* Basel III calls for 7 pct ratio for top-level capital
* Each country finalizing their version of global pact
* Fed proposal does not give in to U.S. banks' requests
By Dave Clarke
WASHINGTON, June 7 The Federal Reserve rejected
pleas by the U.S. banking industry in releasing on Thursday a
rigorous interpretation of an international agreement on higher
capital standards for banks, known as Basel III.
U.S. banks have pushed the Fed, for instance, to allow them
to more heavily count mortgage servicing rights and the
unrealized gains and losses of certain securities toward their
capital requirements than allowed by Basel III, but the U.S.
central bank's draft rule closely follows the international
"Some of the major, major things the industry, particularly
the big banks, were looking for it sounds to me like the Fed
showed them no mercy," said Karen Petrou, managing partner of
Washington-based Federal Financial Analytics.
The basics of the Fed's proposals would capture even the
smallest banks, a move likely to irritate community bankers who
had been hoping to escape the brunt of the new standards.
The Fed board voted 7-0 on Thursday to put the proposal out
for public comment for 90 days. The Federal Deposit Insurance
Corp and the Comptroller of the Currency are expected to approve
the proposal soon as well.
The Basel agreement is the cornerstone of efforts by
international regulators following the 2007-2009 financial
crisis to make sure the global banking system is more resilient.
JPMorgan's announcement last month that a hedging strategy
had gone awry, producing at least $2 billion in unexpected
trading losses, has been pointed to as a reminder of the need
for substantial capital cushions.
The new capital standards would force banks to rely more on
equity than debt to fund themselves, so that they are able to
better withstand significant losses.
The banking industry has complained that the rules could
limit their ability to lend.
At Thursday's meeting Fed staff mostly dismissed this
concern saying the benefit of a safer financial system far
outweighed any potential decrease in lending activity.
Fed staff also said banks of all sizes should be able to
meet the new requirements by retaining earnings.
The accord, which is to be phased in from 2013 through 2019,
will require banks to maintain top-quality capital equivalent to
7 percent of their risk-bearing assets, about three times what
they are required to hold under existing rules. The Fed proposal
adheres to this standard.
It is up to each country to write rules to implement the
Basel agreement for its banks.
The U.S. banking industry was not optimistic that the Fed
would do major surgery to the international Basel agreement but
there has been a push by lobbying groups to get regulators to at
least go easy on aspects that would hit U.S. banks the hardest.
Mortgage servicing rights (MSR), for instance, are used far
more by U.S. lenders than by their international competitors.
Banks get paid fees for servicing a home loan, which means
collecting payments and managing foreclosures, and because they
can be sold in markets, their value has been allowed to count
toward capital requirements.
The Basel agreement limited to 10 percent how much MSRs
could count toward the common equity component and the Fed
decided to strictly follow that standard.
In anticipation of the new rules, some banks have been
selling off mortgage servicing rights. This week, Bank of
America Corp agreed to sell $10.4 billion in mortgage
servicing rights to a unit of Nationstar Mortgage Holdings Inc
BUFFER STILL IN THE WORKS
While grumbling about the details, banks have mostly agreed
with the minimum capital levels required by Basel.
The biggest banks, however, have balked at a part of the
agreement to have 28 global "systemic" banks hold as much as an
additional 2.5 percent capital buffer.
This provision would hit the largest international financial
institutions such as JPMorgan Chase & Co, Goldman Sachs
Group Inc and Deutsche Bank AG.
The Fed draft proposal released on Thursday does not address
the capital buffer for the largest banks; a rule is expected to
be unveiled next year.
Fed Governor Sarah Bloom Raskin raised concerns about a
section of the rule that allows the largest banks, those with
more than $250 billion in assets, to use complex formulas to
determine the risk of assets and consequently the capital needed
to offset that risk.
She said banks have not always used these models wisely and
that regulators will have to pay particular attention to the
"Trust but verify," she said.
The effectiveness of these models, known as VaR, or
value-at-risk, has been a source of debate in recent weeks
because of the role they played in the JPMorgan's trading
TRADING BOOK RULES
Also on Thursday, the Fed board voted 7-0 to approve a final
rule implementing new capital standards regarding risks posed
specifically by banks' trading books.
This update for trading books is known as Basel 2.5.
In response to the financial crisis, regulators across the
world agreed to update their capital guidelines to better take
into account the risks from such things as securities made up of
mortgages, which played a key role in the meltdown.
U.S. regulators had delayed putting this rule into place
because the 2010 Dodd-Frank financial oversight law prohibits
regulators from allowing banks to continue to use ratings done
by credit rating agencies to comply with U.S. banking
Regulators have struggled since the law was enacted to find
an alternative to the work done by credit ratings agencies that
banks can use when assessing the risk of assets for the purpose
of complying with federal regulations.
In December, regulators proposed a set of alternatives but
banks have argued that some of these substitutes will not be
effective in measuring risk.
For instance, they have questioned whether relying on
assessments done by the Organisation for Economic Co-operation
and Development (OECD) to gauge the riskiness of sovereign debt
In the proposed final rule released on Thursday the Fed
rejected this concern and said regulators will use OECD ratings.