Risk Management, PRMIA

Ted, it is a sorry state of affairs isn't it and as the FDIC wins the US banking sector seems to loose. Unfortunately the article is correct although what is going on is not so and even if US banks put all their efforts at the accord right NOW they would still be behind the game. That is one argument fuelling the fire of debate and there is a solution to that specific issue but we won't entertain it here. The Basel II accord has three parts and many European banks have been spending recent history working on the biggest components and they are now on the second major objective of Pillar II. US banks however are at a standstill but many of them are in fact more sophisticated than they are being portrayed. The reason for this is that many internationally active US banks have offices in other locales which require them to reach a risk based and intricate perspective of the capital and many of them have been contributing to the QIS exercises in he US. Under current US law however they can't use these analytics and that then leaves them frustrated and impotent.

So what caused this problem, in part the US has so many regulators that non of them really see eye-to-eye on the capital requirements. The Federal Deposit Insurance Corporation, The Office of Thrift Supervision, The Federal Reserve Board, The Comptroller of Currency, the Securities Exchange Commission all have different perspectives, requirements and agendas and, it has seriously made transparent efforts for accord implementation in the US difficult. In some aspects the whole philosophy behind the mandate is being lost. The US has also had to struggle through SOX rulings which is a pre-control compliance exercise and has distracted many financial institutions away from this hot topic.

As stated in the article

A bank's capital, essentially calculated by subtracting liabilities from assets.

This is a naive view of reality because it assumes that liabilities and assets are stationary in value, perhaps only a position in time at best and the author Damian Paletta has done well to capture US outlook in this cliché. Both these balance sheet entities of liabilities and assets are in fact floating, variable, seasonal, influenced by many factors and importantly have a volatility coefficient. The accord in essence embodies that theory, it puts all banks on the path of measuring such factors in combination with those volatility levels and then ties capital against the gap.

Of course the US is trying to dig itself out of this embarrassing position by installing a consistent leverage ratio which puts a floor on the capital requirement but that again is an action that is counterintuitive to the risk based capital maxim itself and the FSA in the UK has rejected support of this leverage ratio. The European regulators are also standing strong and are committed to the agreed capital requirements directive which transposes Basel II capital adequacy rules into European Union Law and will be taken up by nearly all countries in the region. Australia, Japan, South East Asia, India and the Middle East will push forwards with their rulings as they have planned.

What is going to be interesting is to see what comes up next. What are your bets and many of us are wondering how Sheila Bair the chairman of the FDIC is going to react when pressure from the US banking community accelerates. What I am looking forward to is reading all the academic spin doctoring and propaganda that is emanating from these authorities because this is definitely going to become another exercise in duck and weave.