Basel II Capital Rule final rule approved by OCC and OTS

WASHINGTON – The Office of the Comptroller of the Currency (OCC) and the Office of Thrift Supervision (OTS) have approved a final rule implementing the advanced approaches of the Basel II Capital Accord. The publication of a final rule was not expected for another month but the current market conditions may have forced the Office of Management and Budget to speed up approval of the implementation of the capital framework.

The new rule establishes regulatory and supervisory expectations for credit risk, through the internal ratings based approach (IRB), and operational risk, through the advanced measurement approach (AMA), and articulates enhanced standards for the supervisory review of capital adequacy and public disclosures for the largest US banks. Adoption of the Basel II framework will occur over a three-year transition period starting on January 1, 2009.

In the press release accompanying the final rule, the OCC stated: “In developing the advanced approaches final rule, the agencies carefully considered comments received during the rulemaking process. Several important changes were made to the proposal in an attempt to balance safety and soundness, regulatory burden, and international and domestic competitive equity considerations.” The supervisors have taken on board comments received following the publication of the advanced notice of proposed rulemaking (ANPR) on the issue in July that raised concerns over the leverage ratio and the limitations on the use of operational risk mitigants. Although the leverage ratio remains, the controversial proposal of modifying the Basel framework if there is a 10% drop in aggregate capital among the top tier banks has been dropped, and the use of op risk mitigants appears at first glance to be much more lenient than the original Basel II Accord text and that in July’s ANPR.

“While the advanced approaches rule is now fundamentally consistent in most respects with the Basel II Framework that is already being implemented internationally, we retained several safeguards unique to the US supervisory process. In so doing, we are able to fundamentally improve the effectiveness and risk sensitivity of our existing regulations while preserving safeguards critical for safety and soundness purposes,” said John C Dugan, comptroller of the currency.

The rule is still to be approved by the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation and must be published in the Federal Register.

Consistent with a July agreement among the banking agencies, the agencies are continuing to develop a proposed rule that would provide all non-core banks with the option to adopt a standardised approach under the Basel II framework.

John Reich, director of OTS, said: “While adoption of the final rule is a significant accomplishment, more remains to be done. We must still introduce into the United States a standardised (non-advanced) approach, consistent with the Basel II framework. We hope to bring forward a notice of proposed rulemaking on the standardised approach in the first quarter of 2008.”

Robert Steel, Treasury undersecretary for domestic finance, welcomed the release of the final rule: “Treasury applauds the US financial regulators for their co-operation in writing a final Basel II rule. This achievement will modernise our bank capital regime to uphold the competitiveness of American capital markets while maintaining and enhancing safeguards for our institutions and the broader financial system. Secretary Paulson has long said that certainty on Basel II was a necessary component of any plan to strengthen the competitiveness of US capital markets, and we are pleased that the regulators worked tirelessly to complete this complex task."

Wayne Abernathy, executive director, financial institutions policy and regulatory affairs at the American Bankers Association, also welcomed the move, deeming it a major step forward, but warned that bankers will need to look at the details more closely to see “how fully the regulators have fulfilled their intent to align the US version with the international accord”. Abernathy also stated that the regulators must now press on with the development of rules for the standardised approach:

“With the advanced approach in place, the regulators must now shift their attention to the development of rules for the standardized approach. Because the standardized approach requires an operational risk component, the regulators should design the standard in a way that eases implementation for adopting banks. We believe that an appropriate menu of operational risk measures would be as important to a successful standardised approach as the standardised approach is important to the success of Basel II. We look forward to working with the regulators on prompt development of the standardised approach.”