the following:
We believe that the 99.9% confidence limit results in overstating the
capital need when summed across individual Operational Risk
distributions. The ANPR provides for a correlation adjustment; however,
most institutions will not have the data necessary to substantiate the
actual correlation. This may suggest lowering the requirement until
institutions can gain some experience with outside sources that provide
this kind of correlation data and/or simulations addressing all
significant Operational Risk simultaneously.
External data may be useful; however, "scaling" it to your own bank
requires significant judgment. The configuration of your operations and
application of best practices will be lost. More time, research, and
general education is needed.
Loss data and distributions are constrained by each banks own
practices, judgments, and risk appetite. Coming to the 'right'
conclusion requires thoughtful analysis.
• Banking organizations will require more specific guidance in
applying limits, mitigates, and qualitative factors. It would be helpful
if industry data were available. This is not just a concern of US
banking organizations, but a global issue if we expect fair comparisons.
• Early versions of operational risk management software are not
mature yet. Even if the new software has appropriate analytics, the
amount and quality of the data may produce widely varying results.
Fitting heavy tailed distributions and extreme value theory calculations
can produce widely varying capital needs from year to year when based on
small amounts of data even though the calculations can be made.1
• The 20% cap for insurance as a mitigate seems arbitrary. We are
concerned that this will eventually be used as a bright-line for other
mitigates.
• Some guidance should be given as to the relationship among 99.9%
confidence limit, scenarios for testing, and a catastrophe (level where
capital relief is impossible).
In summary, we believe there is extensive work remaining at the
individual bank level, and the Agencies with respect to data, scenario
analysis, and the overall framework of AMA. We would like to see the
Agencies propose progress incentives by allowing a sequence of capital
estimation methods leading ultimately to AMA. We believe that this
approach would provide a larger population of institutions a substantial
incentive to implement more sophisticated operational risk management
practices, which in turn will promote improved safety and soundness in
the industry.
Comments on OTS CEO Memorandum #177
CEO Memorandum #177 listed five questions which thrift institutions
should consider in conjunction with their comments on the proposed Basel
legislation. These questions are listed below along with Sovereign's
comments:
1.) Would Basel II present a general disadvantage to your
organization? - Sovereign Bank does not meet thresholds to be considered
a 'core" bank. However, we are currently evaluating whether to "opt-in"
to Basel II. We find the opportunity to evaluate this option challenging
and are currently weighing the advantages and disadvantages of adopting
the new capital accord.
Based upon the results of the Quantitative Impact Study (QIS), it
appears that the implementation of Basel II may result in a net
reduction of capital required for certain institutions. This can be seen
in the QIS summary, which showed that the average US institution reduced
their capital requirement by a net factor of 2%. This is an average,
however, and includes banking organizations in which capital
requirements increased, as well as those which experienced a decreased
requirement. Since the new capital rules are more risk sensitive than
the 1988 accord, institutions which have predominantly high risk assets
(as defined by the new accord), will see their capital requirements
increase, while institutions with low risk portfolios will see capital
requirements decrease. Therefore, the advantage of Basel II
implementation would be expected to accrue to those institutions with
low risk portfolios.
Another noteworthy benefit of Basel II is that the requirements will
raise the standards significantly for credit and operational risk
management The organizations which adopt Basel II will have dearly
defined objectives for improving their risk management practices and
internal control environment. We do believe that implementation of
enhanced risk management practices, which are integral elements of Basel
II would provide an advantage. Sovereign has implemented certain risk
management processes and systems and will continue to enhance its
overall risk management and internal control environment regardless of
its final decision as to whether it will "opt-in" to Basel II.
Accordingly, we believe that Basel II does not present a general
disadvantage to our organization.
2.) Should a single risk-based system be devised for all institutions?
We
understand it is expected that there will be 10 institutions which would
be required to adopt Basel II as "core" banks, and possibly another 10
which would voluntarily 'opt-in." The result will be a bifurcated
capital framework, with approximately 20 institutions utilizing Basel II
capital rules, while the remaining banks and thrifts (approximately
9,300 institutions) will continue to apply the existing capital
framework.
This environment is in contrast with the single risk-based system
that currently exists. This current capital framework has created a
level playing field under which most US banking organizations have
thrived. The single capital framework has created a common capital
metric that does not give an advantage to selected institutions. This
level playing field allows institutions of various sizes and profiles to
compete for customers. The result of that competition being high
quality, low price banking products. Accordingly, we believe that a
single capital framework is preferable.
The potential implications the new rules to create a bifurcated
capital system are significant and should be addressed thoroughly, and
with the utmost care. We believe that the OTS, as well as the other US
regulators, should single out this issue as a critical one, and develop
consensus that has broad support of all constituents. We look forward to
participating in this process
in tandem with the Agencies.
(See also Comments on a Bifurcated Capital Framework above)
3.) Would Basel II create pricing advantages for certain
institutions? - We believe that Basel II may create pricing advantages
in some circumstances.
In most institutions, the cost of capital is a consideration in the
pricing of a loan. Since Basel II will give more favorable capital
treatment to low risk loans, it is possible that these savings may be
passed on to the customer in the price of the loan. Conversely, under
Basel II banking organizations which hold higher risk loans will not
yield capital savings and, consequently, will probably not reflect any
reduction of price. It seems to follow that Basel II might create a
greater price spread between low risk and high risk loans.
In summary, it is probable that there will be pricing advantages for
Basel II institutions which realize a capital savings. However, we do
not think that this result will be inappropriate. There are already
pricing discrepancies under the current capital framework, which may
arise from different reasons such best practices in pricing, highly
capitalized institutions, and geographic or regional trends.
Accordingly, we believe that the pricing advantages realized from Basel
II will not be significant and will not adversely affect the US banking
industry.
4.) Would Basel II promote further industry consolidation? - We do
not believe that Basel II, by itself will be a major impetus to cause a
wave of consolidations. However, we do believe that Basel II will become
a new criterion to add to the many decision points involved in
acquisition decisions.
If the proposed bifurcated capital framework comes to fruition, Core
and Opt-In banks may see the potential capital savings embedded in an
acquisition target. As such, there may be opportunity to arbitrage the
different capital methods. For example, a smaller institution, which is
under the old rules, may have some capital savings embedded in its
portfolio that a larger institution could take advantage of if the new
capital rules were applied to those assets as a result of an
acquisition.
In summary, we believe that Basel II, in itself, will not be a
significant cause of industry consolidation. However, the potential to
realize embedded capital savings might be a contributing factor in
evaluating a target.
5.) Would Basel II require the agencies to consider changes to the
Prompt Corrective Action leverage ratio requirements? - The prompt corrective action ratios (PCA) were designed by FDICIA and FIRREA
to serve as a trigger for supervisory action. As such, these ratios
serve as benchmark for safety under the Basel accord of 1988. These
ratios, which were calculated under the existing capital rules, included
a minimum total risk based capital ratio of 8%. This target was set
considering the existing regulatory capital framework, which is not as
risk sensitive as the new rules. The question above considers whether
the 8% target can also be applied to the new Basel II capital framework
which is risk sensitive.
Since the Basel II capital calculation is risk sensitive, banking
organizations which invest in predominantly lower risk assets should see
an improvement in their capital ratios. Conversely, those institutions,
which have invested in predominantly higher risk assets, will see a
reduction in their capital ratios under the new risk sensitive rules.
Therefore, the new capital rules will emphasize the safety of low risk
institutions, while highlighting the risks of problem institutions.
Based on these ideas, we believe that the PCA ratios do not have to
be changed. We must assume that the original PCA target of 8% was set
with a buffer to reflect the differing risk levels not considered in the
old capital rules. Accordingly, the new capital rules may result in a
higher capital ratio, however, the risks have been reflected in that new
ratio.
Recent Developments
We have been pleased with the recent statements from the Basel
Committee on Banking Supervision (BCBS). We are in agreement with the
dropping of the requirement to provide capital for expected losses. We
are also pleased to see BCBS shifting to a simpler and less prescriptive
approach. We hope the US Agencies will harmonize the US implementation
with the new positions of the BCBS.
Conclusion
We again would like to extend our appreciation to the Agencies in
providing this forum under which we could share our comments on the New
Basel Capital Accord. We are very supportive of creating a more risk
sensitive capital framework. We believe that this will provide
institutions with incentive to expand advanced risk management
practices. These practices will improve organizational profitability and
efficiency as well as contribute to overall improved safety and
soundness of the industry.
The possible advantages, disadvantages, and consequences of the new
rules should be evaluated extensively with input from all constituents.
In particular, we would encourage in depth analysis of the potential
effect of a bifurcated capital framework. In addition, we believe it
would be very beneficial to consider the implications of using a broader
approach to measuring credit risk and operational risk in the proposed
capital framework.
Sincerely,
James D. Hogan, CPA
Executive Vice President
Sovereign Bank
Chief
Financial Officer
Sovereign Bancorp, Inc.
1130 Berkshire Boulevard
Wyomissing, PA 19610
Dennis S. Mario, CPA
Chief Risk Management Officer
Robert Rose
Chief Credit Officer
Larwrence E. McAlee Jr., CPA
Chief Accounting Officer
Robert L. Crane, CPA
Director of Regulatory Reporting
CC: OTS Northeast Regional Office
1 See Modeling, Measuring and Hedging Operational Risk- by M. Cruz
pages 277 - 281.
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