SPEAKERS CONTENTS INSERTS
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THE NEW BASEL ACCORD: IN SEARCH
OF A UNIFIED U.S. POSITION
Thursday, June 19, 2003
U.S. House of Representatives,
Subcommittee on Financial Institutions and
Consumer Credit
Committee on Financial Services,
Washington, D.C.
The Subcommittee met, pursuant to call, at 10:06 a.m., in Room 2128, Rayburn House Office Building, Hon. Spencer Bachus [Chairman of the Subcommittee] presiding.
Present: Representatives Bachus, Kelly, Toomey, Hart, Capito, Tiberi, Hensarling, Murphy, Brown-Waite, Oxley (ex officio), Sanders, Maloney, Watt, Sherman, Velazquez, Davis and Frank (ex officio).
Chairman BACHUS. [Presiding.] Good morning. The Subcommittee on Financial Institutions and Consumer Credit is convened. The Subcommittee meets to examine the proposed Basel II Capital Accord and its potential effects on the domestic and international banking systems.
The goal of Basel II is to develop a more flexible and forward-looking capital adequate framework that better reflects the risks facing banks and encourages them to make ongoing improvements to their risk assessment capabilities. The Subcommittee on Domestic and International Monetary Policy, Trade and Technology held a hearing in February to examine the proposal, where we heard from a distinguished panel of regulators, including Federal Reserve Vice Chairman Ferguson, Comptroller Hawke, Chairman Powell and a panel of private sector witnesses.
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This hearing revealed that the federal regulators did not have a unified position on the scope and merits of Basel II. Following this hearing, I along with Congresswoman Maloney, Chairman Oxley, Ranking Member Frank, introduced H.R. 2043, the United States Financial Policy Committee for Fair Capital Standards Act.
H.R. 2043 requires the federal banking regulators to develop a unified position on issues under consideration and the Basel Committee on Banking Supervision. Today, we will hear from the Federal Reserve, OCC and FDIC, along with OTS Director James Gilleran.
Our second panel of private sector witnesses includes representatives of a large bank, a financial services trade association and university professor. I look forward to hearing from today's witnesses and thank them for taking time from their busy schedules to join us.
I applaud the intent and the objectives of Basel II agreement: to ensure solvency of our banking institutions and protect against substantial losses; to create international standards to better manage risk; and align regulatory capital to economic risk.
The distinguished witnesses on our first panel are to be commended for the work they have already accomplished on this agreement. Nonetheless, I have concerns regarding Basel II on several grounds.
First, I believe it is unnecessarily complex and costly, with inflexible formulas replacing current rules and supervisory examinations. In addition, I believe that the current draft would create an uneven playing field, one that unfairly penalizes many banks in this country, particularly our regional banks.
But my main concern is about the transparency of the Basel process as a whole and specifically, how the U.S. position at the Basel Committee is determined. I know that there has been an extensive comment period. And representatives of the Federal Reserve Board assure me that the banks that would be subject to Basel II approve of it.
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Nonetheless, some of the banks have indicated to me, through their representatives, that they are in fact tremendously concerned about Basel. I understand that banks that have reservations about the U.S. position are hesitant to object openly to a regulatory agency that exercises power over them.
This concern seems reasonable to me. I believe we must arrange for a full airing of the views of all interested parties, without institutional constraint.
In addition, it has become clear to me that the bank regulators are not in agreement on the desirability of the accord as currently drafted. I am hesitant about this Congress supporting fundamental changes to our banking system in the face of a lack of consensus among thoughtful regulators.
And I note at this time that the Senate testimony yesterday by banking representatives did describe Basel II as a fundamental change in banking supervision and regulation. H.R. 2043 would require the regulators to reach agreement by establishing a procedural framework for further deliberations on Basel.
Our bill would create an interagency Committee, chaired by the Treasury Department, and include federal banking regulators. If the members cannot reach consensus on a position, the position of the Treasury would prevail.
It is important that the secretary, as part of the elected administration, set U.S. policy. Yesterday, I announced at the Exchequer Club, that the Subcommittee plans to mark up this legislation in July.
In closing, I want to thank Chairman Oxley, Ranking Member Frank and Mrs. Maloney for working with me to develop this legislation. I look forward to working with them and other members of this Subcommittee on this important issue. I also look forward to the testimony of our regulators this morning because, as I have said on two or three occasions, we are concerned that there are different opinions on Basel II and its effect on the banking institutions and our financial system as a whole.
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I now am pleased to recognize Mrs. Maloney for an opening statement. Or Mr. Frank—I am sorry. Mr. Frank has come in.
[The prepared statement of Hon. Spencer Bachus can be found on page 62 in the appendix.]
Mrs. MALONEY. I defer to the ranking member of the Committee and appreciate so much his intelligent concern on this issue and so many others. Thank you, Barney.
Chairman BACHUS. I just simply did not see that you had come in. So I apologize.
Mr. FRANK. I try to be as unobtrusive as possible, Mr. Chairman.
[Laughter.]
I appreciate your acknowledging that. I want to comment—and I appreciate your diligence in giving us a chance to be involved in this. I must say, I do get the feeling from the Federal Reserve that our interest is not entirely welcome. But that is one of the things that concerns me.
I have procedural concerns here as much as substantive. And I was pleased to hear that you plan to move on this legislation because I think we have a very big problem in the way in which we formulate policy here.
Globalization is a fact. It is probably as important in the financial markets, given the nature of money and its fungability in finance. Globalization is as powerful a force there as anywhere else.
So formulating American policy to deal with these global issues is very important. And I think we do not have a coherent process in place for formulating these.
And we began these conversations. And some financial institutions had substantive concerns, called them to my attention and the attention of some others.
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We began these discussions based on those. But my concern broadened to include the procedures because we were initially told that there was a Committee of U.S. regulators that had come up with this common position.
But it now is clear that two of the three federal agencies disagree with the position to some extent. And frankly, we were told, to some extent, by the Federal Reserve it seemed to me, that everybody was in agreement.
And then we heard from the Comptroller of the Currency and the head of the FDIC that there was not agreement. And to adapt the line from Chico Marx when he was caught at something he had denied, the question became, ''Who are we going to believe, them or our own ears?''
And I am going with my ears. And I think what we need to do is to create a structure here.
I also continue to believe that while I, along with everybody else, have not just respect but gratitude for the great work that the New York Federal Reserve Bank does in helping us manage our financial institutions, it ought never to be considered to be on a par with those institutions of the federal government which have a Presidential appointee at the head who was confirmed by the Senate.
So when we are told that there is a four-member Committee and it is the Federal Reserve Board, the New York Fed and the Comptroller of the Currency and the FDIC, I think that is not an appropriate structure. I should add that I have been concerned about some of the substance. And I will ask some questions specifically about that.
But I also believe that, given the lack of coherence in the procedures and given the disagreements that evidently exist—and they are legitimate disagreements. These are not easy questions to answer.
There is nothing wrong at all with there being legitimate differences of opinion among regulators. To some extent, they have different regulatory functions. But they also have inarturial perspectives. And these are the things that we ought to have discussed.
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But given the obvious differences that continue to exist among the responsible regulators, it seems to me an error for us to go forward with what purports to be an American government position, which does not represent not just some of the important regulators, but frankly does not seem to have a lot of support in Congress.
And as much as I respect the work that the Federal Reserve does, it is not, I think, empowered to speak for the U.S. government by itself to the extent that it seems to me to be doing in this situation. I do think that there needs to be some better working together.
Now I would assume the Fed would have a major role here, a lead role in some ways. But I think that we have gotten ahead of ourselves in purporting to have a unified position from which there is significant dissent among the relevant regulators and within the Congress and the relevant Committees.
So I appreciate this further chance to address that. And I thank you very much, Mr. Chairman, for your very diligent work in this regard.
Chairman BACHUS. Thank you. Are there other members wishing to make—Chairman Oxley? Would you like to make an opening statement?
Mr. OXLEY. Thank you, Mr. Chairman. And thank you for calling this hearing.
I think the presence of the Chairman and the ranking member of the full Committee indicate how concerned we are about the whole process and that this rarely occurs. And I do think it does point out some concerns that we have, particularly because it does appear that the regulators have different opinions on this.
Certainly, the last hearing reflected that. And subsequent events have also indicated a fissure within the regulating community here. And obviously, there are some concerns on this side of the dais as well.
I am going to ask unanimous consent that my formal statement be made a part of the record, Mr. Chairman.
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Chairman BACHUS. Without objection.
Mr. OXLEY. But only to say that I echo some of the concerns that the gentleman from Massachusetts brought up in regard to the substance, as well as the process going forward. This is a big deal. And the decisions ultimately will reflect and affect the financial system in this country for a long, long time.
And it is critical that we get it right, not just from the banking perspective, but a number of non-banking perspectives as well. I notice we have, on the second panel, some testimony from the Bond Market Association, which would indicate that there are some folks that have, perhaps, some opinions as well that are not technically in the banking community.
So this has a broad reach and a long effect, a long-term effect on our markets and our banking system. And that is why I applaud the Chairman for his diligence in this.
We thank him for scheduling a markup on the Oxley-Frank legislation. And I think it does reflect some of the very sincere concerns that many of us have.
We have a great deal of respect for Mr. Ferguson and for the Fed and for their distinguished leadership. It does appear that there is a difference of opinion on this issue. And we need to make certain that, at the end of the day, we have a unified position from this side before going forward.
And with that, I yield back the balance of my time.
[The prepared statement of Hon. Michael G. Oxley can be found on page 60 in the appendix.]
Chairman BACHUS. Thank you.
Mrs. Maloney?
Mrs. MALONEY. I thank the Chairman for holding this second hearing on the Basel II Capital Accord. For more than a year now, I have been closely following the progress of Basel II.
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I participated in the earlier hearing. And I have met with regulators and bankers. After all this discussion, I still believe there are significant issues appropriate for congressional review. As early as last August 14, I wrote the regulators about this issue. And I believe that many of my concerns expressed then are still relevant. I remain concerned about the inclusion of operational risk in Pillar 1. And most importantly, I want to know more about what the ultimate impact of the accord will be on U.S. competitiveness.
As a New Yorker, I am very aware of the contingency planning effort that financial institutions are taking for physical attacks. I want to be reassured that investments and business continuity planning, backup systems and insurance will not be reduced because institutions have to devote resources to capital charges for operational risk.
From an international competitiveness standpoint, the U.S. is fortunate that we have the opportunity today to receive testimony from probably the most sophisticated and most professional group of financial service regulators in the world. In each country where Basel II is applied, the domestic regulators will ultimately be responsible for the compliance of the in-country institutions.
Not every country has as distinguished a group of regulators as the U.S. And I fear that differing levels of application by various international regulators of such an enormously complex proposal could affect the competitiveness of our industry and have an impact on all of our constituents and our economy.
For these reasons, I am pleased to have joined Chairman Bachus, Chairman Oxley and Ranking Member Frank in introducing H.R. 2043, the United States Financial Policy Committee for Fair Capital Standards Act. This legislation takes a balanced approach to ensuring a unified U.S. position at Basel and a full study of the effects of the accord on our domestic industry.
I look forward to the markup in July. And I look forward to working with the Chairman on this proposal. And I thank him again for making it a priority of this Subcommittee.
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And as I said, I am highly, highly concerned about the impact of Basel on the competitiveness of our financial institutions, our financial system. We should not do anything that would place the United States at a disadvantage by having a higher capital standard for U.S. institutions.
I yield back.
Chairman BACHUS. Gentleman from Pennsylvania is recognized.
Mr. TOOMEY. Thank you, Mr. Chairman. I just want to briefly second the comments generally that the gentlelady from New York just made. One of my concerns is that we have the most robust, in some ways most aggressive and most effective regulatory framework for financial institutions arguably in the entire world.
We also have some of the most competitive and most successful financial institutions in the world. And I am a little bit concerned about one specific aspect of the proposed capital requirements.
And that would be that we would use a Pillar 1 approach for operational risk, which strikes me in many ways more appropriately dealt with under the Pillar 2 approach. And I am concerned that if we go with the Pillar 1 specific capital requirement, we would in fact be placing our financial institutions, extremely well regulated, extremely successful in a variety of ways, at a competitive disadvantage to other financial institutions.
So I hope we get a chance to explore that issue at this hearing today. And I thank you for conducting this hearing, Mr. Chairman.
Chairman BACHUS. Mr. Davis, do you have an opening statement? All right. Thank you.
Ms. Kelly or Mr. Hensarling? All right.
If there are no further opening statements, at this time I want to welcome our first panel of distinguished witnesses. From my left to right, they are: the Honorable Roger W. Ferguson, Jr., Vice Chairman, Board of Governors of the Federal Reserve System; the Honorable John D. Hawke, Jr., Comptroller, Office of Comptroller of the Currency; the Honorable Donald Powell, Chairman of the Federal Deposit Insurance Corporation; and the Honorable James E. Gilleran, Director, Office of Thrift Supervision.
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I would like to commend you gentlemen on your work to date on the Basel Agreement, Basel II, and for the attention you have paid to this issue. I think there have already been positive changes in the U.S. position. We applaud those.
I note from your testimony today, Vice Chairman, that you indicated further movement on the real estate issue, and I commend you for that.
At this time, we will start with Vice Chairman Ferguson. We welcome your testimony. You will not be limited by the 5-minute rule. And I am sorry that some of you may not have received that message earlier. I apologize for that.
STATEMENT OF HON. ROGER W. FERGUSON, JR., VICE CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. FERGUSON. Chairman Bachus, members of the Subcommittee on Financial Institutions and Consumer Credit, Chairman Oxley, Ranking Member Frank, thank you for inviting me to testify on behalf of the Federal Reserve Board on Basel II and H.R. 2043.
I will be brief. But I ask that my entire statement be included in the record.
The development of Basel II over the past 5 years has been transparent and has been supported by a large number of public papers and documents on the concepts, framework and options, as well as by a large number of meetings with bankers. Over the past 18 months, I have chaired a series of meetings with bankers, often jointly with Comptroller Hawke.
The banking agencies last month held three regional meetings with banks that would not, under the U.S. proposal, be required to adopt Basel II, but may have an interest in choosing to do so. The comment period for the third Basel consultative paper, sometimes called CP-3, is now in progress.
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And in about a month, the banking agencies in this country hope to release an advance notice of proposed rulemaking, so-called ANPR, that will outline and seek comment on specific proposals for the application of Basel II in this country. We continue to be open-minded about new suggestions, backed by evidence and analysis, and approaches that simplify the proposal, but still attain its objectives.
When the comments on CP-3 and ANPR have been received, the agencies will review them and meet to discuss whether change are required in the Basel II proposal. In November, we have scheduled to meet in Basel to negotiate our remaining differences.
Realistically, this part of the schedule may be too tight because it may not provide U.S. negotiators with sufficient time to digest the comments on the ANPR and develop a national position to present to our negotiating partners. Some slippage in the schedule will no doubt occur.
Implementation in this country of any final agreement on Basel II would require a notice of proposed rulemaking, an NPR, in this country in 2004 and, of course, a review of comments from that notice of proposed rulemaking. Additional quantitative impact studies starting in 2004, and probably conducted for the next 2 years, will also be necessary so we can be more certain of the impact of the proposed changes on individual banks and the banking system.
As it stands now, by the fall of 2004, core and opt-in banks will be asked to develop an action plan leading up to final implementation. Whenever a final rule is developed, in 2004 or in 2005, there would be at least a 2-year lag before implementation.
Within that implementation interval, the large banks to which Basel II will be applied in this country will be developing their individual bank implementation work plans in conjunction with their supervisor. As you know, most of the banks in this country will remain under the current capital rules. No bank that will be required or chooses to adopt the new capital accord would be forced into a regime for which it is not ready.
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To be sure, supervisors will expect a formal plan with a reasonable implementation date from the latter banks once a final rule is developed. But no bank will be required to adopt Basel II if it has not yet built the required infrastructure.
At any time during that period, we can slow down the schedule or revise the rules if there is a good reason to do so.
Mr. Chairman, you have asked for the Board's views on H.R. 2043. We understand and support the bill's objective, to ensure that the people sitting at this table work together cooperatively and that all of us shape our positions, especially at Basel, with a full understanding of the likely effects of any decisions on our economy.
With respect, however, the Board believes that the current process achieves those goals and that legislation is not necessary.
Moreover, H.R. 2043 could be counterproductive. In the Board's view, the agencies have demonstrated their ability to work together, one must admit sometimes not as smoothly as perhaps others would like.
But also, we have demonstrated our ability to change our minds on the basis of evidence and persuasion, as you have indicated, Mr. Chairman, in your opening remarks. The bill would reduce our ability to negotiate with our foreign counterparts, eliminate the room for us to disagree and work out our differences and involve Congress in technical supervisory and regulatory issues that are probably better left to the supervisors.
Obviously, of course, we recognize the appropriate interest and role of Congress in aggressive oversight. And in that regard, I am obviously pleased to be here.
Let me now turn to three other issues that have been raised about the current Basel II proposal. The first is competitive equity.
While this concern takes several forms, the most frequently voiced is the view that competitive imbalances might result from what is called a bifurcated set of rules, requiring Basel II for large banks, while applying the current capital rules for all other U.S. banks.
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The fear is that the banks that remain under the current capital rules, with capital charges that are not as risk sensitive, might be at a competitive disadvantage compared to Basel II banks that would get lower capital charges on less risky assets.
We take this concern seriously and will be exploring it through the ANPR. But without prejudging the issue, there are reasons to believe that little, if any, competitive disadvantage would be brought to those banks remaining under the current capital regime.
The basic question is the role of minimum regulatory capital requirements in the determination of the price and availability of credit. Our understanding of bank pricing is that it starts with the capital allocations that the banks themselves make internally, within their own organizations, then factors in explicit recognition of the riskiness of the credit and is then further adjusted on the basis of market conditions and local competition from bank and non-bank sources.
In some markets, some banks will be relatively passive price takers. In either case, regulatory capital is mostly irrelevant in the pricing decision and therefore, unlikely to cause competitive disparities.
Moreover, most banks—and especially the smaller ones—hold capital far in excess of regulatory minimums for various reasons. Thus, changes in their own or others' minimum regulatory capital, as might occur under Basel II, probably would not have much effect on the level of capital they choose to hold and would therefore not necessarily affect either internal capital allocations or the resulting pricing.
Finally, the banks that most frequently express a fear of being disadvantaged by a bifurcated regulatory regime have for years faced capital arbitrage from larger rivals, who are able to reduce their capital charges by securitizing loans, for which the regulatory charge was too high relative to the market or economic capital charge.
The advanced versions of Basel II to be adopted here would provide, in effect, risk-sensitive capital charges for lower-risk assets that are similar to what the larger banks have, for years, already obtained through capital arbitrage. In short, competitive realities between banks might not change in many markets in which minimum regulatory capital charges would become more explicitly risk sensitive.
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Now I do not mean to dismiss competitive equity concerns. Indeed, I hope that the comments on the ANPR bring forth insights and analyses that respond directly to the issues, particularly the observations that I have just made.
But to take a different view, we need to see reasoned analysis, and not just assertions.
The second area of concern that I would like to focus on is the proposed Pillar 1 treatment of operational risk. Operational risk refers to losses from failures of systems, controls or people.
Capital charges for such risks have been implicit under Basel I for the last 15 years. These risks will, for the first time, be explicitly subject to capital charges under the Basel II proposal. Operational disruptions have caused banks to suffer huge losses and, in some cases, failures—both here and abroad. My written testimony provides some recent and familiar examples.
In an increasingly technologically-driven banking system, operational risks have become an even larger share of total risk. At some banks, they are indeed the dominant risk.
To avoid addressing them would be imprudent and would leave a considerable gap in our regulatory system. The Advanced Measurement Approach—or the so-called AMA approach—which I am sure we will discuss further, for determining capital charges and operational risk, is a principles-based approach that would obligate banks to evaluate their own operational risks in a structured but flexible way.
Importantly, a bank could reduce its operational risk charge by adopting procedures, systems and controls that reduce its risk or by shifting the risk to others through measures such as insurance. Some banks, for which operational risk is the dominant risk, oppose an explicit capital charge and would prefer the operational risk be handled case by case through the supervisory review of buffer capital under Pillar 2 of the Basel II proposal, rather than being subject to an explicit regulatory capital charge under Pillar 1.
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The Federal Reserve believes that would be a mistake because it would greatly reduce the transparency of risk and capital that is such an important part of Basel II. It would lessen potential market discipline and would make it very difficult to treat risk comparably across banks because Pillar 2 is judgmentally based.
The third concern I would like to discuss is the fear that the combination of credit and operational risk capital charges for those U.S. banks that are under Basel II would decline too much for prudent supervisory purposes. Speaking for the Federal Reserve Board, let me undermine that we could not support a final Basel II that caused capital to decline to unsafe and unsound levels at the largest banks.
There will be several stages before final implementation, at which resulting capital levels can and will be evaluated. At any of those stages, if the evidence suggests that the capital were declining too much, the Federal Reserve would insist that Basel II be adjusted or recalibrated, regardless of the difficulties with bankers here and abroad, or with supervisors in other countries.
But let us keep this in mind: supervisors can achieve their objective of maintaining the same level of average capital in the banking industry either by requiring that each bank maintain its Basel I capital levels or by recognizing that there will be some divergence levels of capital among banks because they will be dictated by different risk profiles of the banks.
To go through the process of devising a more risk-sensitive capital framework, just to end with the Basel I result in each bank, is pointless. Greater dispersion in required capital ratios, if reflective of underlying risk, is an objective, not a problem to be overcome.
Of course, one must also recognize that capital ratios are not the sole consideration. The improved risk measurement and management and its integration into the supervisory system under Basel II are also critical to ensuring the safety and soundness of the banking system.
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Let me just say, by way of conclusion, that the Basel II framework is the product of an extensive, multi year dialogue with the banking industry, regarding evolving best practice risk management techniques in every significant area of banking activity. Accordingly, by aligning supervision and regulation with these techniques, it provides a great step forward in protecting our financial system and those of other nations to the benefit of our own citizens.
We now face three choices. We can reject Basel II or we can delay Basel II as an indirect way of sidetracking it. Or we can continue the domestic and international process, using the public comment and implementation process to make whatever changes are necessary to make Basel II work effectively and efficiently.
The first two options require staying on Basel I, which is not a viable option for our largest banks. The third option recognizes that an international capital framework is in our self interest, since our institutions are the major beneficiaries of a sound international financial system.
The Fed strongly supports the third option.
I will be happy to respond to questions. Thank you, Mr. Chairman.
[The prepared statement of Hon. Roger W. Ferguson can be found on page 82 in the appendix.]
Chairman BACHUS. I appreciate that.
Comptroller Hawke?
STATEMENT OF JOHN D. HAWKE, JR., COMPTROLLER, OFFICE OF THE COMPTROLLER OF CURRENCY
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Mr. HAWKE. Thank you, Chairman Bachus, members of the——
Chairman BACHUS. Is the microphone on?
Mr. HAWKE. It is the job of the Fed to help the OCC.
[Laughter.]
Chairman BACHUS. That was the Vice Chairman that turned your microphone on.
Mr. HAWKE. Again, I think it reflects on the fact that they have an unlimited budget and they can study things like this.
[Laughter.]
Chairman Bachus, thank you, Chairman Oxley, Ranking Member Frank and members of the Subcommittee. We appreciate the opportunity to participate in this hearing. And I very much welcome the interest and involvement of the Subcommittee in these important issues.
I want to assure the Subcommittee that the OCC, which has the sole statutory responsibility for promulgating capital regulations for national banks, will not endorse a final Basel II framework for U.S. banks until we have determined, through our domestic rulemaking process, that any changes to our capital regulations are practical, effective and in the best interests of the U.S. public and our banking system.
In response to a point that Ranking Member Frank made in his introductory remarks about who is in charge here, I think it is important to recognize that Congress has clearly allocated to each of the federal banking agencies responsibility for overseeing the capital of banks within their jurisdiction and for adopting capital regulations. The Fed has authority over bank holding companies and state member banks; the FDIC over state non-member banks; and the OCC over national banks. So it is up to each of us, in the final analysis, to make our own decision. But the need for achieving agreement among the agencies, I think, is recognized by us all.
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My written testimony provides a detailed discussion of the background and content of Basel II and the important issues with which this Subcommittee is properly concerned. I would like to use this time to make several important points that may help to put today's testimony into proper focus.
First, all of the U.S. banking agencies share a concern about the potential effect of Basel II on the capital levels of large U.S. banks. Our banking system has performed remarkably well in the difficult economic conditions in recent years, and I believe that is due, in significant part, to the strong capital position our banks have maintained. While a more risk-sensitive system of capital calculation might be expected to have the effect of reducing the capital of some banks, we would not be comfortable if the consequence of Basel II were to bring about very large decreases in required minimum capital levels.
By the same token, if Basel II were to threaten significant increases in the capital of some banks, it could undermine support for the proposal itself and might threaten the competitiveness of those banks. As things stand today, we simply do not have sufficiently reliable information on the effect of these proposals on individual institutions or on the banking industry as a whole.
Before we can make a valid assessment of whether the results are appropriate and acceptable, we have to know, to a much greater degree of reliability than we now have, just what the results of Basel II will be.
The OCC believes that significant additional quantitative impact analysis will be necessary. Even if the Basel Committee does not itself undertake such a study—and I think that would be the preferred approach—I believe it is absolutely essential that the U.S. agencies make such an assessment prior to the adoption of final implementing regulations. I strongly believe that we cannot responsibly adopt final rules implementing Basel II until we have not only determined with a high degree of reliability what the impact will be on the capital of our banks, but have made the judgment that that impact is acceptable and conducive to the maintenance of a safe and sound banking system in the United States.
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Second, a number of Subcommittee members have commented on differences among the U.S. banking agencies and are of the view that a new interagency coordinating mechanism is needed. Mr. Chairman, you and some of your colleagues have introduced H.R. 2043, a bill that would establish an interagency Committee whose purpose would be to resolve such differences. While I am sympathetic to the concerns that underlie this legislation, with great respect, I suggest that it is not necessary at this time.
There have, indeed, been some differences among the agencies during this process. But I believe the agencies have generally worked exceedingly well together on the Basel II project for the past 4 years, and I am confident that we will continue to do so. To be sure, we have not always agreed on every one of the multitude of complex issues that Basel II has presented, but that is no more than one would expect when a group of experts have brought their individual perspectives to bear on difficult and complex issues. Where there have been differences, we have worked our way through them in a highly professional and collaborative manner. In a few weeks, we will be jointly issuing an Advance Notice of Proposed Rulemaking, seeking broad comment on the Basel II structure, together with draft supervisory guidance for those of our banks that will be subject to Basel II. Both the ANPR and the guidance have been developed in a collaborative process in which each of the agencies has had substantial input.
I believe we agree on the need for further quantitative impact study before Basel II is finally put in concrete although I do not want to speak for Governor Ferguson on that.
I think it is probably correct to say that we at the OCC have had some reservations that the Fed does not share about the overall approach to Basel. For example, I commented in my earlier testimony about the complexity of Basel II. I have a concern about complexity because it seems to me that complexity could work toward competitive inequalities across countries, given the difference in the nature of supervision from country to country. Governor Ferguson, I think at the last hearing, pointed out that we live in a complex world and we are dealing with complex subjects, and complexity is a necessary consequence of this process.
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We may have some difference of perspective on time schedule. I think the Fed wants—and I do not mean to speak for the Fed—but I think the Fed wants to adhere to the current time schedule. We certainly would like to, if it is possible. But I think we may have the view, more so than others, that achieving the present time schedule is a daunting challenge.
While we had differed on operational risk at earlier stages of this process, I want to make clear that we are completely comfortable and supportive of the treatment of operational risk under the AMA approach in Pillar 1. And I would like to expand on that just for a moment because this is such an important issue for the Subcommittee.
As the Subcommittee knows, I had argued earlier in the Basel Committee that operational risk should be treated under Pillar 2 because it involved qualitative judgments about the adequacy of internal control systems. Nobody else on the Committee agreed with that. And it was very clear to me that that view would not be accepted by the Committee.
As a result, we and the Fed worked very closely together developing the Advanced Measurement Approach to operational risk. The product of that collaboration, I think, has been very productive. We are completely comfortable that the AMA approach to operational risk imports a degree of supervisory discretion and judgment of exactly the sort that would come to bear if this had been a Pillar 2 issue. Indeed, I think that if operational risk were to be treated under Pillar 2, it would be essential for us to have a framework for the consideration of operational risk that would probably look very much like what we presently have under the AMA approach. So I do not think the Pillar 1 versus Pillar 2 issue should any longer be a matter of significant concern.
Third, as I said earlier, I think we are all committed to a process that has real integrity to it. The current Basel Committee timeline presents, as I said, a daunting challenge to both the U.S. banking agencies and the banking industry. And while it is clearly necessary to address the acknowledged deficiencies in the current Basel Capital Accord, the banking agencies must better understand the full range and scale of likely consequences before finalizing any proposal.
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We have identified in our written testimony a lengthy and formidable list of critical milestones that the agencies must meet under the current Basel II timeline. They include: first, consideration by the Basel Committee itself of the comments that have been received on CP-3, its latest consultative paper. Next, the preparation and issuance by the U.S. agencies of the Advanced Notice of Proposed Rulemaking and draft supervisory guidance that goes with it, with a 90-day period for comments. At the end of that comment period, we will jointly consider those comments, analyze them, and make a judgment about the implications of those comments for the final iteration of the Basel document.
The Basel Committee is presently scheduled to meet in December, which will give us the opportunity to feed back into the Committee the results of that ANPR process. We are also going to be requesting comment in the ANPR process on the economic impact of Basel II.
Executive Order 12866 requires that we make an economic impact analysis in the case of any significant regulatory action, which is defined to mean an action that will have an annual effect on the economy of $100 million or more. We are soliciting information to enable us to determine whether that executive order will be triggered by the Basel proposal. If it is, we will conduct that economic analysis as part of this process.
After the Basel Committee issues the definitive paper, the U.S. agencies will jointly draft and put out for additional public comment the final version of the regulations that will implement Basel II. At some point during that process—earlier rather than later, I hope—we will conduct an additional quantitative impact study to determine exactly what the capital impact will be.
We will then consider all the comments that are received in the NPR process and come to a final decision as to whether we should issue the final U.S. implementing regulation and what it should look like. If we find that our current target implementation date of January 1, 2007 is simply not doable, consistent with that process—and my personal opinion is that realization of that target may be very difficult—we will take additional time. But I think it is still too early to draw that conclusion.
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The important point here is that we will take great care not to let the timeframe shape the debate. If we determine that changes to the proposal are necessary, we will make those views known to the Basel Committee. And we will not implement the accord until those changes are made.
I would like to make one more point. Some have viewed the new Basel II approach as leaving it up to the banks to determine their own minimum capital essentially, putting the fox in charge of the chicken coop. I do not think that is the case by any means.
While the banks internal models and risk assessment systems will be the starting point for the calculation of capital, bank supervisors will be heavily involved at every stage of the process. We will publish extensive guidance and standards that the banks will have to observe. There will be standards set out in the Basel documents themselves. We will not only validate the models and systems that banks propose to use, but we will assure that they are being applied with integrity.
In my view, the bank supervisory system that we have in the U.S. is unsurpassed anywhere in the world, in both its quality and in the intensity with which it is applied, and we are not going to allow Basel II to change that. In fact, if we do not believe, at the end of the day, that Basel II will enhance the quality and effectiveness of our supervision, we should have serious reservations about proceeding in this direction.
Moreover, while Basel II has largely been designed by economists and mathematicians and while these ''quants'' will play an important role in our oversight of the implementation of Basel II, the role of our traditional bank examiners will continue to be of enormous importance. Such values as asset quality, credit culture, managerial competence and the adequacy of internal controls cannot be determined by mathematical models or formulas, nor can many of the risks that banks face be properly evaluated except by the application of seasoned and expert judgment. I can assure you that those national banks covered by Basel II will continue to be closely monitored and supervised by highly qualified and experienced national bank examiners who will continue to have a full-time, on-site presence.
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I am pleased to have the opportunity to provide our views on this important initiative, I would be happy to answer any questions you may have.
[The prepared statement of Hon. John D. Hawke can be found on page 141 in the appendix.]
Chairman BACHUS. Thank you.
Chairman Powell?
STATEMENT OF DONALD POWELL, CHAIRMAN, FEDERAL DEPOSIT INSURANCE CORPORATION
Mr. POWELL. Thank you, Chairman Bachus and members of the Subcommittee for your interest in the new Basel Capital Accord. I believe that Basel II ranks among the most important pieces of proposed banking regulation in our nation's history.
The FDIC supports the goal of lining up capital regulation with the economic substance of risk that banks take. Basel II encourages a disciplined approach to risk management and it addresses important weaknesses in our current capital rules. We applaud the intense and prolonged efforts that have been made to address these important issues.
Since my testimony before the Subcommittee on Domestic and International Monetary Policy, Trade and Technology, on February 27, 2003, there has been good progress on the domestic implementation efforts. The federal banking and thrift regulatory agencies are working hard to issue an Advance Notice of Proposed Rulemaking for comment this summer. The proposed rulemaking will identify those aspects of Basel II that will be proposed for adoption in the U.S. for application to a small group of large banking organizations. At this time, we are addressing various technical issues, developing interagency guidance and conducting industry outreach.
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Specifically, we have conducted outreach sessions to banking institutions of varying size at meetings held in Chicago, Atlanta and New York. We are approaching a crossroads where judgments will need to be made on some critical issues. The interagency process and the public comment period will help us reach those judgment, and I am confident that our process will result in an appropriate outcome. My written testimony provides a broad overview of some of the critical judgments that will need to be made before the agencies commit to adopt Basel II in the United States.
The first key issue is capital adequacy. The Basel II formulas allow, at least in principal, for significant capital reductions. The proposals issued by the Basel Committee specify that after a phase-in period, there would be no floor on the level of risk-based capital that banks would be required to hold.
The level of risk-based capital that banks actually hold would depend upon their own internal estimates of risk—validated by their supervisors—and on the demands of the marketplace. It is difficult to predict the ultimate effect of Basel II on overall bank capital, but we do know that the formulas are forceful tools for affecting risk-based capital requirements.
There is no question the Basel formulas will help the regulators segregate risk. But the formulas cannot stand on their own.
Banks face other risks besides credit risk and operational risk. Lending behavior can change over time, causing losses to escalate in activities perceived as low risk.
The simple fact is that no one knows what the future holds. For these and other reasons, the FDIC believes that Basel II must be supplemented by the continued application of existing regulatory minimum leverage capital and prompt corrective action requirements. I am gratified at the support that my fellow bank regulators have expressed for this conclusion.
We also understand that a leverage ratio alone cannot provide protection without the support of sound, risk-based capital rules. It will be necessary to better understand the impact of the proposals on the capital required for specific activities. Finally, maintaining capital adequacy under Basel II would be an ongoing task. Validating banks' internal risk estimates would be a challenge. Doing so consistently across agencies would be a greater challenge, for which an interagency process would be needed.
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The other key issue is competitive equity. Basel II has been expected to provide some degree of regulatory capital relief. The banks that stand to be directly affected by Basel II have expressed strong support for such capital relief. They have expressed concern where they believe Basel II capital was too high.
The key policy question is: what economic benefits and costs would come with changes in regulatory capital requirements? Would the economic benefit of lower risk-based capital requirements for large banks enhance their competitive posture or accelerate industry consolidation?
We recognize there are differences of opinion about the importance of competitive equity issues, and that is why we need to pay close attention to the comments we receive on this issue. The agencies received a number of comments on both sides of this issue at recent industry outreach meetings, and this dialogue will continue.
With respect to proposed House legislation, the FDIC appreciates the goal of H.R. 2043, ''The United States Financial Policy Committee for Fair Capital Standards Act.'' We share in Congress's desire to ensure that uniform U.S. positions are developed and communicated to the Basel Committee. However, we do not believe that H.R. 2043 is the best means to accomplish this end. The legislation would, in effect, move the important task of capital regulation away from the agencies with decades of experience in this arena to the United States Treasury Department.
This could compromise the independence of the federal banking regulators and impair our ability to handle an important function of prudential regulation at a particularly sensitive time.
As our testimony indicates, we are working with the other regulatory agencies to develop interagency positions regarding the domestic application of Basel II. The bank regulatory agencies are actively engaged in an almost daily dialogue on issues and concerns. We will take whatever time is necessary to seek input from all interested parties prior to the final adoption of the new framework in the U.S., especially the concerns of banks that may feel they will be disadvantaged in competing with Basel II banks.
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In short, the ingredients for the success of Basel II continue to be: one, appropriate minimum capital standards; two, a consistent approach to validating banks' risk estimates; three, an adequate vetting of competitive issues; and four, time to address these and other policy issues as we finalize our views on this new Accord.
We will continue to work closely with our fellow regulators to work through these important issues and reach the right conclusions. We are committed to evaluating the cost and benefits of the Basel II proposal and their impact on the U.S. banking industry and the safety-and-soundness of the financial system. Thank you for the opportunity to present the views of the FDIC.
[The prepared statement of Hon. Donald Powell can be found on page 167 in the appendix.]
Chairman BACHUS. All right.
Director?
Thank you. Thank you.
Mr. Gilleran, I am sorry.
STATEMENT OF JAMES GILLERAN, DIRECTOR, OFFICE OF THRIFT SUPERVISION
Mr. GILLERAN. Mr. Chairman, Ranking Member Frank, thank you for including me in this panel.
Chairman BACHUS. I think we have a microphone problem.
Mr. GILLERAN. I think all of the concerns that I have—the OTS has—have been already expressed. So I will just make some general comments before we turn it over to questions. I would ask that my written comments be included in the record.
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Up until this time, the OTS has not been involved in the international accord efforts, even though we have had people who have been involved in Subcommittee work here in the United States. Bill McDonough did invite me to attend the last Basel meeting as an observer, which I did.
And subsequently, I have asked the replacement for Mr. McDonough as head of the Basel Committee, who is now the head regulator in Spain, for an official seat on the Basel Committee. And I am told that that is a definite possibility for the future.
I think it is important that the OTS be included as a full voting member on Basel because of the OTS unique focus on the mortgage industry. And our interest is, number one, to share with others our perspective on mortgage lending here in the United States and internationally, since at least one of our major thrifts will be included within the Basel Accord, if it is adopted.
And we also have a focus on interest rate risk that is unique in the industry. And each quarter, we mark to market our entire industry, from an interest rate-risk point of view. So I think that that also is a contribution to the understanding of interest rate and the whole subject of risk and capital.
My own personal views on Basel are that I believe that the Basel work to date has moved the ball forward in terms of understanding the relationship of risk and setting capital. Basel I was a simple method, but very effective really, since it was first adopted because Basel I capital has held up very well over very tumultuous economic times.
And it has produced capital levels that are now viewed as being quite substantial. And in fact, the financial services industries have just completed 2 years of probably the best results it has ever had. And in addition, this year looks awfully good too.
So Basel I has functioned well, even though I think that almost everybody would admit that if we just stayed with Basel I, we would want to make additions to it, so that it takes into consideration more of the kinds of differentiation of risks that we now have in the financial services industry. So I completely support the fact that we would have to do additional work on Basel I if that was the only thing that we had.
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It has been expressed here that Basel II would only be applicable to 10 of the major international banks in the United States and perhaps 10 others who will opt in. I have received information from a number of people that there will be literally hundreds of other banks that will make application to the regulators to be able to use Basel II because I think it is perceived that Basel II will result in lower capital levels.
And I think everybody—almost everybody—concludes that lower capital levels will mean greater competitiveness. It is also an issue too in connection with what happens to the community banks in the United States.
Because if the major banks are allowed to have lower capital levels but the community banks will continue with higher capital levels under Basel I, then that will mean that they can be acquired, quite simply, by the major banks. And we will have a further roll-up of the community banking system here in the United States. And that has to be evaluated by Congress, along with everything else, as to whether or not that is a good thing to have happen.
So I believe we have to do a lot of work. I believe a lot of work has been done.
I salute those who have really been working on it so hard in the past. We intend to be part of it going forward in the future. And I believe that your attention to this matter is very well deserved.
Thank you for inviting me. I look forward to questions.
[The prepared statement of Hon. James E. Gilleran can be found on page 114 in the appendix.]
Chairman BACHUS. Thank you. At this time, we will start questions.
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And Vice Chairman Ferguson, my first question is, you have commented—let me read testimony from yesterday's hearing in the Senate. D. Wilson Ervin, Credit Suisse First Boston, are you aware of his testimony on Basel II?
Mr. FERGUSON. I am generally aware of it. But it would certainly be helpful for you to read the quote that you want me to respond to.
Chairman BACHUS. He said the proposed accord is not a minor refinement to the banking regulatory process, but is instead a wholesale reform of bank regulation, a regime that covers roughly $2 trillion of capital and is a key economic engine. Do you agree with that?
Mr. FERGUSON. I believe that what the proposed accord is doing is to catch up with where the leading edge banks are. So yes, it is a change. It is a change from Basel I, without question.
We have to move from Basel I because we believe it is no longer appropriate for our largest banks. It does not give good signals on the risks that they are undertaking. I do believe it is a major change, yes.
It is, however, a change that is catching up with what the leading edge banks are doing. The ideas embedded in Basel II are not things that we, as regulators, thought up independently from the industry. It is a catching up to where the industry is.
But yes, it is a major change.
Chairman BACHUS. All right. What I guess I am having trouble seeing is—and you said that Basel II is an acknowledgment of what the largest banks are doing today.
Mr. FERGUSON. What the leading edge largest banks are doing—not all of them, but what many of them are doing.
Chairman BACHUS. Many of them. And your part of your testimony—is designed to have a regulatory capital system that reflects what the largest banks are doing today. And I think Senator Sarbanes asked you. And you saw it as just an acknowledgment about what they were doing today.
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You mean what they need to be doing today or what they are doing today?
Mr. FERGUSON. I am trying to use the word ''leading edge.'' Out of the many banks that we have, there are some—not all, some—that are using the kind of quantitatively-driven approaches to estimating their own internal capital, economic capital, getting a much better feel for the risks in their lending behavior, their credit behavior.
Importantly, we had a discussion at the Federal Reserve Bank of New York about 10 days ago, almost 2 weeks ago now, where we saw again some leading edge banks are doing exactly the same kind of quantified approach to operational risk that is being proposed under the AMA. So both on the credit risk side and the operational risk side, there are examples of banks that are moving very much in this direction.
There are some large banks that I think are further behind, some that are further ahead. So it is a validation, in a sense, that we reflect, and we encourage banks and give them incentives to continue to move in this direction. And we think it is quite doable because there are a number of banks that have already started to move in this direction.
It still will require the, supervisory validation of the databases that they use, the approaches that they use to quantify. So as my colleague, Comptroller Hawke has indicated, there is still a great deal of room for supervisory oversight to guarantee that what comes out seems appropriate.
And, it is important to recognize that the information that the banks provide is an input to formulas that the supervisors put forward. So that ultimately, it is the supervisors and the supervisory approaches and formulas that determine the capital.
Chairman BACHUS. Let me ask you this. The same gentleman testified that the current Basel proposal is unnecessarily complex and costly. But you are actually saying that——
Mr. FERGUSON. I am the first to admit that it is complex. I am not denying in any sense the complication here.
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I think it is too simple to say that, in my view, it is complex because we live in a complex world. That is partially true. But that is——
Chairman BACHUS. Can you tell me some banks that would comply with this today? You say that some of the leading edge banks already are?
Mr. FERGUSON. Well, would comply with every component of it today? I am not sure there are any banks that would comply with every component.
Chairman BACHUS. With the major components.
Mr. FERGUSON. There are a number that are moving in this direction relatively quickly. I am a little cautious here to give out confidential information. But I will assure you that there are some banks that we have looked at. And we are comfortable that, certainly by the implementation date, they will be ready.
Chairman BACHUS. But all your major banks today——
Mr. FERGUSON. I am sorry, sir?
Chairman BACHUS. All your major banks today are sound.
Mr. FERGUSON. This is not a question of sound——
Chairman BACHUS. I understand that. But their own models show that several of them are going to have to raise significant amounts of capital. Do you disagree with their models?
Mr. FERGUSON. That they are going to have to raise capital? I think what will happen is that some will find that their regulatory minimum capital goes up. Some will find that the regulatory minimum——
Chairman BACHUS. Right. Some go up, some go down. But for those that go up——
Mr. FERGUSON. But that is not a bad sign. It means that their regulatory capital is going to reflect what many of them already recognize as what they need to hold internally.
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I do not think there are any banks that are going to have to go out and raise new capital. They will simply have regulatory capital that is adjusted either up or down. But it is not inconsistent with their own view, necessarily, of their risk.
Chairman BACHUS. Okay. All right. Let me ask you this. This is probably, maybe, the most important question I will ask you today.
Comptroller Hawke and Chairman Powell said that we will take whatever time necessary to reach a consensus. Do you agree with that statement?
Mr. FERGUSON. I do. As Comptroller Hawke was describing areas of agreement and disagreement, I sent him a little note and perhaps a little body language that suggest otherwise. But I think we are in close agreement on exactly that point.
I have said in my opening statement here that the original timetable of trying to meet in November is unreasonable at this stage, and seems likely to slip. He described it as daunting. I would not have made it to this table if I were not prepared to take on a daunting challenge, so I am not intimidated by it.
But I know we will have a lot of work to do. I am cautiously optimistic that we will get to the end of the year and have plenty of time to look at the comments, listen to the comments and respond to them, and develop a negotiating position.
If it turns up that we cannot, then we will take the time required.
Chairman BACHUS. Okay. So we do not have—there is no deadline out there. We cannot say we have to do it by a certain——
Mr. FERGUSON. Let me be very clear. As with anything in life, there are cost and benefits. It is appropriate to get the benefit of taking a sufficient amount of time, sir. But it is also important for all of us to recognize that there are great costs of uncertainty to our banks.
There are a number of banks that want to know where they should be investing, what kind of databases are required. So we have to move ahead as expeditiously as possible, in order to minimize the uncertainty in the banking industry.
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This is not a matter to take lightly on either side. It is not a matter to rush into and ignore the comments, which we would not do. Nor is it a matter to go too slowly and leave uncertainty in the banking industry. Having seen 4 to 5 years of consultative papers, outreach meetings, quantitative impact studies, they are asking for a certain amount of certainty.
And one of the things that you certainly will have seen, because you followed yesterday's testimony as well, while there are a range of views, when it is wrapped up, everyone recognizes that we need to move off of Basel I, both on the first panel and the second.
I think Senator Sarbanes asked the question, in which the agreement was yes. Everyone recognizes that we need to move to a framework that is quite like Basel II, without question.
There is still room to discuss a lot of the details. But the concept of moving in this direction is well accepted, both by the regulators and, I think, in general the private sector.
And we have to be careful not to slow it down unnecessarily, slow it down enough to listen to the comments, but not unnecessarily to the point that we are leaving uncertainty in the banking industry and leaving our largest banks on an old accord that we know has passed its useful life, as far as the largest banks are concerned.
Chairman BACHUS. Thank you.
Ms. Maloney? Mr. Frank, I am sorry.
Mr. FRANK. Thank you, Mr. Chairman. I know there has been frankly some effort to say that there really is agreement and you are all going to be able to work this out.
But I would just make a suggestion to you. If this is an agreement, if you guys ever disagree, sell tickets, because it will be a hell of a show.
Mr. Powell on June 9th said in a memo that we have, ''The framework is being rushed into place with discussions of significant alternatives now virtually ruled out by the timeline and by the international collaborative nature of the project.'' You do say, in a generous show of courtesy, you acknowledge the recognition by Vice Chairman Ferguson that this may, indeed, be the case.
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You know, virtually anything may indeed be the case in this world. But then Mr. Ferguson expressed his view that this great rush to judgment may indeed be the case, in his answering memo, by saying, ''The Fed believes it is important to move on to the next step in an international process that has already created too much uncertainty.''
I mean, there is clearly more disagreement here than people are acknowledging. And I do not understand what you think you gain by that. And I understand there are some constraints and let's be polite.
But I have to say, Mr. Ferguson, you lose some credibility with me when you say, ''We are all together here.'' There seems to be much more disagreement.
I do have a couple of specific questions.
Mr. Hawke, you say that when you were for Pillar 2 instead of Pillar 1, you were the only member of the Committee who felt that, so you were outvoted. Mr. Powell, did you have a horse in that race between Pillar 1 and Pillar 2?
Mr. POWELL. I did not.
Mr. FRANK. You did not. So Mr. Hawke, you were outvoted one to one.
Mr. POWELL. I am sorry?
Mr. FRANK. Then Mr. Hawke was outvoted one to one. I mean, there were three federal agencies on this. You did not have a vote.
Mr. POWELL. I came into the process late. But I would have to refer to some of our folks that were in the process. But I think we were in support of Pillar 2.
Mr. FRANK. You were for Pillar 2? And Mr. Hawke, you were for Pillar 2. And Mr. Ferguson was for Pillar 1. So Pillar 2 lost one to two.
Mr. HAWKE. Pillar 2 lost, Congressman Frank, in the Basel Committee. Pillar 2 lost by——
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Mr. FRANK. Oh, not within the United States, but internationally, is that?
Mr. HAWKE. Yes.
Mr. FRANK. Okay, so the United States position——
Mr. HAWKE. I made that argument in the Basel Committee.
Mr. FRANK. I was not clear about that. The other question I would have for the gentleman from the OTS, you said you were asked to be made a voting member of the Basel Committee.
Mr. GILLERAN. I was not a voting member, no. Not.
Mr. FRANK. You said you had asked to be one.
Mr. GILLERAN. Yes.
Mr. FRANK. Well, who are the voting members of the Basel Committee. Are the other three? I mean, there is an international Basel Committee. You are all voting members. I am now unclear.
Mr. GILLERAN. There are three U.S. members.
Mr. FRANK. What?
Mr. GILLERAN. One is the head of the New York Fed. And then there is a Washington——
Mr. FRANK. Excuse me, are you asking to be a voting member of the International Basel Committee or the American Basel Committee?
Mr. GILLERAN. I would like to be either. But I will take the U.S.
Mr. FRANK. So you are asking to be a voting member of the U.S. Committee. But they do not seem to count the votes. I mean, that is like—I do not know why you want to vote.
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Then I continue to be perplexed by this. And let me ask, Mr. Ferguson, both Mr. Powell and Mr. Hawke seem to have severe reservations about the current timeline. At least, that is—can you tell us that until they agree, their agencies agree that we are ready to go, that we are not going to go? Is that something we can——
Mr. FERGUSON. I can tell you that. Yes.
Mr. FRANK. Okay. Then let me ask you another question. And I understand, Mr. Powell, you make a point about getting Treasury into it. And that is something I will think about.
But I still have to say, this is the most incoherent decision making process I have encountered on very important issues. And by the way, who will it be up to to make him a voting member?
Do you know? You said you talked to the guy from Spain. I mean, is he deciding who is a voting member in America?
Mr. GILLERAN. Right. Well, he is the Chairman of the Basel——
Mr. FRANK. But does he decide who gets a vote in the United States?
Mr. GILLERAN. He has a vote. And he is now Chairman. So he will determine when other countries and whether or not——
Mr. FRANK. But what is his input into whether you get a vote in the United States Committee? I mean, I thought you said you were trying to get to be a voting member of the U.S. Committee. And we are going to ask a guy from Spain to do that?
Mr. GILLERAN. Well, I did.
Mr. FRANK. That is why I think we need some clarity.
Now Mr. Ferguson, one substantive question. I understand one of your arguments has been—and I appreciate the willingness you have had to meet with us and talk and explain these things. I mean, it can be frustrating because these are complicated and we do not ever know as much about them as you do because of the difference in our focus of attention—and maybe even our attention span, but I will speak only personally there.
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On the question, you have said, well, the amount of capital may not be that much. It would not be necessarily increased. But there is a big gain in transparency.
And you and I have had this conversation, that you said that you thought some of the institutions, while they might now have capital, have not been transparent about it. I relayed that concern to some of the institutions that had raised this with me.
And I am told that one of them, State Street Bank, said that they would be willing to work on ways to increase the transparency of the capital. And that did not seem to resonate much.
So are there not ways or are there ways that we could require these institutions—talking about operational risk now—to increase the transparency of the capital that might be helpful here? And I was frankly—I encouraged them to go and talk to you about that. And the impression I got was that they did not think this really meant as much to you as I had thought it did.
Mr. FERGUSON. Transparency always means a great deal to me. And there should not be any doubt about it.
And yes, the institution that you talked to called me the other day to say they would be interested in pursuing ways to have more transparency. Recognize the benefits of Pillar 1, which is what we are talking about, versus Pillar 2 are in part because of transparency, not exclusively.
Mr. FRANK. Right.
Mr. FERGUSON. I am sorry, Congressman Frank, may I finish?
Mr. FRANK. I am sorry. I thought you were finished.
Mr. FERGUSON. No, not yet.
Mr. FRANK. My attention span again. I apologize.
Mr. FERGUSON. There are a number of other benefits from Pillar 1 that are important. One is that it allows for greater comparability because it is important to have framework——
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Mr. FRANK. Okay. In other words, what you are saying is that even if they could resolve the transparency issue, that would not affect your view on——
Mr. FERGUSON. No, I did not say it did not have any effect on my view. What I said, Congressman, is not that it would not have an effect on my view. Obviously, it would have an effect on my view.
I think it is not the only reason to favor Pillar 1.
Mr. FRANK. Okay.
Mr. FERGUSON. And as you have heard now at this stage, the regulatory group in front of you——
Mr. FRANK. By a vote of one to two.
Mr. FERGUSON. No, Congressman Frank, that is unfair.
Mr. FRANK. How did the American—what was——
Mr. FERGUSON. It is unfair because, as I think you heard the Comptroller say, we collectively developed what we think of as a very solid middle ground.
Mr. FRANK. After he felt he had been outvoted, he said that.
Mr. FERGUSON. He had been outvoted by the entire Committee.
Mr. FRANK. But let me—if the Comptroller thinks I am misquoting him, he is free to interrupt me. I give him that permission.
The last question I have is this. You say one of the reasons for speed or for moving quickly, despite others' reservations, is——
Mr. FERGUSON. Can I interrupt you? I did not say ''moving quickly.'' I said ''reasons to move ahead.''
Mr. FRANK. Okay. But you said one of the problems was the uncertainty that the financial institutions are suffering from. I just want to give you a comment.
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Not a single bank has called me up and said, ''Hey, I am really feeling angst here from the uncertainty. Would you move quickly?''
So you say that it is important to move quickly because you want to relieve the uncertainty of the banks. But they are calmer than you think they are.
Mr. FERGUSON. It is a good thing we have calm regulators and calm banks. I did not say ''move quickly.'' I said to ''continue to move.''
Mr. FRANK. I understand. But you said a reason for progress and not as much delay.
Mr. FERGUSON. Right.
Mr. FRANK. Are you not in disagreement with your colleagues about how much delay?
Mr. FERGUSON. No, I am not in disagreement with my colleagues at all.
Mr. FRANK. Dr. Ferguson, I have to say I do not believe that. I mean, you are not leveling with us. There is clearly a difference of opinion on how quickly this ought to go.
Mr. FERGUSON. No, Congressman Frank, there is not a disagreement on how quickly this should go. We all agree that we have to put out an ANPR in about——
Mr. FRANK. Okay, well then——
Mr. FERGUSON. We all agree that we need to have a comment period. We all agree——
Mr. FRANK. Report to——
Mr. FERGUSON. Sir, may I finish?
Chairman BACHUS. Let me say this, we have actually got 2 minutes left on the floor.
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Mr. FRANK. All right. I apologize.
Mr. FERGUSON. No, I think it is fair to ask questions. But I am giving you honest answers. I am not, in any sense, disagreeing with what anyone else here——
Mr. FRANK. That is not what these two memos clearly suggest.
Chairman BACHUS. Could I interject? Vice Chairman, could you—would you write Chairman Oxley and Chairman Frank a letter and just confirm what you have said this morning?
Mr. FERGUSON. That we will have a comment period?
Chairman BACHUS. That you will not——
Mr. FERGUSON. Of course.
Chairman BACHUS. That you will not move forward until——
Mr. FRANK. Mr. Chairman, I will return to listen, not to ask any questions. But I owe them. I will return after I vote to listen.
Chairman BACHUS. We will return. And we ask the panel—we will reconvene at a quarter till 12. Thank you.
[Recess.]
Chairman BACHUS. The hearing will come to order. We welcome our four witnesses back. And at this time, two of the witnesses wanted to respond to Mr. Frank. So I will recognize the ranking member for that purpose.
Mr. FRANK. I simply—both Dr. Ferguson and Mr. Gilleran had comments to make. And I, having used up my time, I hope they will get as much time as they need to respond.
Mr. GILLERAN. I just wanted to clarify the record is that the OTS is fully engaged with the other regulators here going forward in the United States. And we are a party to the ANPR that will be coming out.
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And it is the international piece in Basel that I was talking about, that we have not been—had a seat at the table. I have been informed by Comptroller Hawke that Basel has never really ever taken a vote.
So you cannot be a voting member. But we would like to be at the table going forward, so that we can add our unique perspective on the mortgage market to the group.
Mr. FRANK. Dr. Ferguson may have felt that I did not give him a chance. So I apologize.
Mr. FERGUSON. I have the impression that some of my colleagues here want to deal with some of your questions.
Mr. POWELL. May I make a comment, Congressman? With regard to the different views and differences of opinions, clearly that is true.
In my short period in Washington, I have watched; there is not much consensus on very many issues. And time builds consensus. People have an opportunity to express their views.
I indeed did send that memorandum to Vice Chairman Ferguson and to Comptroller Hawke and expressed our views. And I have met with Vice Chairman Ferguson at least on two different occasions, going over some of my concerns and some of my views.
He has accepted those concerns and views in the spirit they were given. On one occasion, he called me back and said that he is doing some more study about one of the specific issues that I talked about.
I am confident—I am confident—in the process. As Comptroller Hawke mentioned, people of good will, in fact, have differences of opinion. And I think it is important that we express our differences of opinion.
But I am confident that the process will ultimately get us to a consensus. There will be give and take in this process, and as each of the panel members here have expressed, we will not be governed by the timeline just in order to make a certain timeline. Governor Ferguson, Comptroller Hawke, Director Gilleran, and I do have differences of opinion. But we have worked through other issues. And I am confident we will work through these issues.
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Mr. FRANK. Let me just—you do not then feel pressured by any timeline? You feel you have adequate time to work it out?
Mr. POWELL. No, sir. I do not feel pressure in any way.
Mr. FRANK. And you will not feel pressured to give in before you are satisfied?
Mr. POWELL. Nor do I feel pressure to change my views, nor feel any pressure not to express my views.
Mr. FRANK. I have never noticed a deficiency in your willingness to deal in those regards.
Mr. POWELL. Thank you.
Chairman BACHUS. Let me clarify something. Right before we left, Vice Chairman, I asked you—in fact, Chairman Powell's statement just then sort of reminded me that he is confident. And Comptroller Hawke has said he is confident that you all will come to a consensus at some point.
And you assured us that—I believe I have heard that you have assured us that you will not sign off until there is consensus and agreement between the regulators?
Mr. FERGUSON. That is correct.
Chairman BACHUS. Now in that regard, we are talking about the same thing, and that is the international Basel agreement?
Mr. FERGUSON. Yes, that is correct.
Chairman BACHUS. Okay. Thank you.
So you will not sign the international agreement until there is. Mr. FERGUSON. I cannot. I mean, you have to understand that the Fed is only one of the regulators here. We cannot, independently of the other regulators, move forward. We need to have exactly what you want us to have, which is a common view before we go ahead.
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Chairman BACHUS. But there is a U.S. agreement on how you regulate between the regulators. There is also the international agreement which you sign.
And what I am focusing on is that you will not sign.
Mr. FERGUSON. First, there is nothing to sign. But we will not agree to anything that we are not all appropriately comfortable with.
Chairman BACHUS. Okay.
Comptroller Hawke?
Mr. FERGUSON. Are you comfortable with that, sir?
Chairman BACHUS. Yes.
Mr. HAWKE. Mr. Chairman, let me go back to the timeline of the process itself. The comment period on our ANPR closes in October. There is a meeting of the Basel Committee scheduled in December. We will take a broad range of comments that come out of that ANPR process and make an initial judgment about whether and to what extent we think changes should be made in the final document that is going to come before the Committee in December. The Committee will then put that out as the final document. The Committee, in the 4.5 years that I have been on it, has never taken a vote on anything. Things seem to get done by osmosis.
That document will be the Committee's view on the final paper. We are not obligated to apply it to U.S. banks until we complete our domestic rulemaking process that implements Basel II through our rules.
The final step in that rulemaking process will be the Notice of Proposed Rulemaking, which will come after the issuance of the Basel paper. That is when we are going to do the final quantitative impact study that will measure the impact on capital of the Basel paper. If that quantitative impact study returns information to us that suggests that the impact on U.S. bank capital is going to be unacceptable, as the Vice Chairman said, there are a number of things that we can insist on with the Basel Committee before we go final with our implementing regulations.
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So there are a number of decision points along the way before we get to the very end of the line, which is the adoption of the U.S. regulations implementing Basel II.
Mr. FRANK. Mr. Chairman, would you yield to me for 30 seconds for a question? Because that is interesting to me. And I must say, my impression before the Comptroller spoke was that once the agreement was signed, our flexibility was not very great.
I mean, how much could you undo? Are you not bound by—are you talking about details? Or could you say, ''Well, we do not want operational risk capital'' or ''We do not want this?''
Subsequent to signing, when we do our regulation, how much are we constrained by international obligation? How free are we?
Mr. HAWKE. Well, first of all, this is not a treaty where we have a legal obligation. But I think it is probably fair to say that once the Basel Committee goes out with its final paper, we either should object to it if we have fundamental reservations, or we should acquiesce in its being published. But during the subsequent domestic rulemaking proceeding and the quantitative impact study that will accompany that, we are going to have to make a very important judgment, and that is: what is the impact of this paper going to be on the capital of our banks? We have not had a reliable——
Mr. FRANK. How free will you feel to undo parts of what you agreed to?
Mr. HAWKE. Well, I would feel free if we conclude as a result of the quantitative impact study that the capital impact on our banks would be unacceptable—unacceptably high or unacceptably low to simply not implement it.
Chairman BACHUS. And that would mean, even if it resulted in some competitive disadvantages for certain banks over other banks or if it impacted specialty banks or if it impacted banks with high commercial real estate holdings.
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Mr. HAWKE. Those are issues, Mr. Chairman, that I think we ought to have a better hold on at the end of the ANPR process. We are going to be receiving comment on the competitive impact before the end of this year. So we ought to be informed on those issues before we go back to the Basel Committee in December.
Mr. FRANK. Can we hear from Dr. Ferguson on that, Mr. Chairman?
Mr. FERGUSON. Let me first agree with the direction that Comptroller Hawke was going in response to your question, Congressman Frank. We should have a strong sense of agreement about the broad contours before the Committee wraps up its work, without question.
I agree with him that the proposal or the approach for next year will be to put out a notice of proposed rulemaking; to start a quantitative impact study; to get the comments from that notice of proposed rulemaking; to get the input from the quantitative impact study; to collectively make a judgment as to whether or not there is a need to go back and reopen; to do what we call recalibration, which is to adjust some of the weights in one way or the other, to make other adjustments that we think are appropriate before we sign on.
And as the Comptroller has indicated, this is not self-executing. It needs some rules here in the U.S. And before we finalize those rules, I think it is important to do the process.
Mr. FRANK. But you are assuming——
Mr. FERGUSON. And, if we need to, go back and renegotiate. And we have said that. This is not the first time we have said that.
Mr. FRANK. When you talk about the timetable, you are assuming that this would be done by the end of this year, the international agreement.
Mr. FERGUSON. As the Comptroller says, it is a daunting task. We have to work hard to see if we can get there. We will go to the December meeting with our collective reflections on the comments and lay out to our negotiating partners what the U.S. positions are. And we will see how far we can get.
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The expectation, the commitment the Committee has made to the world, is that we will attempt to get some finality the end of this year. I want to try to live up to that if we can.
If it turns out that we cannot reach a consensus on the Committee, then so be it.
Let me add one other point on this. If I can take another minute to give the Committee a really clear view, because I see this is an issue of some uncertainty.
Not only is 2004 a chance where we will have a quantitative impact study. But as I said in my opening statement, there will be—I think—a quantitative impact study in 2005. There will probably be one in 2006.
At each one of those, we will get a better handle on the impact on our banks and the banking system overall. And frankly, I believe that if we have to go back and reopen and recalibrate to some degree, we have the right to do that. We have been clear that we intend to do it.
Chairman BACHUS. When you say you think that we have that right.
Mr. FERGUSON. No, we intend to do it. We have the right.
Chairman BACHUS. We do have the right?
Mr. FERGUSON. We have the right to do it. We will, if we do not like and are uncomfortable with the quantitative impact on the banks in the U.S., go back and recalibrate. Period. Full stop. Declarative sentence. I hope it is clear.
Mr. HAWKE. Mr. Chairman, can I just add one point on that?
Chairman BACHUS. Yes.
Mr. HAWKE. Up until now, the Committee itself has done three quantitative impact studies, but they have not had a final document to work against. So it has not been possible to calculate the impact of Basel II on our banks because we were dealing with a work in progress. It will not really be possible to calculate the impact until our banks get all their systems up and running and we have a fully operational system. But after the Committee comes out with the final version of the paper, we will be in a much better position to go through a quantitative impact study, that will be carefully overseen by the regulators, to make a judgment about what the impact will be. That is an absolutely essential step, in my view, and satisfactory results will be a precondition to our final adoption of the implementing regulation.
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Chairman BACHUS. Thank you. And let me say this, what I am going to do at this time, Mr. Toomey, the gentleman from Pennsylvania, is going to take the chair and recognize Mr. Gilleran. He has been wanting to respond.
What we are doing, as you have noticed, is we are going to give each member remaining here 10 minutes of questioning because these are very important matters. And I think, Mr. Frank, I would agree, we have taken close to 10 minutes.
[Laughter.]
Mr. FRANK. Is 12 close to 10?
[Laughter.]
Chairman BACHUS. So what we will do is Mr. Toomey will take the chair. He will have his 10 minutes to question. Then we will go to Ms. Maloney and the other two members that are here.
And the other members that arrive after that will have 5 minutes.
Mr. TOOMEY. [Presiding.] Thank you, Mr. Chairman. At this time, I would recognize Mr. Gilleran to respond.
Mr. GILLERAN. I just want to say that Basel II is no different than Basel I as far as it relates to the authority of the U.S. supervisors to request capital and to obtain capital that they think is necessary. If Basel I came up with the calculation that the regulators disagreed with, the regulators are not bound by Basel I, in terms of the capital that is required.
And they would not be bound by Basel II in any different way. And I think it is very important to point that out, that Basel II is a technique to get to a number. But it does not bind the regulators as to what is required in any specific instance.
Mr. TOOMEY. Thank you. I would like to begin my questions following up on the question of the question of the impact on the competitiveness of American banks if we were to proceed with the Basel II proposals. And specifically, it is my understanding that the majority of the institutions that engage in the asset management operations, for instance, do not come under Basel requirements at all. It does not apply to them.
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And in addition, it is my understanding that the actual capital required by the market for the conduct of this business is considerably less than what the Pillar 1 requirement under Basel II would impose. So I guess my first question for either Mr. Ferguson and/or Mr. Hawke would be, number one, does this discrepancy between what the market requires and what the Basel proposal proposes, does that suggest a flaw in the requirements?
And secondly, if we were to adopt this Pillar 1 requirement, wouldn't that put our American institutions at a significant competitive disadvantage and have all the unintended consequences that flow from that, including creating incentives to push this business elsewhere to avoid this capital requirement?
Mr. FERGUSON. Was that question addressed to me, sir?
Mr. TOOMEY. Actually, if you and Mr. Hawke would both address the question, I would appreciate that.
Mr. FERGUSON. Okay. Well, I hope we get the same answer.
First, we will be asking questions about the competitive impact broadly. And it will include, by implication, the kinds of issues that you have just raised. So we will get the facts, as far as the industry sees them.
Secondly, I would say, recognize that there are already bank and non-bank participants in the asset management activity. As far as I can tell, the capital requirements are probably slightly different because the market has slightly different requirements versus what the banks have to hold.
There are reasons that we have capital requirements for banks, obviously, because they are regulated institutions. They have access to a variety of things that deal with the safety net. And so as we think about the competitive differences, we have to calibrate it against what currently exists, as opposed to an ideal world.
To try to respond to a technical question, just to make sure you understand what the accord calls for, it calls for capital with respect to the credit elements of the asset management activity. Insofar as a bank that is an asset manager makes a loan as part of that activity, that would require capital.
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General asset management as an activity does not, I believe, attract capital. And the way that gets calculated will depend very much on the inputs, the probability of default, et cetera, that are involved.
Mr. TOOMEY. I may have misspoke. I was referring to the operational activities generally.
Mr. FERGUSON. Oh, operational activities generally. Oh, I am sorry. So your issue then is about operational risk.
Mr. TOOMEY. That is right.
Mr. FERGUSON. Oh. I thought you said asset management.
Mr. TOOMEY. I am sorry. I did, I think.
Mr. FERGUSON. Let me then, since you and I know Congresswoman Maloney is also interested in this issue, I will also continue a bit on operational risk.
The first point to make is operational risk already attracts an implicit capital charge. We are not doing something new by having capital for operational risk.
Excluding or even leaving what the regulators call for, large financial institutions, large banks in particular, already hold economic capital, the capital they themselves determine, in order to deal with the challenge of operational failures. We have done a survey that shows in the world at large, for larger institutions, out of their economic capital, the capital they impose upon themselves, about 14 to 15 percent of that capital is being held for operational risk matters.
So just to get the lay of the land, there is already regulatory capital for operational risk, regulatory minimum capital and the banks themselves impose their own economic capital.
Mr. TOOMEY. But that is a significantly lower number than what is contemplated by Pillar 1?
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Mr. FERGUSON. No, that is not true. No, that is not true.
Mr. TOOMEY. Oh, it is not.
Mr. FERGUSON. I think there may be a little bit of a misunderstanding. There was a time, several drafts ago, when operational risk charges were either tied to gross revenue or you may be thinking of a number of 20 percent that was floated at one point.
That is not the proposal. The proposal under the Advanced Measurement Approach, the AMA approach, as I have described it and as Comptroller Hawke, who was part of developing this idea described a bit, is a principles-based approach that does not have implicit in it a specific target number of capital.
Rather, it asks the banks to use some quantification that we as regulators can replicate, that we can understand, that is not purely top-down, judgmental, a guess, if you will. But based on an analysis of their own experience, the experience of others, what is called scenario analysis and a few other techniques that are relatively common in this area, to determine their perception of the operational risks they might face.
Mr. TOOMEY. Okay.
Mr. FERGUSON. And then how they offset it. And that will lead to a capital charge. But it will not necessarily be higher. We do not know if it is going to be higher or lower than the 15 percent that—or 14 to 15 percent—of economic capital that is currently held, that I have just alluded to.
Mr. TOOMEY. Okay.
Mr. FERGUSON. I hope that is clear.
Mr. TOOMEY. Yeah, it is surprising. I was under the impression that it is extremely likely that it would be considerably higher than the economic capital that the market requires today. But that is——
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Mr. FERGUSON. I do not think we can have a point of view that it is extremely likely to be one thing or another until the banks work their way through it. A number of banks have already developed some of these approaches and are moving along, which gives me some comfort that what we are proposing, what is being proposed with this AMA approach, is really quite doable.
But it is, I think, premature to say it is extremely likely to lead to a particular number in the industry.
Mr. TOOMEY. Okay.
Mr. Hawke, is that your view as well?
Mr. HAWKE. I generally agree with Governor Ferguson. I would just make a couple of points.
We already have differences today between regulated financial institutions that carry on such things as asset management activities and non-regulated institutions that carry on the same activities. There are pluses and minuses in each case. The regulated institutions have access to the discount window. They have the benefit of the federal safety net and the like. The non-regulated institutions do not have the burden or regulatorily imposed minimum capital requirements.
We are going to be seeking comment on the competitive effects in the Advanced Notice of Proposed Rulemaking proceeding. We would be concerned if one of the consequences of Basel II were to cause the de-banking of banks that were engaged in these activities. So this is an issue that we are going to focus on in this process.
Mr. TOOMEY. Okay. So do you share the view that it is not possible to determine, generally speaking, that these rules would require greater capital than the market currently imposes?
Mr. HAWKE. I think it is premature to make that judgment. The AMA approach has a lot of complexities to it. We have very extensive supervisory guidance that is about to be put out for comment that details this whole process. Until that guidance is finalized and we get a final Basel paper, I think it is premature to make a judgment about what the ultimate capital impact is going to be from the operational risk charge.
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Mr. TOOMEY. My next question for you, Mr. Hawke, is that you had mentioned earlier that you had previously argued against the Pillar 1 capital for operational risk, if I understand correctly. And I am not aware of what has changed with regard to the arguments that have historically been made against that. So I am just wondering what your thought process was to cause you to come to a different conclusion.
Mr. HAWKE. Well, in part—and I do not mean to be facetious—but in part, it was deference to the shortness of life. I argued in the Committee for 4 years that because operational risk was a subject that involved the need to make qualitative judgments about a bank's internal control systems, it was appropriate to deal with it under Pillar 2.
The Committee does not take votes, but I can tell you that there was nobody on the Basel Committee—25 people—who shared that view. It was not going to prevail. So rather than continuing to make the argument, we and the Fed worked together, I think very constructively, to develop the AMA approach.
I am completely comfortable with the AMA approach to operational risk because I think it imports exactly that degree of supervisory discretion and supervisory qualitative analysis that I would have hoped for under Pillar 2. And I made the point earlier that even if this were a Pillar 2 issue, we would still have to have a framework for the supervisors to assess operational risk. My guess is that that framework would end up looking a lot like what we have in the AMA approach.
Mr. TOOMEY. Okay. Well, thank you very much. My time is running out.
I would be happy to recognize the gentlelady from New York.
Mrs. MALONEY. Thank you, Mr. Toomey. Thank you. And I thank all of the panelists.
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What I am most concerned about is the competitiveness feature. And apparently, all of you agree that it will not be a disadvantage to American financial systems.
I would just want to know what proof there is. You mentioned we have had two quantitative studies. There is another one that will be ongoing.
So I would like to ask Mr. Ferguson and Mr. Hawke, I would like to see the proof and the studies that you have done to make sure that American institutions are not disadvantaged. You testified that the capital requirement would be lower under the number two accord.
Is that correct? Requirements for American banks? I heard someone say that. No?
It will not be? Okay, but——
Mr. HAWKE. That remains to be seen.
Mrs. MALONEY. It remains to be seen. And what studies have you done and what proof do you have—beginning with Mr. Ferguson—to show that we will not be at a competitive disadvantage? What was your process to determine that?
Mr. FERGUSON. First, what we are expressing is an opinion. We will be asking questions in the ANPR to determine how others view this.
Let me explain a bit of how at least I have come to the opinion at this stage that——
Mrs. MALONEY. Do you have anything in writing that supports your opinion? Any studies or research that support the opinion you came to?
Mr. FERGUSON. Well, if you would let me, I will tell you what I have and then you can tell me if it is sufficient. Does that work?
Mrs. MALONEY. Great.
Mr. FERGUSON. Good. Here is why I had the view that I have. First, the reason we are engaged in an international exercise is to create a level playing field across nations. If we chose one capital approach and other countries chose another, the probability of an uneven playing field would go up.
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So the entire goal of having an international accord that is hammered out over 4 years and has a variety of approaches that you have heard about, is to increase the probability of a level playing field internationally. Because large, internationally active banks will be on a comparable set of rules, by and large.
Secondly, one of those rules involves transparency, which is to say banks disclosing not just the regulatory minimum capital under the set of rules, but also disclosing some of the inputs—not anything that is competitively sensitive, but some of the inputs—so that market analysts can observe the inputs of Bank A versus Bank B, whether or not the capital outcome looks the same. So it is not just that the rules are, broadly speaking, similar, but also the disclosure allows the market to do some comparisons across institutions.
The third thing that we have tried to do in order to minimize the risk of disparities is create a process within this Committee, called the Accord Implementation Group that brings together the various regulators from around the world that are involved in this to talk about how they are making judgments on things, such as: How do you validate the inputs? What data does one look at? That type of thing, to try to create a strong sense of a level playing field among, if you will, the umpires, the regulators internationally. So that we, here in the U.S., are to some degree encouraging improved supervisory oversight that we think will come closer to ours, which again should give us some comfort.
The fourth degree of comfort frankly is that if it turns out that this is not the case, that these three things I have just talked about are not the case, we will certainly hear from our institutions if they are feeling competitively disadvantaged. I have not heard that at this stage. But it will be the ultimate control.
And finally, as I said, we will be asking questions to see if the industry or others see within the accord and the approaches that we are planning to take to implement it, any flat spots, any lacunae, any gray areas where they can see some room for competitive disadvantage.
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I believe that those different approaches should be sufficient to give us a much better feel in response to your question. And you may have other questions. But that is the basis on which I have based the opinion I have so far.
Mrs. MALONEY. Well, are you concerned that the vigor with which the Basel Accord is implemented in the U.S. by our regulators, which are very vigilant, could be a potential disadvantage for other international banks where their regulators are not as stringent? That could be a possible disadvantage to our banks.
Mr. FERGUSON. Are you addressing that question to me or to someone else?
Mrs. MALONEY. Yes, to anyone.
Mr. FERGUSON. Well, I will answer. But then I would be more than happy to have some of my colleagues on the panel answer as well.
Mrs. MALONEY. It may be applied differently in different countries.
Mr. FERGUSON. That is the reason why we have developed this Accord Implementation Group, to try to create a more consistent application of this accord across borders. I would say one other thing as well, I believe that we have the world's strongest banking system, some of the most sophisticated banks.
Mrs. MALONEY. Without a doubt.
Mr. FERGUSON. Without a doubt.
I believe that is partially the case because they are, by their nature, well managed. In fact, much of it is due to that.
I think some of it is due to the fact that we have very solid regulators here that are pushing the best practice. I think there is—and one can look at other countries where their banking system is, to use a colloquial term, ''flat on its back'' because they have had frankly perhaps lax—too lax—regulations.
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Mrs. MALONEY. Exactly, that is my point.
Mr. FERGUSON. Exactly. But let me finish. I understand. And the point I am making is that a strong banking system does not result from lax regulation. A strong banking system results from good regulation.
We are going to continue to do good regulation here, supporting a strong banking system. And, through this Accord Implementation Group, encouraging others to maintain a level of supervisory behavior —
Mrs. MALONEY. In all due respect, I have noticed our country, through the United Nations and through other means, try to impress other countries with certain standards. And they really have not listened to us, from the Presidents, the premiers, their elected government. But I would like to hear from Mr. Hawke. I am specifically interested in written documentation that I can read that shows that our financial institutions will not be placed at a disadvantage.
This is tremendously important to me. The financial system is the main employer in the district that I represent. And they are domestic banks, international banks.
And I am concerned that there be some type of way, that either with this capital charge or the operational charge or whatever, we could be placed—or even with regulatory, more severe regulatory oversight, placed at a disadvantage. And I am interested in any written documentation that shows the process that we will not be disadvantaged.
Do you know of any? Or have you done any, Mr. Hawke?
Mr. HAWKE. Congresswoman Maloney, I do not know that there is any—or could be any—written documentation of the sort that you are asking for. Let me say that I completely agree with everything that Governor Ferguson has said. I think he gave a very complete and cogent answer to the question of competitive equality. The whole purpose of this Basel effort is to try to bring about competitive equality.
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I do share the concern that differences in the nature of supervision from country to country could result in disparate application of Basel II, but the Accord Implementation Group will be one of the safeguards there. Frankly, I think the Basel Committee itself needs to address standards of supervision in member countries. That is certainly something that we will be arguing for.
But I cannot hold out that there is any documentation that could be created or that exists of the sort you are looking for on these issues. We are going to be making a quantitative impact study that will look at the impact of Basel II on the capital of our banks. We will have to make a judgment whether that is acceptable or not acceptable and what it does t