Marc Saidenberg, senior vice-president of bank supervision at the Federal Reserve Bank of New York, says the US has implemented Basel II on a timeframe consistent with other international partners. "We have taken the approach of a strong supervisory overview of firms adopting Basel II particularly where capital is dependent on firms' internal measure of risk, which has been characterised by some as the US being late in implementing Basel II," he says. "This is to a large degree a reflection of our prudence; on how comfortable we are with moving firms to Basel II without having a thorough review of their internal risk management."
However, according to an October 18 progress report on Basel II implementation by the Bank for International Settlements, as of September 30, the US was classified as having Basel II rules in force but with institutions still in the process of implementation, a category that included countries such as China, Indonesia and Turkey. The report says in the US "all Basel II mandatory institutions remain in parallel run: formal regulatory ratios are reported under Basel I and institutions are continuing to work towards implementing the Basel II advanced approaches."
Saidenberg adds: "More broadly, the US is committed to implementing Basel III in a timeframe consistent with international peers." He says that even outside the US the Basel Committee is focusing on how Basel III standards will be implemented in practice and how outcomes and consistency will be achieved.
Saidenberg also warns there is a danger of institutions using creative measures to "manage" risk-weighted assets. Under Basel III rules, capital ratios are calculated using risk-weighted assets rather than total assets. Banks may therefore be looking for assets on their balance sheet to structure differently to achieve lower risk weights.
Most critically where we see material reductions in measured risk which is reflected in risk weighted assets and not consistent with actual reduction of risk there has to be a strong supervisory response to push back against that activity
"There is a concern about firms managing risk-weighted assets, which is tied to consistency," he says. "In any rule-based framework market participants will arbitrage the rules and sometimes that takes the form of recognition that rules don't align with risks and market solutions could better align risks and requirements; other times, admittedly, there are ways of arbitraging which are less benign and really about reducing requirements without materially reducing risk."
Saidenberg adds that supervision needs to play a greater role in ensuring that banks play by the rules, noting that some actions may conform to the letter of the law but be outside the spirit of those rules. "Most critically where we see material reductions in measured risk, which is reflected in risk-weighted assets and not consistent with actual reduction of risk, there has to be a strong supervisory response to push back against that activity."
This article first appeared on Risk.net