via emailPNC
November 3, 2003
Office of the Comptroller of the Currency
250 E Street, SW
Public Information Room, Mailstop 1-5
Washington, DC 20219
Attn: 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
Attn: Docket No. R-1154
Robert E. Feldman
Executive Secretary
Attn: Comments
Federal Deposit Insurance Corporation
550 17th Street, NW
Washington, DC 20429
Regulation Comments
Chief Counsel’s Office
Office of Thrift Supervision
1700 G Street, NW
Washington, DC 20552
Attn: No. 2003-27
Re: Comments on the Advanced Notice of
Proposed Rulemaking
Ladies and Gentlemen:
The PNC Financial Services Group, Inc.
(“PNC”), Pittsburgh, Pennsylvania, is grateful for the opportunity to
comment on the Risk-Based Capital Guidelines Advanced Notice of Proposed
Rulemaking (“ANPR”) for The New Basel Capital Accord (“NBCA”). As with
the NBCA’s third consultative paper (“CP3”), the ANPR establishes
enhancements in the methodologies for measuring, validating, and
reporting risk. These changes dovetail with PNC’s commitment to being a
leading risk management institution and will instill within other
institutions a desire to reach beyond minimum requirements. With
industry feedback incorporated into the ANPR framework, a timely
convergence of supervisory requirements and best practices will be
achieved.
PNC is one of the largest diversified
financial organizations in the United States, with $72.3 billion in
total assets as of September 30, 2003. Its major businesses include
community banking, corporate banking, real estate finance, asset-based
lending, wealth management, and global fund services. PNC also engages
in business outside the United States through BlackRock, Inc., PNC’s
investment advisory subsidiary, and PFPC, PNC’s global funds servicing
subsidiary. PNC’s lead bank, PNC Bank, National Association, Pittsburgh,
Pennsylvania, has branches in Indiana, Kentucky, New Jersey, Ohio, and
Pennsylvania.
PNC is pleased to see many of the
beneficial principles outlined by CP3 retained in the ANPR. In
particular, the risk sensitive capital formulae and operational risk
provisions encourage risk management advances without mandating
industry-wide change. Furthermore, the criteria used to select mandatory
Advanced Internal Ratings-Based (“A-IRB”) approach institutions are
clear and rational. Despite these favorable aspects, there remain a
number of guidelines outside the range of industry best practice.
Modifying these per the commentary of PNC and other institutions will
bolster the ANPR’s effectiveness at ensuring capital adequacy and
competitive equity.
This letter addresses the questions posed
by the ANPR that are of relevance to PNC. Each set of ANPR
questions--reprinted in order of publication--is followed by PNC’s
response. Other concerns with ANPR guidelines that are not addressed by
these responses are discussed separately in this letter.
Responses to ANPR questions
• ANPR p. 14 questions:
What are commenters’ views on the
relative pros and cons of a bifurcated regulatory capital framework
versus a single regulatory capital framework? Would a bifurcated
approach lead to an increase in industry consolidation? Why or why not?
What are the competitive implications for community and mid-size
regional banks? Would institutions outside of the core group be
compelled for competitive reasons to opt-in to the advanced approaches?
Under what circumstances might this occur and what are the implications?
What are the competitive implications of continuing to operate under a
regulatory capital framework that is not risk sensitive?
PNC agrees with the industry view that a
bifurcated approach is required to accommodate smaller banks that do not
utilize economic capital in the same manner as larger institutions.
Smaller banks typically lack sophisticated risk quantification analytics
(e.g., a framework to analyze operational risks) required for Basel A-IRB
compliance.
Small- to medium-size banks that choose
to adopt Basel A-IRB (opt-in) would benefit from the enhanced risk
discipline and insight provided by the IRB framework. However, this
benefit would be at least partially offset by the investment in
technology and staffing required for implementation. Even operating
under A-IRB, smaller banks would still not pose competitive threats to
larger banks since pricing mechanisms would remain unchanged.
If regulatory minimum capital
requirements declined under the advanced approaches, would the dollar
amount of capital held by advanced approach banking organizations also
be expected to decline? To the extent that advanced approach
institutions have lower capital charges on certain assets, how probable
and significant are concerns that those institutions would realize
competitive benefits in terms of pricing credit, enhanced returns on
equity, and potentially higher risk-based capital ratios? To what extent
do similar effects already exist under the current general risk-based
capital rules (for example, through securitization or other techniques
that lower relative capital charges on particular assets for only some
institutions)? If they do exist now, what is the evidence of competitive
harm?
Capital held by A-IRB institutions would
not likely decline, as U.S. banks hold capital commensurate with the
risks they assume—not the minimum requirements. The level of capital
held will depend largely on the risk of bank portfolios as measured by
economic capital. This practice ensures that a buffer exists between the
regulatory minimums and what the economic capital models prescribe. The
buffer serves to absorb temporary changes in a bank’s risk profile or
regulatory requirements, thereby ensuring adequate capitalization.
Because U.S. bank pricing is more aligned
with economic capital assessments, competitive inequities will not arise
among domestic competitors. However, reductions in capital charges may
lead foreign competitors, who typically price from regulatory capital,
to reduce prices.
Apart from the approaches described in
this ANPR, are there other regulatory capital approaches that are
capable of ameliorating competitive concerns while at the same time
achieving the goal of better matching regulatory capital to economic
risks? Are there specific modifications to the proposed approaches or to
the general risk-based capital rules that the Agencies should consider?
Certain modifications to the existing
approaches will adequately address competitive concerns and help align
regulatory capital to economic risk. These modifications are described
throughout the remainder of this letter in response to specific ANPR
questions.
• ANPR p. 20 questions
Given the general principle that the
advanced approaches are expected to be implemented at the same time
across all material portfolios, business lines, and geographic regions,
to what degree should the Agencies be concerned that, for example, data
may not be available for key portfolios, business lines, or regions?
Satisfying data history requirements is
one of the preeminent challenges faced by PNC and its peers. Not only do
data gaps exist, but also certain exposure classes lack the required
length of history. The adequacy of operational risk data is also
problematic, as many institutions have only recently commenced data
collection initiatives. With slight modification and clarification to
the ANPR guidelines, most of these issues can be reconciled.
If the NBCA is to take effect January 1,
2007 then consideration should be given to shortening credit parameter
history requirements, at least for the transitional period. For example,
Basel CP3 paragraph 234 states that banks can have a minimum of two
years of data at the implementation date. ANPR guidelines do not specify
whether banks can avail themselves of any such history relief. This
provision would enable institutions to ensure that they have sufficient,
valid credit parameter data across all relevant business lines. It would
also encourage more non-mandatory banks to pursue Basel compliance.
In addition to a transitional
arrangement, the standard loss given default (“LGD”) data requirement
should be truncated from 7 to 5 years. Requiring use of older loss data
may skew LGD estimates because of changes in lending practices or
portfolio management techniques over the course of such timeframes.
Older LGD values are also more difficult to calculate because of
incomplete charge-off and recovery data. A 5-year LGD history would also
be consistent with the probability of default (“PD”) and exposure at
default (“EAD”) history requirements, which are deemed to be reasonable.
We recommend that institutions that minimally meet the timeframe
requirement or with data quality issues be addressed through Pillar II,
as referenced in the existing ANPR guidance.
Though a 5-year history requirement seems
prudent for parameter estimation, clarification on what constitutes the
5-year “profile” is needed. Specifically, what constitutes a period of
stress within a time series? Details on the nature of the stressed
period, including quantity of defaults and affected business lines,
would help institutions better focus their data collection efforts. If
stressed periods are to be utilized, it’s assumed that the capital
function will need recalibration. Otherwise, the goal of having a
framework that is capital-neutral, and which provides incentives for A-IRB
adoption, will not be met.
In reference to operational risk data, it
is unclear why the advanced management approaches (“AMA”) need to be
implemented concurrently with credit risk. The two risk domains are
functionally independent and share little in the way of assessment
framework. It is recommended that institutions be allowed to implement
the AMA within a reasonable period of time relative to their attainment
of A-IRB status. Though the transitional three-year history requirement
is beneficial, there is no provision for incorporating external data
into parameter estimation. Post-transition, some institutions may still
lack sufficient internal data to fulfill the standard five-year data
history requirement. The ability to supplement internal records with
relevant external data would greatly aid the accuracy of capital
calculations. As a substitute for the 5-year requirement, a 3-year
internal, 5-year external data history combination should be considered.
In the event that these accommodations
are made, PNC would have no objection to a simultaneous implementation
of A-IRB across material business lines (a materiality threshold of,
perhaps, 10% of Tier 1 capital would be a useful component to ensure
that institutions do not spend inordinate resources to capture smaller
exposure groups). However, in the absence of any changes it is suggested
that institutions be allowed to stagger implementation in order of those
businesses with the most complete data histories. Understandably, an
institution’s strategy would have to be clearly articulated in its Basel
implementation plan to U.S. supervisors.
Is there a need for further
transitional arrangements? Please be specific, including suggested
durations for such transitions. Do the projected dates provide an
adequate timeframe for core banks to be ready to implement the advanced
approaches? What other options should the Agencies consider?
As mentioned we would like to see further
definition of transitional data history requirements, specifically as
they relate to credit risk parameters. In addition, clarification should
be made as to the effective date for historical data. It is not clear
from ANPR guidelines whether data history requirements take effect on
the 1/1/07 implementation date or the first transition period. Given the
challenges faced in collecting valid data, it is recommended that 1/1/07
be used as the data effective date.
The Agencies seek comment on
appropriate thresholds for determining whether a portfolio, business
line, or geographic exposure would be material. Considerations should
include relative asset size, percentages of capital, and associated
levels of risk for a given portfolio, business line, or geographic
region.
Materiality thresholds for business lines
and portfolios should be established using a capital-at-risk measure,
not a benchmark based upon assets or exposure. We recommend that the
threshold for materiality be set at 10% of Tier 1 capital.
• ANPR p. 25 questions
The Agencies seek comment on the
conceptual basis of the A-IRB approach, including all of the aspects
just described. What are the advantages and disadvantages of the A-IRB
approach relative to alternatives, including those that would allow
greater flexibility to use internal models and those that would be more
cautious in incorporating statistical techniques (such as greater use of
credit ratings by external rating agencies)? The Agencies also encourage
comment on the extent to which the necessary conditions of the
conceptual justification for the A-IRB approach are reasonably met, and
if not, what adjustments or alternative approach would be warranted.
Should the A-IRB capital regime be based on a framework that allocates
capital to EL plus UL, or to UL only? Which approach would more closely
align the regulatory framework to the internal capital allocation
techniques currently used by large institutions? If the framework were
recalibrated solely to UL, modifications to the rest of the A-IRB
framework would be required. The Agencies seek commenters’ views on
issues that would arise as a result of such recalibration.
A-IRB represents a substantial
improvement over the existing capital framework and promotes closer
alignment of regulatory minimums and industry best practice. However,
additional refinement is required to ensure that guidelines represent
minimum standards and use industry-consistent definitions. These
concerns are elucidated in PNC’s responses to other ANPR questions. In
general, they relate to excessive conservativeness in parameter
estimation techniques and inconsistencies between regulatory and
industry definitions for capital and default.
• ANPR p. 29 questions
The Agencies seek comment on the
proposed definition of wholesale exposures and on the proposed inputs to
the wholesale A-IRB capital formulas. What are views on the proposed
definitions of default, PD, LGD, EAD, and M? Are there specific issues
with the standards for the quantification of PD, LGD, EAD, or M on which
the Agencies should focus?
The default definition proposed by the
ANPR requires simplification and slight modification in order to ensure
greater consistency with the industry’s definition. Simplification would
address those definitional categories not typically employed by U.S.
banks. These include the categories for sold loans, distressed
restructurings, 90-days past due, and bankruptcy. Modification of the
definition is recommended in the areas of silent defaults,
asset-based/debtor-in-possession lending, and facilities with collateral
coverage.
Simplification of the existing definition
would avoid the need for banks to employ two different risk rating
frameworks—one for internal use and another for regulatory reporting. In
the case of sold loans, institutions have found it difficult to isolate
credit-specific losses from those affected by market supply/demand,
interest rates, and liquidity. Hence, sold loans are typically not
considered when estimating a business’ PD parameter. Because distressed
restructurings are often prompted by the desire to maintain a business
relationship, a default flag is rarely assigned--even if conditions
warrant one. Finally, categories for 90-days past due and bankruptcy are
sometimes omitted from the default definition because of redundancy with
the non-accrual category. Loans that are 90-days past due are often, by
definition, in non-accrual. Similarly, a bankruptcy declaration would
typically trigger a non-accrual designation.
In addition to simplification, we
recommend that the definition be modified to better reflect actual
lending practices. First, many institutions do not consider silent
defaults since the resulting increase in PD is usually offset by a lower
average LGD. Records of historical defaults that would have been
ascribed to this category are elusive in some institutions.
Second, text should be appended to exempt
asset-based and debtor-in-possession lending from the current default
definition. These businesses have a unique operating structure
characterized by borrowers who are in, or close to, default (using the
standard corporate definition). Losses, though, are minimized through
the use of fastidious collateral monitoring. Including these customers
in the definition would add little value to parameter estimates since
the high default rate (by common standards) would be more than offset by
the negligible losses.
Even if the proposed definitions were
adopted, many institutions would be unable to modify their watchlist and
credit recovery policies within a reasonable timeframe. The cost alone
would be difficult to justify given the degree to which other Basel
initiatives are consuming human and financial resources. Streamlining
the default definition will ease the burden of identifying past defaults
and allow institutions to focus on more essential Basel work items. If
loan sales are to remain a component of default then materiality rules
need to be developed for loan size and sales discount. Otherwise, there
will be inconsistent default definitions across institutions.
As explained in PNC’s CP3 response
letter, several changes are required to align parameter estimation with
industry best practice. Generally, all parameters need not be held to a
99.9% soundness standard in conjunction with to-be-defined conservative
margins and stress test results. These conservative measures, once
combined, may result in regulatory capital exceeding economic capital
and risk influencing pricing. While a conservative margin over derived
parameter estimates may be reasonable in some instances (such as when
historical data is sparse), it cannot be so great as to compress the
buffer between institutions’ regulatory and economic capital. Currently,
any one of the prescribed “conservative margins” may engender this
result.
To address these concerns, guidelines
should specify a more modest confidence interval, perhaps 99.5%, for
portfolio-level parameters (which would effectively result in a ~99.9%
soundness standard for the entire bank). Furthermore, stress tests
should be relegated to evaluating the sensitivity of capital holdings to
worst-case events; they should not be used to set parameter estimates.
The LGD and EAD parameter estimation horizon should mimic that for PDs.
Using recession-only data to calculate LGD and EAD estimates and the
conservative 99.9% confidence interval is too punitive for the purpose
of deriving minimal capital thresholds. In short, parameter estimates
should be based purely on expectations of future performance without the
addition of conservative margin.
• ANPR p. 33 questions
If the Agencies include a SME
adjustment, are the $50 million threshold and the proposed approach to
measurement of borrower size appropriate? What standards should be
applied to the borrower size measurement (for example, frequency of
measurement, use of size buckets rather than precise measurements)? Does
the proposed borrower size adjustment add a meaningful element of risk
sensitivity sufficient to balance the costs associated with its
computation? The Agencies are interested in comments on whether it is
necessary to include an SME adjustment in the A-IRB approach. Data
supporting views is encouraged.
We believe that the rationale for the
small- to medium-sized enterprise (“SME”) adjustment is sound given the
inherently lower asset value correlation (“AVC”) of smaller firms (by
way of their greater sensitivity to idiosyncratic risk). However, we
feel that AVC, and not sales size, should be used to differentiate among
exposure classes. The AVC of SMEs is the only measure that transcends
geographic and political boundaries; measures such as sales or exposure
are not consistent.
Exposures within the SME domain could be
further differentiated by their portfolio management technique, since
this is largely indicative of the AVC. Loans managed as part of a pool
could be given capital relief that’s commensurate with the pool’s PD or
EL grade, as large pools are often subdivided by such measures. Loans
that are individually rated could benefit from a different tier of
capital relief. Overall, this methodology will enhance competitive
equity and reduce complication stemming from exposures with high sales
variability.
• ANPR p. 34 questions
The Agencies invite comment on ways to
deal with cyclicality in LGDs. How can risk sensitivity be achieved
without creating undue burden?
As previously discussed, LGDs predicated
on recessionary time spans will go beyond minimum capital requirements
and risk having regulatory capital exceed economic capital. LGDs should
instead be calculated from a through-the-cycle (“TTC”) period using
weighted average defaults. This alone provides adequate sensitivity
since the majority of default events occur during recessionary times.
Furthermore, correlations among PD, EAD, and LGD result in higher losses
for each default.
Alternately, point-in-time (“PIT”) LGDs
could be employed, rendering capital to be more of a PIT measure of
risk. This would result in an institutions’ capital buffer shrinking
during recessionary times and increasing during expansions.
Procyclicality could become an issue under this proposal, depending upon
the number of other markets adopting the PIT approach.
• ANPR p. 36 questions
The Agencies invite the submission of
empirical evidence regarding the (relative or absolute) asset
correlations characterizing portfolios of ADC loans, as well as comments
regarding the circumstances under which such loans would appropriately
be categorized as HVCRE. The Agencies also invite comment on the
appropriateness of exempting from the high-asset-correlation category
ADC loans with substantial equity or that are pre-sold or sufficiently
pre-leased. The Agencies invite comment on what standard should be used
in determining whether a property is sufficiently pre-leased when
prevailing occupancy rates are unusually low. The Agencies invite
comment on whether high-asset-correlation treatment for one- to
four-family residential construction loans is appropriate, or whether
they should be included in the low-asset-correlation category. In cases
where loans finance the construction of a subdivision or other group of
houses, some of which are pre-sold while others are not, the Agencies
invite comment regarding how the “pre-sold” exception should be
interpreted. The Agencies invite comment on the competitive impact of
treating defined classes of CRE differently. What are commenters’ views
on an alternative approach where there is only one risk weight function
for all CRE? If a single risk weight function for all CRE is considered,
what would be the appropriate asset correlation to employ?
In footnote 19 (bottom of page 33) the
ANPR states “CRE exposures are typically non-recourse exposures”. We
agree that this is consistent with data researched for prior “white
papers,” but it is not accurate in reference to bank construction loans.
We also feel that the lack of available
commercial bank data makes the statements on asset correlations more
conjecture than fact-based. From our discussions with other major real
estate lenders, the lack of default and loss data is more from lack of
observations than difficulty in gathering data. We continue to believe
that the changes in commercial real estate (“CRE”) lending, following
the 1987-1991 real estate crisis, are a significant driver for the low
observed defaults and losses.
To address cyclical LGDs, we suggest
using the emerging data on commercial property performance or value
changes to determine acceptable LGD bands by property type. Banks may
alter significant deal structures based on current market conditions;
the outlook for the property type in a particular market is a common
driving factor. Thus, these would be mutually supporting methodologies.
The supervisory slotting criteria (“SSC”)
approach does not appear to offer a better implementation solution. Bank
risk rating criteria, at least for core and opt-in banks, is much more
granular than the current slotting criteria. In addition, new credit
decisions are rarely approved in the fourth category (weak). Rather, the
core issue pertains to the change in risk rating over the life of the
project. Bank strategies in dealing with deteriorating credit situations
will also impact PD and LGD outcomes, making the regulatory task more
difficult in defining additional rating criteria.
Duration clearly adds risk to any
transaction. The table on page 35 of the ANPR indicates that the capital
assignment on a three-year, high volatility commercial real estate (“HVCRE”)
transaction (at a .05 PD) is twice that of a one-year loan. Available
bank loan market pricing will not support such a difference. This is
critical as construction loans generally have 36-month durations. We
continue to believe that in the absence of actual bank default and loss
data (including the correctness of creating an HVCRE classification),
new requirements could result in a substantial and unwarranted shift of
capital away from acquisition, developmental, and construction (“ADC”)
loans.
The issue of borrower equity as a key
risk factor for loan performance is revisited on page 35. Since 1993,
two substantial reforms--FIRREA and FDICIA--have been created that deal
with property value, loan-to-value, and borrower equity. Without an
examination of how banks determine project values and deal structures
today, their portfolio performance would indicate that this is not as
substantial an issue as it was pre-1993.
Overall, PNC believes that all real
estate should be treated with a single risk weight function and that it
be based on low asset correlation. This includes 1-4 family properties.
To do otherwise is to potentially penalize the banking industry for
risks not in evidence. As commercial banks are the primary supplier of
ADC loans in the U.S., this could have profound market implications.
Barring substantial loan pricing changes in the markets, risk-adjusted
returns on real estate would fall relative to other available bank
assets, reducing the amount of bank capital assigned to the real estate
industry.
• ANPR p. 37 questions
The Agencies are seeking comment on the
wholesale A-IRB capital formulas and the resulting capital requirements.
Would this approach provide a meaningful and appropriate increase in
risk sensitivity in the sense that the results are consistent with
alternative assessments of the credit risks associated with such
exposures or the capital needed to support them? If not, where are there
material inconsistencies? Does the proposed A-IRB maturity adjustment
appropriately address the risk differences between loans with differing
maturities?
The A-IRB capital formulas currently
provide a meaningful portrayal of risk when tested with successive PD
and LGD input grades. The maturity adjustment is similarly effective,
except in the context of under 1-year facilities. For these instances an
allowance should be offered to reflect the greater economic certainty
inherent in shorter horizons. The allowance should assume the form of a
reduced PD, holding the maturity constant at 1 year. The maturity should
not be adjusted below 1 year because mark-to-market (“MTM”) losses are
typically not incurred from pre-maturity facility closeouts.
• ANPR p. 38 questions
The Agencies are interested in comment on
whether the proposed $1 million threshold provides the appropriate
dividing line between those SME exposures that banking organizations
should be allowed to treat on a pooled basis under the retail A-IRB
framework and those SME exposures that should be rated individually and
treated under the wholesale A-IRB framework.
Consistent with our recommendation for
corporate SMEs, retail SME thresholds should also be tied to AVCs and
not measures that are inconsistent across countries. The AVCs of each
institution’s exposure groups are (presumably) sufficiently different as
to make a single threshold inappropriate. If a meaningful threshold is
to be employed, each institution should establish it from internally
calculated and validated AVCs. Institutions would review their threshold
annually by reevaluating the AVCs of the relevant exposures.
ANPR p. 42 questions
For the QRE sub-category of retail
exposures only, the Agencies are seeking comment on whether or not to
allow banking organizations to offset a portion of the AIRB capital
requirement relating to EL by demonstrating that their anticipated FMI
for this sub-category is likely to more than sufficiently cover EL over
the next year.
Although recent Basel developments appear
encouraging, capital should not be required to cover expected losses
(“EL”). This recommendation applies to Qualifying Revolving Exposures (“QRE”)
as well as all other wholesale and retail categories. Proper pricing
methodology dictates that expected future margin income (“FMI”) is
sufficient to cover expected losses and a return to capital. Banks
employ a shareholder value added (“SVA”) formula to ensure that margins
are sufficient to generate a positive SVA. By requiring capital to cover
both expected and unexpected losses, banks would effectively be double
counting expected loss provisions.
The Agencies are seeking comment on the
proposed definitions of the retail AIRB exposure category and
sub-categories. Do the proposed categories provide a reasonable balance
between the need for differential treatment to achieve risk-sensitivity
and the desire to avoid excessive complexity in the retail A-IRB
framework? What are views on the proposed approach to inclusion of SMEs
in the other retail category? The Agencies are also seeking views on the
proposed approach to defining the risk inputs for the retail A-IRB
framework. Is the proposed degree of flexibility in their calculation,
including the application of specific floors, appropriate?
Definitions for the retail A-IRB category
and input parameters are consistent with industry best practice. The
inclusion of SMEs in the “Other Retail” category seems prudent
considering the similarity of their AVCs to retail exposures. As stated
previously, any measure used as a segmentation threshold should be
consistent across countries. The proposed $1M exposure threshold would
not be as practical as a rule allowing institutions to define “Other
Retail” exposures by AVC, as proxied by management characteristics such
as whether the credit is managed individually or as a pool.
Additionally, a waiver of the 10% LGD
floor should be allowed if an institution can prove that lower LGDs have
been historically observed. Otherwise, this floor compounds the
conservative bias engendered by other IRB guidelines.
The Agencies are seeking comment on the
minimum time requirements for data history and experience with portfolio
segmentation and risk management systems: Are these time requirements
appropriate during the transition period? Describe any reasons for not
being able to meet the time requirements.
This topic is addressed on pp 4-6 of this
letter.
• ANPR p. 46 questions
The Agencies are interested in views on
whether partial recognition of FMI should be permitted in cases where
the amount of eligible FMI fails to meet the required minimum. The
Agencies also are interested in views on the level of portfolio
segmentation at which it would be appropriate to perform the FMI
calculation. Would a requirement that FMI eligibility calculations be
performed separately for each portfolio segment effectively allow FMI to
offset EL capital requirements for QREs?
Comparing expected FMI to EL does not
provide an accurate comparison of excess margin to required reserves, as
FMI projections are based on historical loss volatility. Instead, we
recommend that an SVA test be performed to ascertain whether FMI is
adequate for a particular product segment. If SVA is positive, FMI will
undoubtedly cover expected losses. Only if SVA is non-positive should
any capital be assigned to cover EL; however, this would indicate an
inherent pricing problem. The SVA test should be applied to products
across all segments, not just QREs.
• ANPR p. 48 questions
The Agencies are seeking comment on the
retail A-IRB capital formulas and the resulting capital requirements,
including the specific issues mentioned. Are there particular retail
product lines or retail activities for which the resulting A-IRB capital
requirements would not be appropriate, either because of a misalignment
with underlying risks or because of other potential consequences?
Retail product capital formulas generally
seem to be adequate. However, a maturity adjustment should be offered as
it is for other exposure classes. This would enhance retail risk
sensitivity and improve competitive equity among institutions.
• ANPR p. 49 questions
The Agencies recognize the existence of
various issues in regard to the proposed treatment of ALLL amounts in
excess of the 1.25 percent limit and are interested in views on these
subjects, as well as related issues concerning the incorporation of
expected losses in the A-IRB framework and the treatment of the ALLL
generally. Specifically, the Agencies invite comment on the domestic
competitive impact of the potential difference in the treatment of
reserves described above. The Agencies seek views on this issue,
including whether the proposed U.S. treatment has significant
competitive implications. Feedback also is sought on whether there is an
inconsistency in the treatment of general specific provisions (all of
which may be used as an offset against the EL portion of the A-IRB
capital requirement) in comparison to the treatment of the ALLL (for
which only those amounts of general reserves exceeding the 1.25 percent
limit may be used to offset the EL capital charge).
Definitions for Tier 1 capital and
economic capital require reconciliation with industry best practice.
First, the inclusion of subordinated debt in Tier 1 capital belies the
purpose of holding capital, since subordinated debt does not mitigate
the probability of insolvency. In contrast, industry equates only
tangible equity and general reserves--insolvency mitigants--to Tier 1
capital.
To ensure competitive equity across
markets and provide alignment with the industry definition, Tier 1
should be redefined to represent the entire ALLL plus tangible equity.
Furthermore, the ½ to 1 relationship between Tier 1 capital and total
capital should be replaced by an insolvency probability (confidence
interval) comparable to a low investment grade rating. Such a measure
would enable a uniform comparison across all institutions; the existing
½ to 1 ratio does not ensure that Tier 1 capital is adequate to provide
an appropriate soundness standard.
Total capital should be defined as loss
at the confidence interval (“LCI”) less EL. Moreover, it should not
include any form of subordinated debt. The EL exclusion relates to the
earlier point about having FMI cover the EL provision.
• ANPR pp 58-59 questions
Industry comment is sought on whether a
more uniform method of adjusting PD or LGD estimates should be adopted
for various types of guarantees to minimize inconsistencies in treatment
across institutions and, if so, views on what methods would best reflect
industry practices. In this regard, the Agencies would be particularly
interested in information on how banking organizations are currently
treating various forms of guarantees within their economic capital
allocation systems and the methods used to adjust PD, LGD, EAD, and any
combination thereof.
PNC agrees with the industry position
that double default and double recovery effects should be allowed for
parameter estimation. Even using a conservative AVC (e.g., 75%) between
guarantor and obligor, the joint guarantor-obligor PD yields a more
realistic capital value than use of the guarantor PD alone. As long as
institutions can cite valid data to support use of the joint
guarantor-obligor PD, the adjustment should be permitted.
While we believe it is prudent to
accommodate guarantees at some level, the decision of whether to apply
them at the PD or LGD level should be left to the institution. This
latitude will better accommodate A-IRB banks’ extant risk rating systems
and lending practices.
• ANPR p. 64 questions
The Agencies encourage comment on whether
the definition of an equity exposure is sufficiently clear to allow
banking organizations to make an appropriate determination as to the
characterization of their assets.
PNC believes the current equity exposure
definition to be adequate.
Comment is sought on whether the
materiality thresholds set forth above are appropriate.
PNC believes that existing equity
materiality thresholds are appropriate.
• ANPR pp. 92 and 97 questions
Does the broad structure that the
Agencies have outlined incorporate all the key elements that should be
factored into the operational risk framework for regulatory capital? If
not, what other issues should be addressed? Are any elements included
not directly relevant for operational risk measurement or management?
The Agencies have not included indirect losses (for example, opportunity
costs) in the definition of operational risk against which institutions
would have to hold capital; because such losses can be substantial,
should they be included in the definition of operational risk?
The Agencies seek comment on the
reasonableness of the criteria for recognition of risk mitigants in
reducing an institution’s operational risk exposure. In particular, do
the criteria allow for recognition of common insurance policies? If not,
what criteria are most binding against current insurance products? Other
than insurance, are there additional risk mitigation products that
should be considered for operational risk?
We believe that the inclusion of an
operational risk capital assignment is prudent, given the industry’s
historical losses in this domain. Furthermore, we appreciate the
latitude provided for banks’ recognition of risk correlation. Overall,
however, we feel that capital calculation guidelines require less
conservatism. Clarification is also requested on several guideline
elements.
Use of a 99.9% confidence interval will
render the regulatory capital charge comparable to that of an economic
capital assessment. This could foster the same undesirable pricing
effect that conservative credit guidelines may trigger. Moreover,
limiting insurance-based risk exposure reductions to 20% is too
punitive. Insurance (or other mitigants) used to offset operational
exposures should be set at a level commensurate with historical loss
recoveries, which are higher than implied by a 20% cap.
Clarification on data source/history
requirements is required to enable banks to calculate an accurate
capital charge and identify relevant data sources. First, minimum
requirements for using external data, from the standpoint of both
stand-alone usage and application with internal data, would be useful.
This is because most banks will be partially relying on external data
until internal histories are sufficient. Therefore, it would be
desirable to know how many years of external data are required for a
given reduction in the 5-year internal data history.
Finally, banks should not have to hold
capital for indirect losses, such as opportunity costs or foregone
transactions. Because foregone transactions never enter financial
records, they do not warrant reserve or capital assignment. However,
tracking such indirect losses is practical--from a business
perspective--since it enhances operational risk analysis and loss
mitigation techniques.
• ANPR p. 95 questions
The Agencies are introducing the concept
of an operational risk management function, while emphasizing the
importance of the roles played by the board, management, lines of
business, and audit. Are the responsibilities delineated for each of
these functions sufficiently clear and would they result in a
satisfactory process for managing the operational risk framework?
The proposed responsibilities are
satisfactory.
• ANPR p. 102 questions
The Agencies seek comment on the
feasibility of such an approach to the disclosure of pertinent
information and also whether commenters have any other suggestions
regarding how best to present the required disclosures.
PNC values the importance of market
discipline and agrees that transparency of information is a crucial
vehicle for goal attainment. However, current guidelines require the
disclosure of several data types that could render institutions
vulnerable to portfolio reverse-engineering. These pertain mainly to
quantitative disclosures.
Disclosures for credit risk and prior
credit losses pose the greatest threat to data security. Specifically,
information pertaining to exposures and undrawn commitments by PD grade,
industry concentration, geographic distribution, and prior loss factors
could reveal individual customer identities. In contrast, quantitative
disclosures for capital requirement by risk type, capital structure, and
capital adequacy offer more benign—and perhaps more meaningful—portfolio
insights.
Notwithstanding confidentiality issues,
the value of prescribed quantitative disclosures is undermined by the
lack of consistent risk grading methodologies among institutions. The
lack of an external audit requirement exacerbates this by raising
concerns over data credibility. There is also the risk of having
disclosed information be misconstrued by individuals who are not
familiar with risk trends or evaluation methodologies. An example is the
publication of actual and predicted losses. The discrepancies observed
in short-term timeframes may be misinterpreted as flawed risk
measurement or incorrect inherent risk.
Comments are requested on whether the
Agencies’ description of the required formal disclosure policy is
adequate, or whether additional guidance would be useful.
The current description is adequate.
Comments are requested regarding whether
any of the information sought by the Agencies to be disclosed raises any
particular concerns regarding the disclosure of proprietary or
confidential information. If a commenter believes certain of the
required information would be proprietary or confidential, the Agencies
seek comment on why that is so and alternatives that would meet the
objectives of the required disclosure.
See response to the first set of
disclosure questions.
The Agencies also seek comment regarding
the most efficient means for institutions to meet the disclosure
requirements. Specifically, the Agencies are interested in comments
about the feasibility of requiring institutions to provide all requested
information in one location and also whether commenters have other
suggestions on how to ensure that the requested information is readily
available to market participants.
Disclosures not already contained in
regular financial reports should be provided in a comprehensive report
accessible through a dedicated public website. Such a website could be
created exclusively for Basel disclosure reporting and be maintained by
the Bank of International Settlements. It is reasonable for institutions
to reference the location of disclosures not contained in this
comprehensive report, provided that said disclosures are listed in
published financial reports.
Commentary on other ANPR guidelines
• Capital Management Policy
ANPR guidelines require a bank’s capital
management policy to be consistent with its risk rating methodology in
terms of input data. The necessity of this rule is unclear; banks employ
different methodologies for specific reasons. A bank that bases economic
capital on current economic conditions may value the need for accurate
performance measures. Simultaneously, the bank may rely upon TTC
parameter estimates for capital planning purposes. For these reasons we
recommend that a bifurcated approach be allowed.
• Commercial Mortgage-Backed Securities
(“CMBS”) Treatment
For highly rated CMBS, the A-IRB approach
requires capital charges to be no less than 56 b.p. of the investment
value. This is very conservative given that some CMBS have historical
losses averaging only 1 b.p. With the current rules based on historical
collateralized debt obligation (“CDO”) performance, the actual
volatility of CMBS is not reflected. It is recommended that highly-rated
CMBS historical data be reviewed so that the capital charge can be
better aligned with their underlying risk.
The capital charge for sub-investment
grade CMBS is higher than that of sub-investment grade corporate
obligations. The higher implied risk is not substantiated by the way
these CMBS are serviced, however. CMBS mortgage pools are maintained in
a manner that allows a special servicer to work-out or liquidate the
underlying loans. This renders their risk comparable to a bank-owned
corporate loan. Data that substantiates this risk profile is available.
PNC appreciates the opportunity to help
refine the proposals set forth in the ANPR guidelines. While these
guidelines largely achieve the goal of improved risk sensitivity and
assessment, incorporating the recommendations of PNC and other industry
members will ensure consistency with best practices and fair
competition. Please contact us with any questions related to the points
raised in this letter.
Very truly yours,
Shaheen F. Dil
Senior Vice President & Director
Risk Analytics
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