May 26

Basel II in the United States (FRM "in the news")

by David Harper, CFA, FRM, CIPM

FRM |

For a gentle introduction to Basel II, Congressional Research Reports (CRS) published a brief status report: Basel II in the United States: Progress Toward a Workable Framework: Open CRS Network - CRS Reports for the People.

Note a key difference between the U.S. implementation of Basel and, say, the European Union. In the EU, several banks will utilize Basel II's intended "evolutionary aspect:" the basic approaches (which have less onerous qualifying criteria) are implemented first, then over time, a progression to the advanced approaches (which require less capital but can only be earned by meeting several rigorous criteria).  In contrast, the U.S. is basically mandating advanced approaches for the largest banks (10 or 11) and making qualification voluntary for those banks who meet the criteria (I've not seen data on how many this might number). For the rest, the clear majority of U.S. banks, they will use an altered version of Basel I called "Basel I-A." (a version of the standardized approach of the Basel II framework). In short, in the U.S., instead of the basic approaches built-into Basel II, these banks will use a modified Basel I.

Highlights (emphasis mine):

  • "The emphasis  of congressional oversight concerns about Basel II is likely to be on the two less popular pillars of Basel II — pillars two and three." Note: Pillar two is the less concrete supervisory review. Pillar three is the set of public disclosure requirements.
  • Bifurcation in the U.S.: "In the United States, banking institutions are not under one Basel II framework, but under a Basel II framework for large banks and  Basel I framework for the remaining banks. There are the Basel II 'core' banks, and Basil I  'non-core,' 'general' banking institutions. " "Core banks are banking organizations with at least $250 billion of consolidated total assets or at least $10 billion of on-balance-sheet foreign exposures...Initially, in 2009, 11 banks are going to be required to use the Basel II framework to determine and maintain their required risk-based capital for credit and
    operational  risk."
  • Advanced approaches required: "Agencies have selected the advanced internal rating-based approach for core banks to calculate their minimum risk-based capital for credit risk, and the advanced measurement approach (AMA) to calculate their minimum regulatory capital for operational risk"
  • In regard to Basel I-A: "some of the major differences are that the standardized approach increases the number of risk weight categories, permits the use of external credit ratings, expands the eligibility of financial collateral and guarantors, and uses loan-to-value ratios to risk weight first and second liens on one-to-four family residential mortgages.   Besides the risk weight of 0,  20%, 50%, 100%, or
    200% depending on the asset’s  external credit rating, the NPR suggests adding four more risk weights: 35%, 75%, 150% and 350%."

Hungry for more Basel II? You are in luck! In November, I penned a free 14-part primer.

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