Federal Deposit
Insurance Corporation

22 October, 2003

Anne Cools
Review of Capital Requirements
DG Internal Market
Unit F2 Banking and Financial Conglomerates
European Commission
B-1049 Brussels
Belgium

Ladies and Gentlemen:

Re: Review of Capital Requirements for Banks and Investment Firms Commission Services' Third
      Consultation Paper

MBNA Europe Bank Limited ("MBNA Europe") thanks the European Commission (the "Commission") for the opportunity to comment on the Third Consultation Paper ("CAD 3"). MBNA Europe is a bank authorised and supervised in the United Kingdom by the Financial Services Authority, specialising in the issuance of bank credit cards in the Visa and MasterCard systems, with branches in Spain and the Republic of Ireland. MBNA Europe is currently the third largest issuer of bank credit cards in the United Kingdom, with total accounts of 7.1 million and total managed loans of £9.4 billion. MBNA Europe is a wholly owned subsidiary of MBNA America Bank, N.A. ("MBNA America"), the principal operating subsidiary of MBNA Corporation.

MBNA Corporation is the largest independent credit card issuer in the world. At 30 September, 2003 the Corporation reported assets net of securitisations totalling $58.7 billion. MBNA Corporation's managed assets, including securitised loans were approximately $141.1 billion as of 30 September, 2003. The Office of the Comptroller of the Currency and the Federal Reserve Bank are the primary regulatory agencies for MBNA America and MBNA Corporation, respectively.

The views expressed in this letter and the appendix represent those of both MBNA Europe and MBNA America.

MBNA America commented in detail on Consultative Paper 3 ("CP 3") published by the Basel Committee on Banking Supervision (the "Committee") in a letter dated 31 July, 2003 to that Committee, a copy of which is attached to this letter at Appendix 1*. Given that CAD 3 is closely aligned to CP 3, it is not our intention to repeat these comments in detail. We believe that it would nonetheless be appropriate to summarise these concerns in a condensed fashion, as the same concerns apply to CAD 3. In addition, there are some unique features about CAD 3, which we comment on here for the first time.

The U.S. banking regulatory agencies have recently released an advanced notice of proposed rulemaking ("ANPR"), requesting that interested banks provide comment to the ANPR by 3 November, 2003. We will provide the Commission for its consideration with a copy of MBNA's comments on or about that date. MBNA America meets the current definition of a "core" bank included in the ANPR, and would be required to adopt the Advanced Internal Ratings Based Approach ("A-IRB") and Advanced Measurement Approach ("AMA"). However, before commenting on either CP 3 or on CAD 3, we need to caveat these comments given the Committee's announcement on 11 October, 2003 of four principal areas where significant changes to the Basel II framework are expected.¹ In its press release and the accompanying attachment, the Committee provided only a general description of how it now intends to have the new Basel Accord (the "New Accord" or "Basel II") treat expected losses ("EL") and unexpected losses ("UL"). It also invited interested parties to provide comment on these changes by 31 December, 2003. There was no discussion in the materials about how the changes should be applied or the appropriate calibration under this new construct. The Committee, the Commission and each of the supervisory authorities involved in the national rulemaking processes will need to provide additional documentation that more fully specifies this change, in order to collect meaningful additional commentary thereon and to ensure that no institution or business line is unreasonably impacted.²

The Committee offered no additional information on the three remaining areas where changes are expected. We anticipate that additional guidance will be provided that will describe the approaches the Committee proposes in these three areas.

Although we support in general the changes announced by the Committee, without additional information as to how these changes will be applied and calibrated, it is difficult for us to evaluate the proposals and provide the kind of meaningful commentary we believe these changes deserve. In fact, the scope of the proposed changes again suggests the need for an additional quantitative impact study prior to adoption of the final rules. We therefore, through this response, will not address fully the recent changes announced by the Committee and will generally limit our comments herein to the issues raised in CAD 3. We would welcome the opportunity to provide comment to the Commission once it has had the opportunity to consider the proposed changes and provide appropriate regulatory guidance on how it proposes to apply these changes, that would be most appropriately accomplished through an additional consultative process.

Commission Services' Third Consultation Paper

Implementation Timetable(s) for Basel II and CAD 3

It appears that the degree of commitment to the current timetable is diverging somewhat as between the Committee and the Commission, with the Committee acknowledging the possibility, even probability of slippage in the overall implementation timetable. The Commission ostensibly seems to remain committed to a 31 December, 2006 implementation date, even if the New Accord is not finalised until mid 2004.

As a matter of public policy, it is fundamental that the timetables for implementation of the New Accord remain in lock step on either side of the Atlantic. Significant divergence will create confusion, arbitrage opportunities and additional expense for banks such as MBNA. As a subsidiary of a "core" bank, earlier implementation of the New Accord in Europe will likely require acceleration of investment to support the New Accord throughout the group, as it would make little sense to invest in New Accord infrastructure on a territory-by-territory basis.

Comitology Process

We fully support the principle of comitology and the division of the New Accord into articles and annexes. It is however essential that any amendment of the annexes is put out for effective consultation to the banking industry and competent authorities, with sufficient time allowed for individual institutions and trade bodies to assess the impact of the proposed change and thereby comment effectively. We believe that the minimum period from publication of the initial draft of an amendment to an annex to its adoption by the Parliament should be six months. We do not believe that this runs counter to the Commissions' desire to modify e.g., "early amortisation triggers ... with relative speed if necessary" (ED ¶275).

Our assumption is that any amendments to CAD 3, whether via Parliament or comitology, will mirror amendments made by the Committee with identical effective dates.

National Discretions

We note that there are a number of areas where national discretion is permitted, one of which is particularly relevant to MBNA Europe (number of days to use in the definition of default on the retail book (ANNEX D-5, ¶ 42)). Generally, we are opposed to national discretion as these could lead to competitive distortions. Also, for an entity which has branched from one member state to another under the aegis of the Second Banking Co-ordination Directive, as MBNA Europe has done, differing definitions of default in different territories will require recalibration of EAD and LGD in those different territories. In all likelihood this will also necessitate for our institution (and most likely for all other subsidiaries and branches of "core" banks) a recalibration back to EAD and LGD values compatible with a 180 day default definition as this is the standard applied by the Federal Financial Institutions Examiners Council in the U.S. As you can appreciate, this would create significant additional cost, in our view disproportionate to any improvement in the calibration of regulatory capital.

Given that it is highly unlikely that a consensus can be reached on this specific point, we would recommend that in this instance the choice of days be at the institution's discretion, subject to home supervisor approval.

Pillar 2 - Supervisory Review

We agree with the Commission that the Supervisory Review proposals will be critical in determining the impact of the New Accord on individual banks and the industry. Initially, the Supervisory Review concept suggested that it was the responsibility of the individual bank to assess its capital needs and the supervisor would review and challenge the process, and intervene promptly where necessary by, among other remedies, being able to set higher than minimum capital standards for individual banks. We support this approach.

We are concerned that CAD 3 has deviated from the original approach, causing a blurring of the boundary between Pillar 1 and 2 which has occurred because of the introduction into Pillar 2 of elements that are intended have "teeth" and to be applied in a structured, prescriptive and quantitative manner. Rather than encouraging banks to assess the appropriateness of a largely transaction based approach to Pillar 1, Pillar 2 is increasingly forcing firms and supervisors to examine certain defined categories of risk using rigid rules.

We support the efforts of the British Bankers Association and other industry groups to develop an industry framework and would hope that the Commission gives due consideration to the industry's views.

Divergences between Basel CP 3 and CAD 3

There are a number of areas where the texts of the two documents diverge, and it is unclear to us whether these are simply the unintended consequences of splitting the text out as between articles and annexes, or whether the Commission intended a different treatment. The only divergence which we identified and which we feel is significant enough to draw to the Commission's attention relates to parallel calculation of capital requirements for institutions using the internal ratings-based approach ("IRB"). The Committee requires a parallel calculation period for one year prior to implementation (CP 3, ¶ 232), whereas the only references we could identify to parallel calculation periods in CAD 3 relate to the two-year post implementation period (Article 146.4, Transitional Provisions, capital floor requirement).

As a general point, if the Commission has not already done so, we recommend that any changes, however minor, between the two texts, be published jointly by the Commission and the Committee at key publication points.

Summary of MBNA America's Comments on Basel Consultative Paper 3

The full letter to the Committee is attached to this letter at Appendix 1. Overall, we have serious concerns about the timing, complexity, and costs of implementation, the associated regulatory burden and consistency of application across national boundaries.

Retail Credit Risk in Pillar 1

In terms of technical content, we have serious concerns about the inclusion in EAD of losses attributable to subsequent draws on the credit card, effectively requiring capital to be held against undrawn limits. This is in spite of the unconditionally cancellable nature of a credit card agreement and deployment by credit card issuers of comprehensive account management strategies built around regularly updated indicators of cardholder behaviour (e.g., monthly behaviour scores). This requirement extends even to securitised card receivables, even though beneficial interest holders are obligated to (1) fund any increase in receivable balances during the revolving period and (2) bear losses pro-rata on both receivables at inception of a transaction and arising subsequently. If the Commission insists on requiring banks to hold capital for the risk of future draws on uncommitted credit lines, the banks should be given wide latitude in determining the appropriate risk factors. The risk of future draws is not a simple, linear relationship, based on average activity within the loan portfolio.

We also have serious doubts about the qualified retail exposures ("QRE") formula:

• No empirical foundation for AVC factors, which are not consistent with our own inferred AVC observations (this is supported by studies performed by the Risk Management Association).

• Pillar 1 capital should be required for UL only.³ Revolving retail exposures are priced to cover EL so full credit should be given to future margin income if it can be demonstrated to be sufficient to cover EL.

The result of the current formulation is that we, in all likelihood, would be required to hold significantly more capital under the A-IRB approach than under the Standardised approach. We believe that the Standardised approach for QREs is more closely aligned to the economic risk than the A-IRB. Substantial recalibration of the A-IRB will be necessary to correct these major differences.

We also have serious concerns about a number of the requirements relating to securitisation, although we understand that the text relating to securitisation in both CP 3 and CAD 3 is under review and likely to change prior to 31 December, 2003.

Operational Risk

We recognise that operational risk management is an emerging risk discipline and appreciate the progress that we see in the evolution towards a balanced, risk-sensitive framework. Our concern is that the current state-of-the-art practices for operational risk measurement and modeling, however, may not have progressed sufficiently to warrant their use for a capital charge. Should a capital charge be necessary, we believe that a transition period must be established to allow sufficient time for the banking industry's operational risk measurement discipline to develop such that a sound methodology can emerge. We will work with the competent authorities and other experts in the field to develop a methodology that accurately captures the operational risks that confront our business.

Provided below are specific comments on various aspects of the Alternative Standardized Approach and the Advance Measurement Approach.

Alternative Standardised Approach (ED ¶¶ 321-324)

We welcome the decision to include the Alternative Standardised Approach in the draft Directive. However we believe that this approach should be available (subject to supervisory discretion), without the additional burden of demonstrating to competent authorities that a significant proportion of an institution's retail and/or commercial banking activities comprise loans associated with a high probability of default.

Advanced Measurement Approach (Article 110)

We appreciate the flexibility offered in the AMA that will allow for the natural evolution of industry best practices. However, as is the case for a number of the credit risk capital requirements, there are certain prescriptive aspects to the AMA (such as a cap on the insurance risk mitigation) that will undermine the development of industry best practices. We believe that the prescriptive elements of the AMA are arbitrary or are based on scant industry data that may not be reflective of industry reality or experience.

In addition we have a number of concerns about the proposed calculation and data requirements, which are listed below:

• Expected Loss Offset (ANNEX H-4, ¶ 1.2.1) - The sum of the EL and the UL will overstate capital requirements based on a bank's EL already being captured in pricing, reserving and budgeting practices. We strongly believe operational risk capital should be solely based on the UL, which is consistent with our position on credit risk capital - a position that has been recently supported by the Basel Committee. (See 11 October, 2003 Press Release, "Basel II: Significant Progress on Major Issues")

• Confidence Interval (ANNEX H-4, ¶ 1.2.1) -The risk measurement requirements assume a level of accuracy in calculating capital levels that may take many years of broad industry data to achieve. Direct calculation of specific risk results to a 99.9% confidence level, with a verifiable degree of accuracy, will not be possible for most business lines, given the available data, or will result in an extremely conservative capital charge, which would not make economic sense to the institution.

• Required Elements of Capital Calculation (ANNEX H-4, ¶¶ 1.2.2 - 1.2.5) - There should be flexibility in the requirement that banks use internal data, external data, business environment and internal control factors, and scenario analysis in calculating capital levels. We would suggest these four components be recommended as data inputs and adjustment factors for calculation of operational risk capital, but not require that all four elements be used for all loss event types/business lines.

• Internal Data (ANNEX H-4, ¶ 1.2.2) -We request flexibility insetting thresholds for data capture to some materiality standard.

• Credit vs. Operational Losses (ANNEX H-4, ¶ 1.2.2) -Verifiable segmentation of credit and operational losses in retail portfolios will prove to be very time consuming, judgmental, and may be of little value to banks.

• External Loss Data (ANNEX H-4, ¶ 1.2.3) - At some point in time external loss data may be of value to banks for those loss event categories where there are few if any data points. Until such time that the external loss data is of sufficient breadth and depth, its use for capital calculation purposes is suspect.

• Business Environment & Internal Control Factors (ANNEX H-4, ¶ 1.2.5) -We agree that assessment of the business environment and internal control factors are critical elements of assessing operational risk exposure.

• Impact of Insurance (ANNEX H-4, ¶ 2) -We strongly believe the cap of 20% on insurance mitigation is arbitrary. Banks should be allowed the flexibility to demonstrate to supervisors the extent that insurance and other forms of risk mitigation impacts their operational risk exposure and capital requirements.

Conclusion

We believe that it is essential that the New Accord be implemented in a synchronised, symmetrical fashion on a global basis. Any delay in shaping the New Accord as a result of concerns in the U.S., be it from regulators or from banks, and specifically as a result of the recent changes announced by the Committee on 11 October, 2003, should not in our view be taken by the Commission as a policy vacuum which it feels compelled to fill by pushing ahead with an unrealistic timetable.

We appreciate the opportunity to provide these comments to the Commission. If you have any questions regarding this submission or if we can provide further information, please contact Vernon Wright directly by telephone at 001 302-453-2074.

Respectfully submitted,
 

Enclosure: Appendix*

* The Appendix can be viewed in the FDIC Public Information Center, 801 17th St, NW, Washington, DC, during business hours of 8:00 am to 5:00 pm.

C:
Financial Services Authority (U.K.)
Office of the Comptroller of the Currency (U.S.)
Board of Governors of the Federal Reserve System (U.S.)
Federal Deposit Insurance Corporation (U.S.)
Office of Thrift Supervision (U.S.)
Office of the Superintendent of Financial Institutions (Canada)
Irish Financial Services Regulatory Authority
Banco de Espana
The Basel Committee on Banking Supervision, The Bank for International Settlements

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