A REVIEW OF REGULATORY

PROPOSALS ON BASEL CAPITAL

AND COMMERCIAL REAL ESTATE

HEARING

BEFORE THE

SUBCOMMITTEE ON 

FINANCIAL INSTITUTIONS AND CONSUMER CREDIT

OF THE

COMMITTEE ON FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED NINTH CONGRESS

SECOND SESSION

SEPTEMBER 14, 2006

Printed for the use of the Committee on Financial Services

Serial No. 109–120

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A REVIEW OF REGULATORY PROPOSALS ON BASEL

CAPITAL AND COMMERCIAL REAL ESTATE

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A REVIEW OF REGULATORY

PROPOSALS ON BASEL CAPITAL

AND COMMERCIAL REAL ESTATE

HEARING

BEFORE THE

SUBCOMMITTEE ON 

FINANCIAL INSTITUTIONS AND CONSUMER CREDIT

OF THE

COMMITTEE ON FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED NINTH CONGRESS

SECOND SESSION

SEPTEMBER 14, 2006

Printed for the use of the Committee on Financial Services

Serial No. 109–120

(

(II)

HOUSE COMMITTEE ON FINANCIAL SERVICES 

MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa 

RICHARD H. BAKER, Louisiana 

DEBORAH PRYCE, Ohio 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

ROBERT W. NEY, Ohio 

SUE W. KELLY, New York, Vice Chair 

RON PAUL, Texas 

PAUL E. GILLMOR, Ohio 

JIM RYUN, Kansas 

STEVEN C. LATOURETTE, Ohio 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

CHRISTOPHER SHAYS, Connecticut 

VITO FOSSELLA, New York 

GARY G. MILLER, California 

PATRICK J. TIBERI, Ohio 

MARK R. KENNEDY, Minnesota 

TOM FEENEY, Florida 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

GINNY BROWN-WAITE, Florida 

J. GRESHAM BARRETT, South Carolina 

KATHERINE HARRIS, Florida 

RICK RENZI, Arizona 

JIM GERLACH, Pennsylvania 

STEVAN PEARCE, New Mexico 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

MICHAEL G. FITZPATRICK, Pennsylvania 

GEOFF DAVIS, Kentucky 

PATRICK T. MCHENRY, North Carolina 

CAMPBELL, JOHN, California 

BARNEY FRANK, Massachusetts 

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

DARLENE HOOLEY, Oregon 

JULIA CARSON, Indiana 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

BARBARA LEE, California 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

HAROLD E. FORD, JR., Tennessee 

RUBE ́ N HINOJOSA, Texas 

JOSEPH CROWLEY, New York 

WM. LACY CLAY, Missouri 

STEVE ISRAEL, New York 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

JIM MATHESON, Utah 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

ARTUR DAVIS, Alabama 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

DEBBIE WASSERMAN SCHULTZ, Florida 

GWEN MOORE, Wisconsin, 

BERNARD SANDERS, Vermont

Robert U. Foster, III, Staff Director 

(III)

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS AND CONSUMER CREDIT

SPENCER BACHUS, Alabama, Chairman

WALTER B. JONES, JR., North Carolina, 

Vice Chairman 

RICHARD H. BAKER, Louisiana 

MICHAEL N. CASTLE, Delaware 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

SUE W. KELLY, New York 

RON PAUL, Texas 

PAUL E. GILLMOR, Ohio 

JIM RYUN, Kansas 

STEVEN C. LATOURETTE, Ohio 

JUDY BIGGERT, Illinois 

VITO FOSSELLA, New York 

GARY G. MILLER, California 

PATRICK J. TIBERI, Ohio 

TOM FEENEY, Florida 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

GINNY BROWN-WAITE, Florida 

J. GRESHAM BARRETT, South Carolina 

RICK RENZI, Arizona 

STEVAN PEARCE, New Mexico 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

PATRICK T. MCHENRY, North Carolina 

MICHAEL G. OXLEY, Ohio 

BERNARD SANDERS, Vermont 

CAROLYN B. MALONEY, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

LUIS V. GUTIERREZ, Illinois 

DENNIS MOORE, Kansas 

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

DARLENE HOOLEY, Oregon 

JULIA CARSON, Indiana 

HAROLD E. FORD, JR., Tennessee 

RUBE ́ N HINOJOSA, Texas 

JOSEPH CROWLEY, New York 

STEVE ISRAEL, New York 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

AL GREEN, Texas 

GWEN MOORE, Wisconsin 

WM. LACY CLAY, Missouri 

JIM MATHESON, Utah 

BARNEY FRANK, Massachusetts 

(V)

C O N T E N T S 

Page 

Hearing held on: 

September 14, 2006 .......................................................................................... 1

Appendix: 

September 14, 2006 .......................................................................................... 57

WITNESSES 

THURSDAY, SEPTEMBER 14, 2006

Antonakes, Steven L., Massachusetts Commissioner of Banks, on behalf of 

the Conference of State Bank Supervisors ......................................................... 18

Bair, Hon. Sheila C., Chairman, Federal Deposit Insurance Corporation .......... 11

Bies, Hon. Susan Schmidt, member, Board of Governors of the Federal Reserve System ......................................................................................................... 9

Colby, Robert L.D., Acting Director, Division of Market Regulation, U.S. 

Securities and Exchange Commission ................................................................ 16

Dugan, Hon. John C., Comptroller of the Currency ............................................. 13

Garnett, James M., Jr., Head of Risk Architecture for Citigroup, on behalf 

of the Financial Services Roundtable ................................................................. 36

Lackritz, Marc E., President, Securities Industry Association (SIA) .................. 38

McKillop, James H. III, President and CEO, Independent Bankers’ Bank 

of Florida, Lake Mary, Florida, on behalf of Independent Community Bankers of America (ICBA), Washington, D.C. .......................................................... 37

Meyer, F. Weller, Chairman, President, and CEO, Acadia Federal Savings 

Bank, Falls Church, Virginia, and Chairman, Board of Directors, America’s 

Community Bankers, Washington, D.C., on behalf of America’s Community 

Bankers ................................................................................................................. 35

Mueller, Glenn R., Ph.D., Professor, University of Denver, Franklin L. Burns 

School of Real Estate & Construction Management and Real Estate Investment Strategist-Dividend Capital Group, Inc. ................................................... 42

Petrou, Karen Shaw, co-founder and Managing Partner, Federal Financial 

Analytics, Inc. ....................................................................................................... 39

Reich, Hon. John M., Director, Office of Thrift Supervision ................................ 15

Simmons, Harris H., Chairman, President, and CEO, Zions Bancorporation, 

on behalf of American Bankers Association, Salt Lake City, Utah ................. 33

White, Robert M., Jr., President and founder, Real Capital Analytics, Inc., 

New York, NY ...................................................................................................... 41

APPENDIX 

Prepared statements: 

Bachus, Hon. Spencer ...................................................................................... 58

Waters, Hon. Maxine ........................................................................................ 62

Antonakes, Steven L. ....................................................................................... 68

Bair, Hon. Sheila C. ......................................................................................... 78

Bies, Hon. Susan Schmidt ............................................................................... 96

Colby, Robert L.D. ............................................................................................ 113

Dugan, Hon. John C. ........................................................................................ 117

Garnett, James M. Jr. ...................................................................................... 138

Lackritz, Marc E. .............................................................................................. 155

McKillop, James H. .......................................................................................... 162

Meyer, F. Weller ............................................................................................... 185

Mueller, Glenn R. ............................................................................................. 214

Petrou, Karen Shaw ......................................................................................... 239

Reich, Hon. John M. ......................................................................................... 244

Page

VI

Prepared statements—Continued

Simmons, Harris H. ......................................................................................... 253

White, Robert M., Jr. ........................................................................................ 281

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Bachus, Hon. Spencer: 

Responses to Questions Submitted to Hon. Sheila C. Bair ........................... 293

Responses to Questions Submitted to Hon. Susan Schmidt Bies ................. 299

Responses to Questions Submitted to Hon. John C. Dugan ......................... 306

Statement of Institutional Risk Analytics ...................................................... 377

Letter from The Real Estate Roundtable ....................................................... 427

Statement of the Risk Management Association ........................................... 430

Fossella, Hon. Vito: 

Responses to Questions Submitted to Hon. Susan Schmidt Bies ................. 319

Frank, Hon. Barney: 

Letter from the Office of the Comptroller of the Currency ........................... 443

Statement of the National Association of Realtors ............................................... 452

(1)

A REVIEW OF REGULATORY 

PROPOSALS ON BASEL CAPITAL 

AND COMMERCIAL REAL ESTATE 

Thursday, September 14, 2006

U.S. HOUSE OF REPRESENTATIVES, 

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS

AND CONSUMER CREDIT, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The subcommittee met, pursuant to notice, at 11:03 a.m., in room 

2128, Rayburn House Office Building, Hon. Spencer Bachus [chairman of the subcommittee] presiding. 

Present: Representatives Bachus, Royce, Kelly, Feeney, 

Hensarling, Garrett, Price, McHenry; Sanders, Maloney, Sherman, 

Moore of Kansas, Frank, Carson, and Crowley. 

Chairman BACHUS. Good morning. 

The Subcommittee on Financial Institutions and Consumer Credit holds its sixth hearing today on Basel reform since the 106th 

Congress. 

Today’s hearing will focus on the current status, recent developments, and potential impact of proposals from the financial regulators on Basel capital reform and commercial real estate lending 

guidance. 

All of the regulators have worked hard to develop the proposals 

we will be discussing. 

Governor Susan Bies deserves special appreciation for her dedication and leadership on the Basel accord. 

Governor Bies has created an open dialogue with Members of 

Congress and the financial services industry. She understands the 

concerns that members of this committee have raised with past 

proposals, and has worked diligently to address those issues. 

To the other agencies and regulators, let me say this, I very 

much applaud your efforts. I think you’ve been very responsive to 

the industry. 

There’s not a consensus among the regulators. There are still 

some important differences. But we’re so far away from where we 

were last year, and we’re very, very close, and I applaud all of you. 

I was pleased this month when the regulators met and approved 

the notice of proposed rulemaking on Basel II that requested comment on whether the so-called core banks and opt-in banks should 

be able to use the standardized approach. 

Alternative compliance options are a feature of the original accord, and banks outside the United States are provided this option. 

2

I’ve lost a page of my opening statement. Actually, this isn’t the 

one I wrote. This was an early one. We’ll try to find it. 

Well, I tell you what I’m going to do. I’m going to let Mr. Sanders 

give his opening statement, and I’m going to come back. 

Mr. Sanders. 

Mr. SANDERS. I haven’t lost my paper. I still have it. 

Mr. Chairman, thank you for holding this important hearing, and 

I look forward to hearing from our witnesses. 

In the interest of time, I’ll make my remarks very brief, and then 

hand the ranking member responsibilities over to Ms. Maloney, 

who has worked on this issue for a number of years. 

This hearing will review both the recent Basel II and commercial 

real estate proposals put forward by the ranking regulators. 

This subcommittee has held several hearings on the Basel capital 

accords, and I would like to applaud the chairman, Ranking Member Frank, Ms. Maloney, and others for their leadership on this 

issue. 

The Basel accords determine the process by which banks determine the capital they must hold in reserve to meet regulatory requirements. 

The Basel II accords apply to the 10 largest banks, while the 

Basel I accords apply to the smaller banks. 

In my opinion, it is extremely important that big banks are not 

given an unfair advantage over smaller banks in this process, and 

I’m not convinced that has happened to date. 

Mr. Chairman, I’d like to ask for unanimous consent to insert 

into the record a statement by the National Association of Realtors. 

Chairman BACHUS. Without objection. 

Mr. SANDERS. Mr. Chairman, I share the concerns of the National Association of Realtors that both the proposed regulations 

and the proposed guidance on commercial real estate lending underestimate the strength and stability of the commercial real estate 

market and do not sufficiently recognize the diverse performance 

traits of the different classes of commercial real estate. 

The combined effect of these two regulatory proposals may 

prompt banks either to avoid making loans for sound real estate 

ventures or to increase the cost of capital required for commercial 

real estate. 

I am also concerned that if the regulatory parameters are not appropriately set, the flow of capital to commercial real estate would 

be diminished, leading to a weakening of the commercial real estate market. Mr. Chairman, we must not allow that to happen. 

We must ensure that the final guidelines on commercial real estate, risk management guidelines, preserve and strengthen the 

safety and soundness of the banking system while not unduly 

harming the flow of capital to commercial real estate. 

Again, I thank the Chair for holding this hearing and I look forward to hearing from our witnesses. 

Mr. Chairman, is it appropriate to give the microphone over to 

Ms. Maloney for a few words at this point? Can I yield to Ms. 

Maloney to complete my statement? 

Chairman BACHUS. Actually, I’m going to recognize—oh, for part 

of your time? 

Mr. SANDERS. Yes. 

3

Chairman BACHUS. Okay. 

Mrs. MALONEY. Thank you, Mr. Chairman, Ranking Member 

Sanders, and Ranking Member Frank. 

I first would like to welcome all of the witnesses, particularly one 

who is a constituent from my district, Mr. James Garnett of 

Citibank, who is testifying today on behalf of the Financial Services 

Roundtable. 

As a representative from New York, the financial capital of the 

Nation, I have been deeply interested in the development of the 

Basel II capital accord since its inception. 

The concept of adjusting capital requirements to reflect risk more 

accurately than the present regulatory system does is a tremendous opportunity for the American financial services industry and 

for the U.S. financial regulatory regime, but also it is a great risk. 

The process of financial services regulation in this country is 

more complex and involves many more players than in most nations, with different agendas and powers, and our regulatory system is by far the most robust in the world. 

We have a more diverse and multi-faceted industry in many nations with different needs and concerns. 

As I have said at many stages of this process, if we are not careful, these factors can drive us to a new regulatory scheme that disadvantages our financial services industry rather than making it 

more competitive, while not improving safety and soundness. 

We can end up with a situation in which the new capital requirements provide incentives to increase, rather than reduce, risk, and 

thus threaten the safety and soundness of the system. 

Congress is certainly not well-equipped to legislate a regulatory 

scheme of this complexity, but it is our job to guide regulators toward policy goals. 

Our goals are the same as those of the Basel Committee, to continue to promote safety and soundness while enhancing competitive 

equity and instituting a more comprehensive approach to evaluating and addressing risk. 

I have to say that I am not confident that the present proposal 

is well designed to achieve that end. 

As I am sure we will hear from the industry witnesses, financial 

institutions, even the biggest ones who are up now, have been presumed to be the biggest beneficiaries of the new rules. Many are 

very apprehensive that the new rule will leave them at a significant disadvantage as compared to foreign financial institutions. 

The regulators have taken the position that the revised formulas 

are necessary to maintain overall capital in the system and respond to the concerns raised by the results of the last quantitative 

impact study, the QIS. 

I am sure that the regulators also want a competitive U.S. industry, but they do not appear to have the confidence of their industry, 

and they have put our banks in as good a position as those of other 

nations. 

One point that I hope the witnesses address is the apparent gap, 

the gap between the practices mandated by the proposed U.S. rules 

to measure risk and those used by the financial institutions at 

present. 

4

Large banks already have very complicated and sophisticated internal risk models and risk management systems, all subject to 

oversight. 

According to some of the financial institutions I’ve talked to, the 

proposed U.S. rules mandate systems that are so different that 

banks will have to keep literally two sets of books, one to measure 

what the regulators want to know about risk, and one to measure 

what the banks think they know to do the job. 

As a policymaker, this is deeply disturbing, since it suggests that 

either the markets or the regulators are missing the boat and 

measuring irrelevant variables. 

I also hope the witnesses will address the cost of compliance and 

the return in terms of better risk management. We cannot institute 

a system that is not cost effective because it will unnecessarily 

hamper our financial institutions and make them uncompetitive in 

the global market. 

Chairman BACHUS. Ms. Maloney. 

Mrs. MALONEY. I have a lot more to say, but I’ll put it in the 

record. 

Chairman BACHUS. Thank you. 

Mr. Frank. 

Mr. FRANK. Thank you, Mr. Chairman. 

I appreciate our having the chance to talk about both of these 

events. 

Let me start on the question of Basel, and I appreciate Governor 

Bies’s diligence in working with us. 

You know, there is a view that says that when Congress intervenes in something, particularly if it is complicated and technical, 

we either muck it up or corrupt it, that we are either looking to 

benefit some undeserving group or we will get in over our heads; 

and that is not always untrue, but neither is it true as often as 

people say, and I really want to hold up the Basel issue as an example of an extremely constructive Congressional intervention. 

I believe that the result of the process we’ve had, it’s been conversations back and forth. I think we have a better proposal. We 

are still working on it. 

I think, frankly, we were the catalyst for there being better cooperation among the regulators. I think we had a situation when 

we first got into this where the relationships among the regulators 

were dysfunctional and I think our impact has been helpful. 

And so I want to say that I think this is a case, on a bipartisan 

basis, where we have played a constructive role. Of course, since 

it has been both bipartisan and constructive, it is rarely chronicled, 

and so that is why I thought it was worth underlining. 

I will say to the regulators, particularly to the Federal Reserve, 

which has had a major initiative, I am skeptical of the resistance 

to the notion about the standardized approaches. 

You know, sometimes, when all the people in industry get together, you get nervous. As Adam Smith said, when all the people 

in the same trade get together, you have reason to worry. 

In this case, I think the consensus that has emerged among the 

banks is a constructive and helpful thing. This is not a case of the 

banks versus the public interest. It’s not a case of the banks versus 

the consumers or the banks versus the securities. 

5

In this situation, I don’t think we have the concern that this is 

a group of people who have a common economic interest in contradistinction to others in the society, and in fact, as we all know, 

many of the problems we had were the differential impact that capital standards could have within the banking industry. 

I am impressed by this consensus. I congratulate the people in 

the banking industry for a very responsible effort to come together 

on this, and I would say to the regulators, this is a case where, in 

my mind, the burden of proof is on those who would say, ‘‘No, 

that’s not going to work given the commonality of interest.’’ 

The next area is the real estate guidance. 

First of all, I have to say I don’t mean to impugn motives. We’re 

not talking about personal stuff here. But I think it would be disingenuous for the regulators to say, ‘‘Oh, this doesn’t have any real 

impact, this is just kind of generalized guidance.’’ 

In the first place, when someone says to me, ‘‘Oh, listen, you 

know, I just want to point out to you that being extremely badly 

dressed is a great defect in your business, and having clothes that 

are ragged and dirty and mismatched, you know, that is something 

that you certainly don’t want to fall into, oh, and by the way, nothing in what I said suggests that you’re at all guilty of this or that 

you have to change your pattern’’—no one would believe anybody 

who said that. 

I mean, there are a lot of things in the world to say, and the very 

fact of singling something out to say it has a great impact, particularly, frankly, when you are you, the regulators. You are enormously powerful people with great impact. 

And so I think we have to begin by saying the fact that you have 

singled out this kind of real estate lending for guidance, I mean, 

whenever someone says to me, ‘‘Oh, by the way, I want to tell you 

not to be stupid and not to be dangerous, but please don’t be offended,’’ I’m offended, because the fact that you felt the need to tell 

me not to be stupid doesn’t make me think you think I’m all that 

bright. So let’s be clear about that. 

I am therefore worried, because, yes, I understand that there is 

an increase in the lending, but by your own figures, there is no increase in risky lending. There does not appear to be a problem. 

And there is a negative side to this. Clearly, if I am a bank, I 

would rather not have you give me explicit guidance on something. 

That is not a good sign. 

I have to say this to cover up my own staff. If I get a letter from 

somebody saying, ‘‘By the way, Congressman, I just would like to 

point out to you that it would not be a good idea for your staff to 

be rude or forgetful or make any enemies; by the way, nothing in 

this suggests’’—I would call in the staff and say, ‘‘What is this? 

What happened? Who did what to whom?’’ I mean, anybody would 

do that. 

So I am afraid you will discourage some of this, and there are 

two areas. 

One, we work a lot with mayors and municipal officials. Downtown lending is very important for them, the commercial development, but even more for me, the fact that multi-family housing is 

included in here. 

6

We have a terrible social crisis in America with housing that is 

far too expensive for a lot of working people. We have municipalities where police officers and firefighters and teachers and sanitation workers can’t live in the city where they work. 

I would hope that you would be extremely loathe to do anything 

that might diminish the construction of multi-family housing. We 

have too little of it in this country. We have local prejudices expressed through zoning that are problems, etc. 

And I believe that you, by your guidance, you have really discouraged to some extent that kind of lending, and unless you’ve got 

a pretty good reason, the fact that there is more lending absent 

anything shouldn’t be the reason, and at the very least—and I appreciate the time, Mr. Chairman, I’ll close with this—you’ve already done that, you say to us, ‘‘Well, this doesn’t mean they 

should cut back.’’ Then I would hope that would be part of the official statement. 

Everybody has gotten that guidance. You ought to write to them 

and say, ‘‘By the way, nothing in here suggests that you have done 

anything wrong, that you have been in any way imprudent, or that 

you should in any way be cutting back on this area.’’ 

That would at the very least reassure me. A failure to do that 

would reinforce my nervousness. 

Thank you for the indulgence, Mr. Chairman. 

Chairman BACHUS. Thank you, Mr. Frank. 

Now I’m going to give the remainder of my opening statement. 

I want to apologize to the staff first for doing the impossible, and 

that’s that I wrote out my speech, my second draft, in longhand, 

and I neglected to give it to them. 

[Laughter] 

Chairman BACHUS. So it was pretty impossible for them to include the additions. 

The goal of Basel is to develop a more flexible and forward-looking capital adequacy framework that better reflects the risks facing 

banks and encourages them to make ongoing improvements to 

their risk assessment capabilities. 

Over the past 7 years, the United States Federal banking regulators have been engaged in negotiations with their foreign counterparts about improving the standards that govern the capital 

that depository institutions must hold against their assets. 

We must ensure throughout this process that we do not include 

a framework that is too complex or too costly to be followed. 

There is a wide variety of views expressed in the testimony that 

we will receive today. 

On one hand, the Federal banking regulators are testifying that 

they have developed a Basel II rule that is intended to produce 

risk-based capital requirements that are more risk-sensitive than 

the existing rules. 

On the other hand, industry witnesses will testify that the current U.S. version of the Basel II rule is less risk-sensitive than the 

internationally negotiated Basel II accord and that the differences 

between the U.S. rule and the accord creates serious competitive 

issues, both within and outside the United States. 

This suggests to me that more work needs to be done on the rule. 

7

I was pleased this month that the regulators met and approved 

the notice of proposed rulemaking on Basel II that requested comment on whether the so-called core banks and opt-in banks should 

be able to use the standardized approach. 

Alternative compliance options are a feature of the original accord and banks outside the United States are provided this option. 

In addition to the issues arising from Basel II, our hearing today 

addresses a January 2006 interagency guidance on concentrations 

in commercial real estate proposal by the bank regulators. The proposal seeks to address high and increasing concentrations of commercial real estate loans at some banks and savings associations. 

The agency suggests recent examinations show that risk management practices and capital levels of some institutions are not keeping pace with their increasing CRE loan concentrations. 

In return, the guidance sets forth thresholds for assessing whether an institution has a CRE concentration that should employ 

heightened risk management practices. The guidance urges those 

institutions with elevated concentration risk to establish risk management practices and capital levels commensurate with the risk. 

Some institutions have expressed the concern, however, that the 

proposed guidance is too much of a ‘‘one size fits all’’ formulation, 

and is effectively a cap on commercial real estate lending. They instead urge that the regulators utilize the examination process that 

identifies lending weaknesses in particular institutions. 

They contend that the data does not support the proposition that 

real estate lending, per se, is more risky than commercial and industrial lending, for example. 

Further, there is concern that the proposed guidance is unfairly 

burdensome for community banks that do not have opportunities to 

raise capital or diversify their portfolios like larger banks. 

It is my hope that, by the end of this hearing, we may all be 

working for the same set of underlying facts with respect to how 

the real estate works. In turn, I would hope that this will help ensure better regulation that will protect the taxpayer while not arbitrarily discouraging sound lending. 

In closing, I want to thank Chairman Oxley, Ranking Member 

Frank, and all of the members of the committee for their interest 

in working to ensure that we get Basel right. 

I look forward to hearing from the witnesses today. 

At this time, I recognize Mr. Hensarling. 

Mr. HENSARLING. Thank you, Mr. Chairman. 

First, let me thank you for holding this hearing. I frankly think 

it’s one of the more important hearings that your committee could 

hold. It’s a very, very tough issue that we have to deal with. 

On the one hand, as somebody who represents a district in 

Texas, although I was not in Congress at the time, I still have a 

very firm memory of the late 1980’s and early 1990’s and the S&L 

meltdown, and how an over-concentration of real estate led to an 

incredible economic contraction and a massive taxpayer bailout. So 

my memory of that incident in American history is still quite clear. 

On the other hand, today we’re enjoying one of the best economies that we have enjoyed in America, with historically low unemployment rates, 5 million new jobs, we’re awash in tax revenues, 

we’ve got the highest rate of home ownership we’ve had in the hisVerDate 0ct 09 2002 13:05 Apr 10, 2007 Jkt 031549 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 K:\DOCS\31549.TXT HFIN PsN: TERRIE
8

tory of America, we have many other good and favorable signs, and 

a very good case can be made that real estate has helped lead to 

this economic boom. 

So anything that would provide onerous burdens on further loans 

to commercial real estate concerns me, and as many on this panel 

know, and share with me, I have a concern about the future of 

community banking in America, which with the help of almost everybody on this committee, we put together what I believe is a very 

good regulatory relief bill that would be very significant for community banks. 

But if we don’t, if the regulators don’t get it right, that burden 

is going to increase even further, and I am led to believe that this 

particular niche in the marketplace is a very, very important niche 

to their profitability and their survivability. 

So I look forward to hearing from all the witnesses, but as always, I come into these hearings with a very strong bias in favor 

of free people and free markets, and I always put the burden of 

persuasion upon those who are proposing further restrictions upon 

loans and loan limits, and I look forward to hearing what compelling case might be made in this regard. 

And again, Mr. Chairman, I thank you for holding this important 

hearing and I yield back. 

Chairman BACHUS. Thank you, Mr. Hensarling. 

Are there any other members who wish to make opening statements? 

Ms. Kelly. 

Ms. KELLY. I thank you, Chairman Bachus, for holding this hearing. 

I, too have shared the interest in this committee in learning how 

the Basel II accords will impact our local communities. 

Unfortunately, we now have the evidence that there is such evidence, and it’s negative. 

On January 10, 2006, an interagency guidance was issued regarding commercial real estate lending. This has been followed by 

weeks of reports from community banks that examiners are now 

questioning bank investments in their own communities that have 

never before raised any concern. 

While there’s a legitimate concern that banks not over-lend in 

any category, commercial real estate is a single name for a very 

broad range of activities. Everything from factories, hotels, golf 

courses to warehouses, office buildings, and parking lots is contained in the category of commercial real estate. 

Unlike housing, which moves broadly to interest and employment 

rates regionally and nationwide, each class of commercial real estate responds differently, and to lump them together for the purpose of bank examination doesn’t seem to make a whole lot of sense 

to me. 

Community banks exist to serve their communities, to understand their needs, and to provide capital for worthwhile investment. By definition, they invest where their customers are. They 

invest also for the long term and have a very large stake in the 

success of their neighbors. 

9

Unlike capital from large institutions, they provide a continuity 

which can often be the difference between the success or failure of 

a whole town or even a county. 

To require an artificial diversification out of the communities 

that they serve doesn’t really benefit them or the taxpayers. 

The guidance issued by the banking agencies, if confirmed, I believe will eliminate the small bank as a viable institution. Commercial lending, like credit cards, home lending, and deposits will be 

dominated by large banks and conglomerate financial institutions. 

I urge these witnesses that are going to be before us today to 

take a look at community banks and their portfolios as individual 

institutions rather than lumping them together just to save regulators time and effort. 

I thank you and I yield back the balance of my time. 

Chairman BACHUS. Thank you, Ms. Kelly. 

Are there any other members? Mr. Price, did you have an opening statement? Okay. No other opening statements. 

All right. At this time, I’d like to introduce the first panel, which 

needs no introduction. 

Mr. Frank wanted to introduce Mr. Antonakes, but I’ll introduce 

all of them, I think. 

The first panel consists of: the Honorable Susan Bies, Governor, 

Board of Directors of the Federal Reserve System; the Honorable 

Sheila Bair, Chairman, Federal Deposit Insurance Corporation; the 

Honorable John C. Dugan, Comptroller, Office of the Comptroller 

of the Currency; the Honorable John Reich, Director of the Office 

of Thrift Supervision; Mr. Robert Colby, Acting Director, Division 

of Market Regulation at the SEC; and Mr. Steven L. Antonakes, 

commissioner, Massachusetts Division of Banks. And you’re testifying on behalf of the Conference of State Bank Supervisors; is that 

correct? Okay. 

We welcome all of the panelists and look forward to your opening 

statements. Thank you. 

Governor Bies. 

STATEMENT OF HON. SUSAN SCHMIDT BIES, MEMBER, BOARD 

OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM 

Ms. BIES. Thank you, Mr. Chairman. I want to thank you, Representative Sanders, and members of the subcommittee for this opportunity to join my colleagues to discuss both the recent developments in regulatory capital and our proposed guidance on sound 

risk management for commercial real estate. 

Let me begin by just saying that the completion last week of the 

draft NPR for Basel II for comment reflects a lot of hard work 

across all of the agencies and active input from many constituencies, bankers and non-bankers, and Congress. We really appreciate all of the effort that people put in; I think all of us know it 

was important in achieving this milestone. 

I want to make one comment before I get to Basel II, about the 

market risk amendment that was also put out for comment. This 

is an update of an old rule that we’ve had that deals with trading 

book risk, and this is applicable to all U.S. banks currently that 

have big trading book activity. 

10

What’s remarkable about this is that it’s based on the framework 

that was jointly agreed to by the Basel Banking Committee and the 

International Association of Security Commissioners. What we’re 

proposing here is both an update that reflects new risk-taking, but 

more importantly, will help to level the playing field between investment banks and commercial banks who are subject to the similar regulatory environment for capital. We’ve been working actively 

with the SEC and we appreciate their support on that; so we look 

forward to those comments, too. 

Let me turn to Basel II. As you know, as we’ve been working 

through this, we have tried to emphasize not just the Pillar 1, 

which has gotten most of the attention, but also Pillars 2 and 3. 

The Pillar 1 proposal that we have put together in this NPR proposes that only the most advanced organizations are required to 

adopt it, and it uses the most advanced approaches of the Basel 

2004 Accord. I want to compare that to what you’re hearing from 

other countries and what they’re doing. 

There’s a difference here, because in other countries, when Basel 

II becomes effective, Basel I goes away. We’ve chosen, in the 

United States, to listen to the smaller community banks and to retain Basel I, which we are working to amend. 

What this means is that since Basel II applies to all banks of all 

complexity and size globally in those countries, there are three general varieties of approaches to risk to reflect the differences in size 

and complexity of those organizations. Again, we in the United 

States have only focused on the most advanced approaches. 

But it’s also important to realize that Pillar 2 is very important 

in all of this, because it requires that an organization look beyond 

credit and operational risk to look broadly at their risk through the 

cycle, and make sure it agrees with their business strategy. 

Finally, Pillar 3, which ensures additional disclosure, is important because it reflects that we want market discipline to differentiate risk. 

We at the Federal Reserve have been consistently supporting the 

most advanced approaches because today’s Basel I does not reflect 

the changes in risk for these big organizations; it doesn’t reflect the 

operational risks that have led to a lot of publicly charged off 

events and some of the legal problems that banks have encountered 

that required chargeoffs; it doesn’t reflect the fact that under Basel 

I a certain portfolio could have very different kinds of risk exposures across banks, and we think a bank who chooses to take on 

more risk of a certain type should hold more capital. 

Finally, we’ve got the safeguards in the proposal, both in terms 

of parallel runs and transition periods, but we also have listened 

to comments, done analysis based on QIS studies, and strengthened elements in this NPR to deal with weaknesses that we’ve already identified, and we’ll continue to do that as we move forward. 

Finally, on commercial real estate. Commercial real estate has 

our concern. As a banker, I lived through the hard side of working 

through the southeast real estate problems in the 1980’s. We know 

today that community and mid-size banks have exposure to commercial real estate relative to capital twice what it was in 1990. 

What we intended in this guidance, since we don’t have a lot of 

information on the call reports, is to indicate to our examiners that 

11

they need to focus on the portfolio management of these banks, not 

just the individual loan underwriting, and that they need to begin 

a dialogue at the screen levels, which would not be ceilings. 

And we do want our examiner to look at how the bank looks at 

the types of real estate loans they have, and how they monitor the 

markets, and to consider the broader aspects of portfolio concentration management which we find is not developing as quickly as 

banks increase their concentration in this line of business. 

Thank you, Mr. Chairman, for your comments, and I’ll wait for 

further questions. 

[The prepared statement of Governor Bies can be found on page 

96 of the appendix.] 

Chairman BACHUS. Thank you. 

Chairman Bair. 

STATEMENT OF HON. SHEILA C. BAIR, CHAIRMAN, FEDERAL 

DEPOSIT INSURANCE CORPORATION 

Ms. BAIR. Thank you, Mr. Chairman. I would also like to thank 

you, Ranking Member Sanders, and the members of the subcommittee for the opportunity to testify on behalf of the Federal 

Deposit Insurance Corporation concerning the Basel II international capital accord and Federal banking agencies’ recent draft 

guidance on commercial real estate lending. 

Basel II and the commercial real estate guidance share one important feature, a focus on the importance of risk management. At 

the outset, I would like to emphasize that we all support moving 

ahead to the next step in the Basel II deliberative process. 

The FDIC board of directors recently voted to publish the Basel 

II notice of proposed rulemaking for public comment. U.S. bank 

and thrift regulators also are developing a more risk-sensitive capital framework for non-Basel II banks, known as Basel IA, which 

we hope to publish for comment in the near future. 

While it is important to move ahead with the process, there’s 

also agreement that we must not do so in a way that will result 

in significant reductions in capital or in the creation of competitive 

inequities among different types of insured depository institutions. 

The agencies’ most recent quantitative impact study suggested 

that the Advanced Approaches would result in a substantial reduction in risk-based capital requirements. The results also showed 

wide variations in capital requirements for similar risks. 

The agencies found these results unacceptable, and as a result, 

included a number of important and essential safeguards in the 

NPR to address these issues. 

I look forward to receiving comments on the NPR and I will approach those comments with an open mind. I particularly look forward to comments on the question of whether the regulators should 

allow alternatives to the Advanced Approaches. 

We have had a number of requests to allow any U.S. bank to use 

the Standardized Approach to capital regulation that is part of the 

Basel II accord. The United States is the only country proposing to 

make the Advanced Approaches mandatory for any group of banks. 

The Standardized Approach includes a greater array of risk rates 

than the current rules. It is simpler and less costly to implement 

than the Advanced Approaches. In addition, because there is a floor 

12

for each risk exposure, it does not provide the same potential for 

dramatic reductions in capital requirements. 

On the other hand, there is the argument that only the Advanced 

Approaches would provide an adequate incentive for the strengthening of risk management systems at our largest banks. Whether 

our largest banks should be required to use the Advanced Approaches is a fundamental issue, and again, I look forward to public comment on this question. 

Before concluding my remarks on Basel II, I would like to say 

a few words about the leverage ratio. The FDIC has consistently 

supported the idea that the leverage ratio, a simple capital-to-assets measure, is a critically important component of our dual capital regime. I am very pleased that all the bank regulators have expressed their support for preserving the leverage ratio. 

I understand that banks in most other Basel Committee countries are not constrained by a leverage ratio, and that effective capital standards around the world vary widely as a result. For this 

reason, I believe that the United States should ask the Basel Committee to initiate consideration of an international leverage ratio. 

The leverage ratio has provided U.S. supervisors with comfort 

that banks will maintain a stable base of capital in good times and 

in bad times. Similarly, the establishment of an international leverage ratio would go far in strengthening the liquidity and stability of the international banking system and help limit the consequences of reduced risk-based capital levels with Basel II implementation. 

The committee also asked us to discuss the proposed guidance on 

commercial real estate exposures. The need for this guidance stems 

from the substantial growth in commercial real estate lending at 

community banks in recent years. 

At the end of March 2006, commercial real estate loans accounted for more than 42 percent of all loans at institutions with 

less than $1 billion in assets. Six years ago, these loans represented less than 28 percent of all loans at these institutions. 

Loan concentrations add a dimension of risk that needs to be appropriately identified and managed, and some examinations have 

revealed that portfolio management practices may not have kept 

pace in this growth. 

The goals of the proposed guidance were to increase awareness 

of commercial real estate exposures, reinforce existing regulations 

and guidelines for real estate lending, and remind institutions that 

strong risk management practices and appropriate levels of capital 

are necessary to mitigate the potential concentration risk. 

The FDIC and the other banking agencies have seriously considered commenters’ views on this proposed guidance. We appreciate 

the importance of CRE lending, particularly for community banks, 

and do not intend to limit CRE lending activity that is prudently 

underwritten and appropriately managed. 

In particular, we agree with the need to emphasize that the stated thresholds are not limits, but rather are designed to trigger 

heightened scrutiny to assure adherence to sound credit principles 

and best practices. Once these perspectives are reflected in the 

final guidance, it should provide a useful tool for both examiners 

and banks. 

13

This concludes my statement. The FDIC appreciates the opportunity to testify regarding Basel II and the CRE guidance. I look 

forward to any comments or questions the subcommittee may have. 

Thank you. 

[The prepared statement of Chairman Bair can be found on page 

78 of the appendix.] 

Chairman BACHUS. Thank you, Chairman Bair. 

Now, Comptroller Dugan. 

STATEMENT OF HON. JOHN C. DUGAN, COMPTROLLER OF THE 

CURRENCY 

Mr. DUGAN. Chairman Bachus and members of the subcommittee, I appreciate the opportunity to discuss two important 

initiatives of the U.S. banking agencies—our proposals to enhance 

our regulatory capital program under Basel II and our proposed 

commercial real estate guidance. 

The U.S. implementation of Basel II is, at its core, an effort to 

move away from the simplistic Basel I capital regime for our largest internationally active banks. The inadequacies of the current 

framework are pronounced with respect to these banks, which is a 

matter of great concern to the OCC because we are the primary 

Federal supervisor for the five largest; these institutions, some of 

which hold more than $1 trillion in assets, have complex balance 

sheets, take complex risks, and have complex risk management 

needs that are fundamentally different from those faced by community and mid-size banks. 

Because of these attributes, Basel II is necessarily complex, but 

it would be mandatory for only a dozen large U.S. institutions. The 

new regime is intended not only to align capital requirements more 

closely to the complex risks inherent in these largest institutions, 

but, just as important—and this is a complete departure from the 

existing capital framework—it would also require them to substantially improve their risk management systems and controls. This 

would be accomplished using a common framework and a common 

language across banks that would allow regulators to better quantify aggregate risk exposures, make more informed supervisory decisions, disclose more meaningful risk information to markets, and 

make peer comparisons in ways that we simply cannot do today. 

Last week, as you’ve heard, the agencies took a critical step forward in this process by approving the NPR. In addition to establishing the basic Basel II framework in the United States, the NPR 

addresses two key issues about implementation. 

The first concerns the reliability of the framework itself. As you 

know, last year’s quantitative impact study of the potential impact 

of an earlier version of Basel II predicted substantial drops and dispersions in minimum required capital. These QIS–4 results would 

be unacceptable to all the agencies if they were the actual results 

produced by a final, fully supervised and implemented Basel II 

rule. But they were not. Some changes already made in the proposed rule and others that will be considered after the comment period, should mitigate the QIS–4 results. More importantly, we believe that a fully supervised implementation of a final Basel II rule, 

with examiners rigorously scrutinizing the inputs provided by 

14

banks, is likely to prevent unacceptable capital reductions and dispersions. 

We cannot be sure, however. That’s why the proposed rule will 

have strict capital floors in place to prevent such unacceptable results during a 3-year transition period. This will give us time to finalize, implement, supervise, and observe ‘‘live’’ Basel II systems. 

If, during this period, we find that the final rule would produce unacceptable declines in the absence of these floors, then we will have 

to fix the rule before going forward, and all of the agencies have 

committed to do just that. 

The second issue concerns optionality. The NPR asks whether 

Basel II banks should have the option of using a simpler approach. 

This is a legitimate competitive question, given that the largest 

banks in other Basel II countries have such an option, although, 

as a practical matter, all such foreign competitors appear to be 

adopting the advanced approaches. We are very interested in comments about the potential competitive effects of providing such an 

option to U.S. banks. 

The OCC has been a frequent critic of many elements of the 

Basel II framework, and we’ve worked hard to make important 

changes to the proposal that we thought made sense. But at critical 

points in the process, the OCC has supported moving forward toward implementation. Our reason for doing so is simple. An appropriate Basel II regime will help both banks and supervisors address the increasingly complex risks faced by our largest institutions. 

While we may not yet have all the details right, and we will 

surely make changes as a result of the public comment process, I 

fully support the objectives of the Basel II NPR for the supervision 

of our largest institutions. Likewise, for non-Basel II banks, I fully 

support our interagency effort to issue the so-called ‘‘Basel IA’’ proposal in the near future as a way to more closely align capital with 

risk without unduly increasing regulatory burden. 

Let me turn now to the proposed interagency guidance on commercial real estate lending, which the agencies proposed for three 

reasons. 

First, although circumstances are different today and underwriting standards are much improved, we know from the painful 

experience of just 20 years ago that commercial real estate lending 

has the real potential to fail banks. 

Second, during the last 5 years, we have seen a dramatic surge 

in the concentrations in commercial real estate lending in community and mid-size banks, to levels beyond what they were in the 

1980’s. 

And third, our examinations revealed that risk management 

practices in many of these banks have not kept pace with the surge 

in concentrations. 

While we believe that commercial real estate concentrations can 

be safely managed, they must be effectively managed in order to 

be safe. Accordingly, the basic message of the proposed guidance is 

not ‘‘cut back on commercial real estate loans.’’ Instead, it is this: 

‘‘You can have concentrations in commercial real estate loans, but 

only if you have appropriate risk management and capital to address the increased risk.’’ And when I say ‘‘appropriate risk manVerDate 0ct 09 2002 13:05 Apr 10, 2007 Jkt 031549 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 K:\DOCS\31549.TXT HFIN PsN: TERRIE
15

agement and capital,’’ that does not refer to expertise or capital levels that are out of reach or impractical for community and mid-size 

banks. Indeed, at its core, the proposed new guidance amplifies 

guidance the agencies developed in the wake of the widespread 

bank failures of the 1980’s. 

In addition, the overwhelming majority of banks affected by the 

guidance already hold capital significantly above the regulatory 

minimums, so these institutions generally would not be affected by 

the capital adequacy part of the proposed guidance. 

The proposed guidance would establish thresholds to help us determine where enhanced risk management and adequate capital 

are needed. I know some banks worry that the thresholds will turn 

quickly into caps. But I can tell you categorically that this is not 

what the guidance says and not how it would be implemented. The 

OCC is emphasizing this very point—that these are thresholds for 

better prudential practices, not caps—in discussions with our examiners in every region of the country. 

In closing, let me emphasize that as we move forward with these 

proposals, the agencies will continue to foster an open process, consider all comments, heed good suggestions, and address legitimate 

concerns. 

Thank you very much. 

[The prepared statement of Comptroller Dugan can be found on 

page 117 of the appendix.] 

Chairman BACHUS. Thank you. 

Director Reich. 

STATEMENT OF HON. JOHN M. REICH, DIRECTOR, OFFICE OF 

THRIFT SUPERVISION 

Mr. REICH. Thank you, Chairman Bachus, Ranking Member 

Frank, and members of the subcommittee. I appreciate the opportunity to be here this morning. Borrowing a phrase often repeated 

in Washington, that everything has been said and not everybody 

has had an opportunity to say it, I’m going to make a few brief 

comments and be quiet. 

Let me say that OTS is supportive of the Basel II advanced approach and we are supportive of considering the standardized approach. Also, I’m very supportive of the safeguards that we have 

included within Basel II. 

I believe that the longer implementation process will provide us 

with ample information, ample time over the next few years between now and the end of 2011 to have the opportunity to make 

any changes that we feel may be necessary. 

Regarding Basel IA, I’m very supportive of dating Basel I but I 

also expect to be supportive of permitting the very well-capitalized 

banks who have indicated a preference to continue operating under 

the present Basel I framework to be able to do that. 

With regard to the proposed commercial real estate guidance proposal issued in January, we’re supportive of the general purpose 

and intent to remind institutions that credit concentrations can 

pose risks and that these risks should be assessed and addressed, 

further, that risk management practices should be commensurate 

with the level of concentration of commercial real estate loans 

within the portfolio. The guidance has drawn substantial negative 

16

reaction, particularly to the specific thresholds which are included 

in the guidance. 

As a former community banker, I’m keenly sensitive to these 

issues and highly cognizant of the magnitude of the public comment received and the nature of that comment. 

My expectation is that the guidance should be viewed as a set 

of guidelines by the industry and our examiners. The proposed 

guidance is not a rule. 

As we continue to work on the guidance, I’m hopeful that it can 

be modified to address the comments that we have received and to 

clarify the Federal banking agencies risk management expectations 

for the industry and to make sure the guidance conveys this intent 

more clearly. 

I look forward to working with my colleagues on this panel in finalizing the guidance. 

Thank you very much, and I’ll be happy to answer questions. 

[The prepared statement of Director Reich can be found on page 

244 of the appendix.] 

Chairman BACHUS. Thank you. 

Acting Director Colby. 

STATEMENT OF ROBERT L.D. COLBY, ACTING DIRECTOR, DIVISION OF MARKET REGULATION, U.S. SECURITIES AND EXCHANGE COMMISSION 

Mr. COLBY. Chairman Bachus, Ranking Member Sanders, and 

members of the subcommittee, I’m very pleased to have the opportunity this morning, on behalf of the Securities and Exchange Commission, to describe the Commission’s program for monitoring capital at U.S. securities firms. 

While the Commission has applied a conservative net capital rule 

for many years to broker-dealers, as the securities business has expanded and broker-dealers became part of international financial 

conglomerates, the Commission became increasingly concerned 

about the risks that a broker-dealer may fail, due to the insolvency 

of its holding company or affiliates. 

Therefore, in 2004, the Commission amended its net capital rule 

to establish a voluntary alternative method of computing net capital for well-capitalized broker-dealers that have adopted strong 

risk management processes. 

This alternative method permits a broker-dealer to use mathematical models to calculate net capital requirements for markets 

and derivatives-related credit risk. 

As a condition to that method, the broker-dealer’s ultimate holding company must consent to group-wide Commission supervision, 

thus becoming a consolidated supervised entity, or CSE. 

Formally supervising the financial condition of the broker-dealer 

holding company and its affiliates on a consolidated basis allows 

the Commission to monitor better and act more quickly in response 

to any risks that affiliates and the ultimate holding company will 

pose to regulated entities within the group or to the broader financial system. 

The Commission’s program to supervise the CSE’s also responded to concerns of the U.S. investment banks regarding the apVerDate 0ct 09 2002 13:05 Apr 10, 2007 Jkt 031549 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 K:\DOCS\31549.TXT HFIN PsN: TERRIE
17

plication to their activities in Europe of the European Union’s financial conglomerates directive. 

The directive requires that firms active in Europe be supervised 

at the group level under a regulatory approach equivalent to those 

applied in the European Union or face significant restrictions on 

their activities. 

The European Union has recognized the broad equivalence of the 

Commission’s CSE oversight program. 

Currently, five U.S. investment bank holding companies are supervised as CSE’s. Under the Commission’s program, the ultimate 

holding company must provide the Commission with information at 

the group level covering its global businesses whether or not these 

activities are conducted in functionally regulated entities. 

Those affiliates that do not have a principal financial regulator 

as well as the holding company itself are subject to examination by 

the Commission. 

The CSE rule requires monthly calculation at the holding company level of a capital adequacy measure that’s designed to be consistent with the standards adopted by the Basel Committee on 

Banking Supervision. 

In requiring a holding company calculation of capital in accordance with the Basel standard, the CSE rules do not specify that 

capital adequacy be calculated using the original framework, Basel 

I, or the revised framework, Basel II. Likewise, the rule does not 

prescribe the use of advanced approaches contained in Basel II. 

Nevertheless, four of the five CSE firms have elected, with Commission support, to satisfy the CSE capital calculation requirement 

by applying Basel II in its advanced approach to credit risk exposure. 

The fifth firm, who because of its fiscal year was confronted with 

a period of only 6 months between publication of Basel II and the 

effective deadline imposed under the E.U. financial conglomerates 

directive, opted to apply Basel I, but this firm is now in the process 

of preparing to implement Basel II. 

When the CSE firms began in earnest to implement Basel II during the latter part of 2004, the only complete description of the 

standard was the mid-year text. Thus, this text served as the basis 

for implementation of Basel II by these firms. 

This is not to say that implementation of Basel II by the CSE 

forms has been simple. The Commission staff has worked collaboratively with our banking colleagues to address issues that are central to the CSE firms, and we believe that the CSE firms have implemented Basel II in a manner that’s conservative while also reflective of the fundamental nature of the securities firms and their 

business model. 

Looking ahead, with the U.S. banking regulators’ formal issuance 

of their notice of proposed rulemaking, Commission staff will review the document carefully to apply the proposed approaches to 

securities firms in the context of their history, risk profile, and 

business mix. 

Where further modifications to the calculation methodologies 

used by the CSE firms are warranted, the Commission has authority to require their adoption. The CSE firms understood, when they 

elected to apply the Basel II standard in 2005, that the standard 

18

was still very much a work in progress and they were likely to 

have to make various adjustments as the broader U.S. implementation process proceeded. 

In summary, we’re confident that the CSE firms are currently 

calculating capital adequacy measure consistent with Basel II in a 

manner appropriately sensitive to the risks assumed by the firms. 

To the extent that further modifications of the calculations become necessary, and to achieve to the maximum extent possible 

consistency with national and international regulatory authorities, 

the Commission has the commitment and the authority under the 

CSE rules to ensure that appropriate changes are made. 

Thank you. 

[The prepared statement of Mr. Colby can be found on page 113 

of the appendix.] 

Chairman BACHUS. Commissioner Antonakes. 

STATEMENT OF STEVEN L. ANTONAKES, MASSACHUSETTS 

COMMISSIONER OF BANKS, ON BEHALF OF THE CONFERENCE OF STATE BANK SUPERVISORS 

Mr. ANTONAKES. Good morning, Chairman Bachus, and distinguished members of the subcommittee. My name is Steven 

Antonakes, and I serve as the commissioner of banks for the Commonwealth of Massachusetts. I also currently serve as the chairman of the State Liaison Committee to the FFIEC. 

I’m pleased to testify today on behalf of the Conference of State 

Bank Supervisors. CSBS is the professional association of State officials responsible for chartering, supervising, and regulating the 

Nation’s 6,230 state-chartered commercial and savings banks and 

400 state-licensed foreign banking offices. 

While Basel II and the commercial real estate, or CRE, guidance 

are clearly very important regulatory proposals, both have the potential to impact the domestic financial system and could do particular harm to community banks by altering the competitive landscape and leading to the shifting of risk among business lines. 

The role that a small bank plays in a local economy cannot be 

overstated. I’m sure that each of you is well aware of the benefits 

that are added to your districts by healthy, well-capitalized banks 

of all sizes. 

It is our responsibility as regulators and legislators to ensure 

that regulatory proposals are prudent and do not create a competitive imbalance. 

CSBS is pleased with the inclusion of several of the safeguards 

discussed already today that have been incorporated into the Basel 

II NPR. While we’re encouraged by the incorporation of these safeguards, we do have process concerns. 

Despite our status as the primary supervisor for the vast majority of banks in the United States, State supervisors have not been 

included in the drafting process of Basel II. State regulators, 

through CSBS, should have a seat at the table when rules that affect our institutions to such a substantial degree are being considered. 

Additionally, the Basel II NPR does not provide a defined rule 

for the States during the qualification process. There are 10 States, 

including my home State of Massachusetts, that charter potential 

19

Basel II banks. For these banks, the State is their primary regulator and must have a role in the implementation of Basel II. 

Once Basel II is adopted and implemented, the States will be responsible for ensuring that our affected institutions are Basel II 

compliant. In order to do so, we must be able to compare the data 

of all Basel II institutions regardless of their chartering agent. Accordingly, information sharing with the Federal bank regulatory 

agencies will be essential for States to properly supervise our Basel 

II banks. 

In reference to the proposed CRE guidance, we share many of 

the worries that motivated its drafting. However, as regulators, we 

must not be overly prescriptive in how risk is managed. 

In our opinion, the benefits of the guidance do not outweigh the 

potential negative impact on competition and our communities. 

Moreover, the guidance could have unintended consequences upon 

the health of the community banking system and the availability 

of credit. 

The implementation of either the Basel II NPR or the proposed 

CRE guidance could significantly impact our Nation’s financial system. Sufficient capital must be maintained to ensure safety and 

soundness and economic stability, and competition in the industry 

must be preserved. 

Our fear is that the impact of one or both of these proposals will 

result in damage to community banks and a dual banking system 

as a whole. 

CSBS seeks to sustain the economic vigor of the local communities we serve. Certainly we share that goal with every member 

of the subcommittee. 

The vast majority of U.S. banks are state-chartered and it is critical that State regulators are given a full role in the regulatory 

process as these and other proposals are discussed, debated, drafted, and adopted. 

I commend you, Chairman Bachus, and the distinguished members of the subcommittee for addressing these matters, and on behalf of CSBS, I’d like to thank you for the opportunity to testify. 

[The prepared statement of Mr. Antonakes can be found on page 

68 of the appendix.] 

Chairman BACHUS. Thank you. 

I appreciate the first panel’s testimony. I think it certainly helps 

us understand where we are. I’m going to ask two questions. 

First of all, it’s my understanding that large banks in Europe 

and Asia will be subject to the Basel II rules in more or less the 

same form that was agreed to internationally, but I’ve been told 

that the U.S. proposal is significantly different in the advanced 

capital approaches, different from the advanced approaches that 

have been implemented abroad, and that for similar asset portfolios, U.S. banks will likely have significantly higher minimum 

capital requirements. 

First of all, is that correct? And if it is, would this not be a competitive advantage for foreign banks over our domestic banks? First 

of all, are there going to be greater capital requirements for our 

banks, and if that’s the case, won’t that disadvantage us from the 

competitive standpoint? 

Governor? 

20

Ms. BIES. Mr. Chairman, let me respond in two ways. We have 

had more time than some of the other national regulators to look 

at the analysis of the QIS–4, and the QIS–5, which was done in 

other countries but not the United States, because they’re on a 

faster timetable. 

We’ve included in our NPR some strengthening from the 2004 

mid-year agreement, where we did see some weaknesses. For example, we have a placeholder in the NPR that acknowledges that 

models that we saw were not strong enough for downturn loss estimates, and so it’s a methodology to use, because what we saw in 

QIS–4 and QIS–5 is, when banks didn’t know how to measure their 

downturn loss, they just used zero. 

Well, in our view, your downturn loss should be higher than your 

best loss of zero; and yet, when you look at the QIS–5 report that 

came out of the Basel Committee, they acknowledge that it’s something that still has to be looked at by other countries, and we’re 

anticipating that they will also make some adjustments as the 

banks are observed in the parallel run. So some of these, I think, 

are timing differences. 

Chairman BACHUS. What if they don’t? What if they don’t make 

those adjustments? What I hear you saying is that you’re using 

this international agreement to strengthen or to increase capital 

requirements domestically. 

Ms. BIES. We’re doing it in our national implementation, in our 

NPR. There are several areas where the Basel Committee knows 

we have further work to do on Basel II, and we’ve all agreed to continue to work on that together as we get more information. 

Chairman BACHUS. But are you saying that you anticipate some 

of the other countries raising their capital requirements, but they 

haven’t done that yet, but you’re almost raising ours anticipating 

that they’ll raise theirs? 

Ms. BIES. What I’m saying is that what we’ve done so far is to 

implement specific changes that respond to risks in the existing 

2004 mid-year agreement. Those weaknesses other countries acknowledge, but they have not yet done anything to move forward 

at their national level to implement any change. 

Chairman BACHUS. Now, if they don’t implement those changes, 

though, it leaves us at a competitive disadvantage, does it not? 

Ms. BIES. Well, it could. But on the other hand, we’ve had differences all along in capital rules. 

Chairman BACHUS. Yes. 

Ms. BIES. Part of this deals with differences in accounting rules. 

We still don’t have global accounting. Some of that will make a difference. 

Chairman BACHUS. I’m not sure that an international accord is 

the proper place to unilaterally raise our capital requirements. 

Ms. BIES. But as a U.S. regulator, my first priority is to make 

sure banks in the United States have strong capital. 

Chairman BACHUS. I understand that. But to say it, to say you’re 

doing it as a part of an international process, but, you know, that 

it needs to be done for Basel II wouldn’t be correct, I mean, not 

necessarily. You’re saying it— 

Ms. BIES. We’re doing it in the U.S. NPR, but I’m saying the 

issues that we’re concerned with are shared globally around the 

21

table for Basel, and we know that there will be work in train to 

address some of the issues. 

Chairman BACHUS. But you understand what I’m saying? 

Ms. BIES. Yes. But we need to move forward and deal with it in 

the United States. 

Chairman BACHUS. But would you acknowledge that, you know, 

if you came to Congress and said, ‘‘We need to do these things because of Basel II, but we’re going beyond what we’re required to 

do in an international agreement,’’ then it wouldn’t be a requirement. 

It would be as if you’re telling me the Fed may be going beyond 

what it’s required to do, or that we’re going beyond what we’re required to do in raising our capital requirements. 

In other words, starting 2 and 3 years ago, I think our institutions were told, as a part of an international agreement, you know, 

we’re going to implement certain requirements, but in fact, if our 

foreign competition, those requirements are not—if their countries, 

their regulators don’t require them to do that, then I see that as 

a disadvantage, and I know Mr. Feeney and Mr. Hensarling and 

Mr. Price, several of us on both sides of the aisle have actually expressed concerns that these international agreements don’t disadvantage our banks in the global marketplace. 

Ms. BIES. I think we are very proud that in the United States 

we consider our capital standards to be the strongest in the world, 

and we’re not going to weaken them. 

Chairman BACHUS. Sure. 

Ms. BIES. And this has not disadvantaged our banks. They continue to have the strongest capital and the highest profitability, if 

you look at financial institutions elsewhere, and I think it’s because 

we’ve been pushing a balance between capital and enhanced risk 

management, and you need to look at all of these together, and I 

think the results are that our banks are very effectively managing 

through this. 

We need to always aspire to make sure that our banks are seen 

as a source of strength. 

Chairman BACHUS. I think you could say there’s a sense of pride 

in that our capital requirements are strict, but I think that anytime a capital requirement is higher than justified, then it raises 

costs, and, you know, there are unnecessary costs then. 

And I don’t want to debate the philosophy. What I’m simply saying is, if we’re doing this as a part of Basel II, because it’s necessary as a part of the international agreement, but, you know, 

what we’ve sort of been told is that it’s going to happen overseas, 

in other words our competition is going to—these requirements are 

going to be put on those so we won’t be disadvantaged. 

Now, I appreciate your candidness, I mean, in saying that you’re 

anticipating that they’re going to catch up with us, but if they 

don’t, I’m just saying there could be some problems. 

Mr. Dugan. 

Mr. DUGAN. Mr. Chairman, I do want to say that I think most 

of the provisions of our version of the advanced approaches and 

what the Europeans have adopted are pretty similar. There are 

some safeguards that I mentioned in my testimony that we put in, 

particularly on a temporary basis, because we were concerned 

22

when we did our study that the drops in capital were a lot bigger 

than we thought they would be. We put in some capital floors during a 3-year transition period, but if we get comfortable with the 

rule and it doesn’t produce those kinds of declines once it is fully 

implemented, then those floors should come off. And of course, 

there is always the leverage ratio that applies in the United States 

but does not apply outside the United States, and that is a difference. 

Chairman BACHUS. Okay. 

Ms. BAIR. I would just, I would agree with everything that my 

colleagues have said, and re-emphasize that’s one of the reasons 

why I think it would be good to engage the international community on an international leverage ratio to the extent we may confront competitive inequities. 

I agree with Governor Bies, I’m not sure low capital is a competitive advantage for the United States. I think our high capital levels 

have been a strength of the U.S. banking system and have certainly been an important buffer for the Federal Deposit Insurance 

Corporation in protecting the funds against bank failures. 

So I think the premise of the question, I think we need to think 

hard about whether low capital really is a competitive advantage, 

and also, to the extent we do have differences, that we should engage the international community in an international leverage 

ratio. 

Chairman BACHUS. Thank you. 

Ms. Kelly. 

Ms. KELLY. Thank you, Mr. Chairman. 

I’ll address this to you, Comptroller Dugan. 

You note in your testimony that guidances are often interpreted 

as caps by bankers. In the recent experience of this committee, 

guidance on the MSB’s was also, de facto, turned into caps by examiners in the field, despite regulator assertions to Congress of the 

contrary. 

I’d like to ask each of the regulatory agencies here if their small 

bank examiners have specialized training in different types of commercial real estate and the commercial real estate cycle. 

So I’m asking this basically of you first, Mr. Dugan, and then I’d 

like to hear from the other regulatory agencies. 

Mr. DUGAN. Mrs. Kelly, we take great pride in the training that 

we provide our examiners at the OCC. At the heart of what examiners learn from their first day on the job is safety and soundness 

supervision, and although there are many things that we have to 

supervise institutions for, credit is at the heart of much of what examiners learn as a core skill. 

I absolutely think we have the expertise. It’s something that all 

of the agencies have focused on because of the problems that occurred in the 1980’s when we sat in this hearing room, in front of 

the subcommittee members, because of all the bank failures that 

were caused by concentrations of commercial real estate lending. 

And I want to emphasize that. What we’re talking about here is 

not that commercial real estate lending is bad, because it’s not. But 

a prime principle of bank supervision is not putting all your eggs 

in one basket, and we have seen such a dramatic rise in concentraVerDate 0ct 09 2002 13:05 Apr 10, 2007 Jkt 031549 PO 00000 Frm 00030 Fmt 6633 Sfmt 6633 K:\DOCS\31549.TXT HFIN PsN: TERRIE
23

tions that we want to make sure institutions are appropriately 

managing those risks. 

Ms. KELLY. Who’s going to pick that up next? 

Mr. REICH. I’ll be happy to. I have a little bit different perspective. 

I share Comptroller Dugan’s comments about the training that 

our examiners receive in all of our agencies, and I share his views 

about their abilities to examine various types of commercial real 

estate loans. But my perspective as a former community banker, 

and I’ve been away from it for quite a few years now, but as a 

former community banker, I am keenly aware of the power of the 

bully pulpit which we occupy as the heads of our regulatory agencies, and I do have concerns that the degree of proscriptiveness 

that is in the current proposal for commercial real estate lending 

may have some consequences that we do not necessarily want to 

see. 

And so I am hopeful that, as we continue to work on the guidance before it goes out, that we modify it to be clear about our intent and not to suffer unintended consequences. 

Ms. KELLY. That’s certainly refreshing. 

It’s a very big concern that the examiners get out in the field and 

they don’t have clarity of what the intent truly is, and then they 

will take a guidance, turn it into caps, as we’ve seen that before. 

I’m also concerned that asset class concentration levels issued in 

the preliminary guidance are discriminatory against commercial 

real estate as opposed to other types of bank assets. 

In particular, the ILC’s often have 100 percent of their businesses in unsecured credit card debt and vehicle payments, but the 

FDIC defends their safety and soundness, so how secured or partially secured debt, how can secured or partially secured debt for 

real estate combined with holding company supervision be any 

more risky than holding a portfolio that’s made up entirely of credit 

cards that are marketed to teenagers? I want to know why you’re 

not mandating portfolio diversity for these institutions. 

Ms. BAIR. Congresswoman, I don’t think by issuing the CRE 

guidance that we were suggesting that other types of risk exposures don’t also need to be appropriately managed. 

I think the overall—I would be happy to—I’m uncomfortable to 

try to get into institution-specific situations, but I think overall, the 

safety and soundness record of the ILC industry today has been a 

good one, and yes, diversification is a fundamental principle of 

lending, and to the extent there are concentrations in those types 

of depository institutions as well as others that perform service in 

niche markets, they need to have more stringent risk management 

systems and procedures in place. 

But again, I don’t think just because guidance was issued on 

CRE, that does not mean to suggest that other areas don’t need to 

also be appropriately managed. 

And as you know, we have a moratorium in place right now, and 

we will offer comment on some of the broader issues regarding the 

adequacy of holding company oversight and other unique issues 

presented by the ILC charter, and we have not completed that review, but should be trying to move forward with some of these 

issues early next year. 

24

Ms. KELLY. I would hope that you would look at some of these 

institutions where they’re marketing heavily to young people, and 

evaluate the quality of that risk vis-a-vis the quality of a local bank 

holding a risk-based mortgage on commercial property. 

Thank you for your answer. 

Yes, Ms. Bies. 

Ms. BIES. Let me just add a couple of things. 

One, to make you aware that we are working inter-agency on the 

training program for our examiners on the new guidance to make 

sure that we are sending the right message and that we will be 

consistent not only within our agencies but across our agencies on 

how the new guidance will be implemented, and that will be in 

train very quickly, too, to address your concern on the knowledgeability of examiners. 

The other point I want to make about commercial real estate is, 

there are certain asset types where an individual bank can do a 

wonderful job in underwriting their credits, but they get contagion 

from poor underwriting by others, and it’s really true in commercial real estate. 

A bank can do a great job of underwriting, but if projects in their 

market are getting funded and create excess capacity so there are 

a lot of vacancies or they’re poorly underwritten for cash flow, so 

the maintenance and the property values go down, it can negatively affect the bank because those other projects could, through 

rent concessions and other things, attract tenants to competitive 

projects. 

And so what we’re really emphasizing here is that the bank has 

to go beyond individual loan underwriting and look externally and 

make sure they’re always aware of what’s going on in the market, 

because unlike other types of credit, bad lending can really affect 

their good credits. 

Ms. KELLY. Thank you, very much. 

Ms. Bair? 

Ms. BAIR. I just wanted to add one more thing. 

Our examiners also go through a very rigorous training program 

through our corporate university, so I just want to get the flag up 

for our examiners as well. 

I’m also advised that 21⁄2 years ago we issued internal guidance 

to our examiners on commercial real estate exposures to remind 

them about what best practice is in terms of risk management and 

to differentiate that obviously within that broad category there are 

some types of assets that are more risky than others. 

So yes, I have very—I’ve actually been told by several community 

bankers that they’ve had positive experiences actually when our examiners have come in and reviewed their CRE portfolios. 

Ms. KELLY. Thank you. 

Mr. HENSARLING. [presiding] The time of the gentlelady has expired. The Chair would now recognize the ranking member, Mr. 

Frank of Massachusetts. 

Mr. FRANK. Thank you. I apologize. We have a bill on the Floor 

that I had to speak on. 

I want to focus in on again on the CRE. And the regulators did 

respond, the four banking regulators, before Chairman Bair was 

there, her predecessor, her acting predecessor did it, but all four of 

25

the agencies signed it, and it’s a response to questions that were 

raised. And here’s what troubles me. 

I got on this committee because of my interest in urban issues. 

I’ve broadened it some. Being ranking member means a lot of 

perks, but it means losing one significant perk, which is the ability 

to ignore things you’re not interested in. You now have responsibility for a whole lot of other stuff. So I accept that. But housing 

is still very important to me. 

Multi-family housing is a great, serious social need, and I worry, 

and I really regret the fact that you appear to have swept multifamily lending into this guidance without, it seems to me, a basis. 

What troubles me is it may be cultural—I don’t know if you have 

the letter you sent me, but on page 5 of the letter, in chart 5, it 

has net chargeoff rate by loan type. I ask that this be put in the 

record, Mr. Chairman. 

Mr. HENSARLING. Without objection. 

Mr. FRANK. In 1991 and 1992, multi-family—let me just ask my 

colleagues, please, could I—I’m sorry, could you not be in the way 

here? 

In multi-family, in 1991 and 1992, chargeoffs for multi-family 

were significantly higher than the average of all loans, 2.10 to 1.61 

in 1991; 1.63 to 1.28 in 1992. Then you began to get parity between 

the multi-family and the average up until about 1996. 

Beginning in 1997 and through 2005, multi-family chargeoffs 

have been 25 percent or less than the average to the point where, 

in the past couple of years, in 2005, multi-family chargeoff, .04 percent. Similarly, in 2004. In 2004, that’s a 15 to 1 ratio. It’s 1/15th 

as much for multi-family as all loans. It’s 1/16th in 2005. In 2003, 

.03 to .91. 

There does not appear to be any reason that multi-family homes 

have been swept in here. Again, it’s cultural. Yes, they were a 

problem, and you say this. Well, we had these problems in the 

1980’s, late 1980’s, and early 1990’s. I went through it. It was a 

terrible problem. But that’s no reason to deal as if things hadn’t 

changed. 

And so given this—and by the way, none of the categories here, 

all loans, .54 percent chargeoff in 2005. For multi-family, .04. For 

non-farm, non-residential, .05. For construction and land development, .03. 

In fact, by your chart, for the last 8 or 9 years, the loans about 

which you are worried have been significantly lower in chargeoffs 

than the other loans, so that when you single those out, that’s why 

people get nervous. 

Could you address that? I mean, why did you put multi-family 

in here when it has performed so well for the last 10 years? 

Let me ask any of the regulators. 

Mr. REICH. Well, Mr. Frank, I would plead guilty to signing onto 

a letter that I didn’t necessarily agree with everything in it. I 

agreed with— 

Mr. FRANK. The letter to me? 

Mr. REICH. I believe that’s the letter that you’re referring to. 

That letter. 

Mr. FRANK. Mr. Supervisor, that is very odd behavior. 

Mr. REICH. Well, let me elaborate. 

26

I share your concern about multi-family lending. We at OTS have 

been working with our regulatory colleagues to try to make some 

progress in this area. 

I totally agree that lumping multi-family loans with shopping 

malls, strip shopping centers, office buildings, and warehouses, 

with the experience that you just cited that has taken place over 

the last 10 years, is inappropriate. 

Mr. FRANK. Thank you. 

Mr. REICH. And I would like to work with my colleagues in the 

days and weeks to come to— 

Mr. FRANK. Well, I appreciate that. 

We are also talking about activities which are not all of equal social worth, and if people think that’s an irrelevancy, let me cite the 

law called the Community Reinvestment Act. 

And I do not think that items that will get a bank Community 

Reinvestment Act credit are to be treated identically with items 

that don’t. 

You know, to some extent, we’re pushing them with one hand 

and pulling them with another, and telling them they got to do this 

for CRA credit, but then make—I wonder if any of the other regulators would tell me why they think multi-family should continue 

to be treated the same as everything else in here, although I have 

to say in fairness to construction and land development and nonfarm, non-residential have also been low, though not as low as 

multi-family. 

Let me ask Mr. Dugan. 

Mr. DUGAN. Mr. Frank, if you go back and look at those losses 

in the 1980’s, they were in a family of risk exposures that did share 

some correlation. They track each other over a long period of time, 

and they depend on rents, whether it’s residential or non-residential. 

We’ve gotten a lot of comments about not just multi-family, but 

residential real estate construction over time having been less risky 

than office rentals. But both are part of a family of exposures 

where we have seen the risks move somewhat in the same way. 

But the main thing I want to come back to is, and I know you 

had concerns that you expressed in your opening statement, we’re 

not telling people not to do this. We really aren’t. We’re saying— 

Mr. FRANK. Do you really think that this has no effect of that 

sort of a discouraging kind? 

Mr. DUGAN. I didn’t say it would have no effect because I think 

it should have an effect. That’s why we’re putting it out. We 

want— 

Mr. FRANK. A discouraging effect? Do you think, everything else 

being equal, that they may say, ‘‘Well, you know what? Maybe we’ll 

do less here and more there’’? 

Mr. DUGAN. I think that when institutions have concentrations, 

and we say they’re going to have to pay more attention to it because concentrations have failed institutions in the past, and they 

have to do more, yes, that can be— 

Mr. FRANK. Okay. But then again—and you know, you say, well, 

they’re all in the same bucket. You made the bucket. I mean, you 

know, God didn’t decide that all these—that construction and land 

development had to be the same as multi-family. 

27

The fact is that the numbers do differentiate. Other buckets, 

other types are, it seems to me, treated in a more risky way. But 

there’s a real difference. C&I loans do appear to have been more 

risky in some ways. 

But, you know, it’s been 13 years. Not in 13 years have multifamily loans been subject to a higher chargeoff rate than others. 

And so when you tell a bank, ‘‘Be careful about these and not about 

the others,’’ or ‘‘Be more careful about these than the others,’’ you 

have the negative effect, and I would hope you would reexamine 

that. It doesn’t have to all be in the same bucket. You can have 

more buckets. 

You know, if we need to appropriate more buckets for you, we’ll 

do it. You don’t have to put them all in one thing. And when things 

are not—you know, maybe you should watch Sesame Street, Mr. 

Comptroller. One of these things is not like the other, you take that 

into account. 

Thank you, Mr. Chairman. 

Mr. HENSARLING. The Chair now recognizes himself. And as the 

father of a 4-year-old, and a 2-year-old, I actually do watch Sesame 

Street. I’m very familiar with that routine. 

I would like to follow up somewhat on the line of questioning of 

the ranking member, because it’s a consistent theme that I hear 

from bankers in the Fifth District of Texas, and that is that they 

feel that the CRE guidance is essentially a single bucket that does 

not account for the diversification of various CRE product types, 

geographical diversification, and variance in loan to value ratio. 

So I would like a little bit more specificity in addressing the concerns of the bankers that I deal with in how do you plan to treat 

these variances and will we see many buckets as opposed to one 

bucket. 

Whoever would like to hop in here first. 

Ms. Bies? 

Ms. BIES. Congressman, let me put in perspective what we intended with these 100 and 300 percent benchmarks. We didn’t intend these to be ceilings. 

When we scope out exams we try to, from afar, look at a bank 

and look at what’s changing in its risk profile. We use our call reports to do that; and unfortunately, our call reports today classify 

loans by collateral, not business purpose. 

So what we are trying to say to our examiners is, because of 

where we are in the credit cycle, we want to make sure that we’re 

getting more information on the kind of commercial real estate 

that’s there. They can only do that by engaging directly with the 

bank. 

So for example, we know that some of the loans that are classified as commercial real estate are really loans that were made to 

small businesses and middle-size companies, and in an abundance 

of caution, the banks takes a mortgage lien on the property in case 

the business cash flow doesn’t work. 

That is not the commercial real estate we want to describe, but 

today’s call report lumps it in as commercial real estate. We are 

looking to change the call report classification so we get better surveillance. One of the challenges we’ve got is trying not to create too 

many buckets in the call report and make it difficult to handle. 

28

But what we want the examiners really to do is to step back and 

meet with the bankers and say, ‘‘What is the mix of your lending, 

what kind of projects are you in, what varieties do you have, how 

do you monitor that?’’ 

They have to have that conversation by engaging with the bank. 

That was the intention, to say, ‘‘You need to begin to have these 

conversations when the concentration on the call report gets above 

that level.’’ It wasn’t intended as a ceiling. It was intended as the 

beginning of more conversation. 

Mr. HENSARLING. Anyone else want to pick up the bucket metaphor? 

Mr. DUGAN. The thing I would amplify is that part of what we’re 

asking is that bankers be able to show that they have those different levels of risk. That’s exactly the kind of reporting and risk 

management that we’d like to see, a demonstration that they know 

where their risks are. When we examined some of the institutions, 

they couldn’t tell us much about their risks, not even in some cases 

what was owner-occupied and what wasn’t, which is a pretty basic 

thing. And so the guts of this is, if you want to be in commerical 

real estate in a bigger way, you have to have more sophisticated 

ways to look at it to make these kinds of distinctions, and that’s 

the kind of thing that will give comfort to examiners. 

Mr. HENSARLING. As a firm believer in anecdotal evidence, would 

anybody else on the panel care to elaborate what they’re hearing 

from their field examiners, and what might be lacking in certain 

risk management or reporting problems that you’re hearing and 

seeing regarding the CRE concentrations? 

Mr. REICH. Congressman, I would simply like to state that I 

think that putting out a reminder to the industry of the risks of 

concentration is a good thing. I’m totally supportive of our doing 

that. 

But I do believe that being as proscriptive as we are, I hate to 

be the skunk at this garden party, putting out the guidance as proscriptive as it presently stands does run the risk of unintended consequences. 

As a former community bank CEO, I well remember how I used 

to sort of hang on the words of the Comptroller of the Currency 

when I operated with a national bank charter. 

The power of the bully pulpit is very strong, and when there are 

more than 3,000 bank examiners around the country trying to implement the guidance and supervise the institutions according to 

the guidance that we issue, I do have a concern that they will view 

these limits as caps and that consequences will be not what we as 

regulators intend for them to be. 

I think that expressing the guidance without the numbers will 

be—is a good thing for us to do, and that in our speeches and outreach meetings with bankers we can express our concerns and 

those will be heard. 

In fact, I’m under the impression that there are already some institutions that have assumed the guidance is the law of the land 

and they’re already changing their policies accordingly. 

I’m also concerned about anecdotal evidence that I’m hearing 

that there are one or more financial analysts who are making buy 

and sell recommendations of financial institutions based upon 

29

whether or not they have reached these thresholds that are in the 

proposed guidance. 

Mr. HENSARLING. Thank you, Mr. Reich, and also thank you for 

your work on regulatory relief in your previous capacity. 

The Chair’s time has expired. At this time, the Chair will recognize the gentlelady from New York, Ms. Maloney. 

Mrs. MALONEY. Thank you, and I thank the panelists. There was 

a bill I had to go to the Floor for. I apologize. 

I’d like to ask Susan Bies and Mr. Colby and anyone else who 

would like to comment, the QIS–4 led the regulators to add their 

additional safeguards to the U.S. version of the accord. And do you 

think the QIS–4 is an accurate measure of risk? 

Ms. BIES. Let me put QIS–4 in perspective. As the plan of work 

was put together several years ago for moving to Basel II, what we 

tried to do through the Basel Committee was encourage countries 

to take a measure periodically through the process to help us identify where banks are in risk management, what issues are there 

around the proposals, so that we could change them as we go. 

QIS–4, and I would say the most recent one that was done globally that we didn’t do, QIS–5, that was released in May, continue 

to find areas where we need to strengthen the framework. 

Keep in mind that that’s the goal, to help us do diagnostics on 

what needs attention, and it also allows the banks a way, in a consistent framework with other banks, to get feedback from regulators so that they may know where they’re lagging behind in the 

development of the risk models. 

Now, as the Comptroller said earlier, and my other colleagues 

mentioned, the way QIS–4 was actually done, none of us would 

have accepted QIS–4 as a standard we could use for banks. The 

models were too early. We didn’t have our completed guidance out. 

There wasn’t a track record to build the databases. There were a 

lot of issues. 

So QIS–4, per se, if that was going to be reality, I don’t think 

any of us would be wanting to use this as the framework, but it 

was meant to test where we are and look at how quickly we could 

move and what we needed to do. 

So from that perspective, it generally reinforced that the kinds 

of things we’re trying to do were moving in the right direction, and 

the quality of the work in QIS–5, for example, is better than what 

we saw in 4, and so we’re seeing progress being made as we move 

forward. 

Mrs. MALONEY. Would anyone else like to comment? 

No? Okay. 

I am concerned that if the present proposals are adopted, we will 

have one risk management standard for large banks and then a 

different one for small banks, and yet a different one for the securities market; and shouldn’t we be concerned that this will create the 

same problems that Federal Reserve Governor Meyer was concerned about in Basel I back in 1991 when he said, and I quote— 

I’m sorry, we’re being called for a vote. We’re not supposed to be 

called for a vote, so I don’t know why they’re calling us. 

But anyway, to quote Governor Meyer on Basel I, he said: 

‘‘Banks are engaging in capital arbitrage to move their higher-quality, lower-risk assets to the security markets or similar arbitrage 

30

issues with the result being through the total capital charges are 

not proportional to the total risk.’’ And capital arbitrage was the 

reason given for many for moving away from Basel I, but aren’t we 

heading in a similar direction in creating a similar problem with 

Basel II? 

And I’d like to ask Mr. Robert Colby and the Honorable Susan 

Bies. 

Mr. Colby? 

Mr. COLBY. Well, the implementation of the CSE rules was done 

at a time when the securities firms were working off an early Basel 

II text, and the story is not over. 

Once the banking agencies move forward on their notice of proposed rulemaking, we plan to work with them to try to bring the 

two in as close alignment as we can. 

Mrs. MALONEY. Honorable Susan Bies? 

Ms. BIES. Thank you. First, let me address the small banks. 

As we’ve been doing this exercise, we’ve done, as you know, at 

the Federal Reserve a series of white papers. Other folks have been 

doing research trying to look at competitive issues. 

We’re still working inter-agency on our Basel I proposal, but I 

think you’ll see when that comes out in a few weeks that we are 

addressing those portfolios where the competitive impact is likely 

to be the greatest, and in putting it out, we’re going to be asking 

the bankers, are we focusing on the portfolios that we should have? 

So we are very conscious of it, and have been spending time trying to craft that, while also listening to the smaller bankers who 

want to make sure that the framework to measure risk is not so 

burdensome that it adds to regulatory burden for them. 

Mrs. MALONEY. I’m really very sympathetic to competitive equality, but what I’m concerned about is we’re in a global competitive 

market, and I’m concerned that American financial institutions, 

large or small institutions, not be put at a competitive disadvantage to foreign banks and financial institutions because of the capital standards, and at the same time, I’m very concerned about 

safety and soundness, and striking that balance to it. 

But I keep hearing concerns from institutions that they feel the 

capital requirements are going to be heavier and more onerous on 

American institutions. 

Ms. BIES. To keep the tie to American institutions, one of the 

things that we are moving toward is again, if you look at the more 

sophisticated products of the larger organizations and the historically different approach that securities regulators and bank regulators have had to capital, one of the things in that new market 

risk proposal that also came out with the Basel II NPR as a separate issue, we have been working very closely with securities regulators to try to make sure that a similar kind of position, similar 

kind of, say, subordinated debt tranche, whether it’s held in a commercial bank or a securities firm, would have similar treatment. 

What was being proposed is something that globally we worked 

on, and the United States here, I think we’re getting closer as a 

result of this effort to similar treatment not just globally, but more 

importantly, between commercial banks and securities firms for 

those firms who do the risk-based kinds of capital. 

31

So we are concerned about competitive issues, but we try to address them in the framework of safety and soundness and keep it 

strong. 

Just as the U.S. bank regulators have very strong capital requirements and our banks have thrived in that environment, our 

securities firms also have a very strict capital requirement and 

they’ve thrived. 

Mrs. MALONEY. Do you feel that our banks and securities firms 

are put at any competitive disadvantage in the Basel II because of 

the capital requirements? 

Chairman BACHUS. If you could wrap this up fairly quickly. 

Ms. BIES. There are some places where we’ve felt, as U.S. regulators, that we wanted something stronger, but those issues have 

also been discussed around the Basel table, and I really think 

many of these issues will be addressed long-term on a more global 

basis by other national regulators, too. 

So there could be a timing difference, but in terms of the Basel 

II risk framework, I think we are getting closer. 

Going to international accounting standards that are more harmonized is going to go a long way, also, to make the impact of capital rules more similar across countries. A big part of the world has 

never had capital on an off-balance sheet. They are finally getting 

it. We’ve had that for years. So I would say they’ve moving up to 

our standards. 

That was a big missing piece in the global capital standard that 

we’re picking up and that, too, is moving us closer together. 

Mrs. MALONEY. Mr. Chairman, if I could get one brief comment 

from the New York banking supervisor and superintendent, Diana 

Taylor. 

She indicated that she had not been called in on any conversations on this debate, and would appreciate it if the committee 

would listen to superintendents of banks across the country, that 

they have a point of view that they feel needs to be heard, also. 

Chairman BACHUS. Thank you, Congresswoman. 

Let me just wrap up with one question, which is what you’ve 

heard most of these questions are about. 

I mean, we all agree that real estate lending ought to be done 

prudently. We further agree that, as a regulator, one of their primary duties is to see that it’s done in a safe and sound manner and 

to examine portfolios, loan ratios, and all of these factors. 

That having been said, you heard the concern expressed by Mr. 

Frank, Mr. Hensarling, and even, I think, Director Reich, that the 

guidance doesn’t take into account the diversification, and that 

even though it’s your intent that these are guidances to the examiners, that it may create as a practical matter arbitrary ceilings 

that don’t relate to actual risk, and that by setting number thresholds, the concern is the examiners in the field may assume that 

these ceilings are absolute. 

We’ve been assured, I mean, even today, that that’s not going to 

happen, and earlier in correspondence, but there’s certainly a lot 

of anecdotal evidence to show that the concern is justified. 

You were mentioning a Wall Street analyst, Director Reich, and 

a lot of our banks are saying they’re afraid that the examiner is 

going to treat it this way. 

32

So my question is this. What plans do you have to address this 

concern and to ensure that the examiners are open to getting into 

the actual condition and diversification of a bank’s CRE portfolio 

rather than simply assuming there’s a problem? 

Or maybe another way, just to say that in a simpler way, is how 

do you plan to address these concerns in order to ensure that the 

guidance will be implemented appropriately by these examiners? 

Mr. DUGAN. Mr. Chairman, we have already heard those concerns loud and clear from the industry as bankers have come 

through and talked to us, and I think it’s a legitimate apprehension 

that we have to always be vigilant about. But we have embarked 

on a campaign with our examiners, in every region of the country, 

with every examiner who examines community banks, to deliver 

the messages that you’ve just described, and we will follow up on 

that. 

We encourage bankers to come to us with specific examples of 

where that’s not occurring, and we will address the issue. I think 

we have to be sensitive, we have to keep repeating it, we have to 

monitor to make sure that it’s clear, and that’s exactly how we will 

approach it. 

Chairman BACHUS. Thank you. I might want you all, maybe in 

the weeks to come, to write a letter to us, telling us in a little detail what you have done, or plan to do, in that regard. 

I’ll close by saying that we’ve talked about commercial loan, lending money for commercial projects, and we haven’t mentioned residential as much, but I did read the new Chairman of the Federal 

Reserve’s book on the causes for the Great Depression, and I’m not 

going to try to paraphrase him, because I’d be incorrect. He did say 

there were a lot of failures to do some things that you all are doing, 

but he also, one of the themes of that was the failure to lend 

money. 

So sometimes a recession, depression, or bank failure can be because of imprudent lending. On the other hand, you can have a recession or depression based on too tight money, or the banks not 

lending money. 

So I would hate to think that actually we end up with a downturn in the economy because of guidance which restricts commercial lending and therefore depresses the economy, and then, as a 

result of that, depresses commercial property values. So you might 

want to pull out his book and read it. Thank you very much. 

We’re going to recess for an hour and 15 minutes, because we 

have 45 minutes worth of votes on the Floor in actual minutes, so 

I don’t think we can be back here before 2 o’clock, so we’re just 

going to recess until 2 o’clock. 

The first panel is discharged, and I very much thank you for 

your attendance and testimony. 

[Recess] 

Chairman BACHUS. Good afternoon. 

First of all, I appreciate your patience in waiting. 

I have read some of the testimony of the second panel, and I 

think it will be very valuable to us as we proceed. 

At this time, I’m going to formally introduce the second panel, 

starting from my left. Mr. Harris Simmons, chairman, president, 

33

and CEO, Zions Bancorporation, on behalf of the American Bankers Association. Mr. Simmons, where is that located? 

Mr. SIMMONS. Salt Lake City. 

Chairman BACHUS. Salt Lake City. Okay. We welcome you to the 

hearing. 

Mr. Weller Meyer, chairman, president, and CEO of Acacia Federal Savings Bank on behalf of America’s Community Bankers. 

1And that’s located in? 

Mr. MEYER. Falls Church, Virginia. 

Chairman BACHUS. Falls Church, Virginia. 

Mr. James M. Garnett, head of risk architecture, Citigroup, on 

behalf of the Financial Services Roundtable. We know where you’re 

located. 

Mr. James McKillop, president and CEO of Independent Bankers’ Bank of Florida, on behalf of Independent Community Bankers 

of America. And where in Florida are you? 

Mr. MCKILLOP. Orlando. 

Chairman BACHUS. Orlando. Okay. 

And then Mr. Marc Lackritz, president, Securities Industry Association. Marc, it’s good to have you back before the committee. 

Mr. LACKRITZ. Thanks, Mr. Chairman. 

Chairman BACHUS. Ms. Karen Shaw Petrou, co-founder and 

managing partner, Federal Financial Analytics. It’s good to have 

you back before the committee. Ms. Petrou has testified before the 

committee on at least four or five occasions since I’ve been chairman. 

Mr. Robert White, Jr., president of Real Capital Analytics. Where 

is that located, Mr. White? 

Mr. WHITE. New York City. 

Chairman BACHUS. New York City. We’re glad to have you. 

And finally, Dr. Glenn Mueller, professor, Burns School of Real 

Estate and Construction Management at Denver University. And 

we all know where Denver University is. Thank you. 

So at this time, we’ll proceed from my left to right, starting with 

Mr. Simmons, and I think opening statements are going to be limited to about 3 minutes, although, you know, if it’s 31⁄2 minutes, 

you won’t be interrupted. 

Thank you. 

STATEMENT OF HARRIS H. SIMMONS, CHAIRMAN, PRESIDENT, 

AND CEO, ZIONS BANCORPORATION, ON BEHALF OF AMERICAN BANKERS ASSOCIATION, SALT LAKE CITY, UTAH 

Mr. SIMMONS. Thank you very much, Chairman Bachus, for holding this hearing. The ABA appreciates the opportunity to express 

our views on these two very important issues. 

Our Basel II message is simple. The current proposal will hurt 

U.S. banks that compete internationally. It requires compliance 

with the most complicated version of the international rules rather 

than allowing U.S. banks the same flexibility that banks have in 

other countries, and it adds layers of constraints that are completely at odds with the principle of tying capital to risk. 

As a result, Basel II has evolved into a risk management exercise 

disguised as a capital rule. This can be fixed if the agencies adopt 

an approach very similar to the international Basel II accord. 

34

To avoid creating a capital disparity in the U.S. domestic market, 

we believe it’s critical that the regulators also revise the capital 

rules for all U.S. banks and implement those rules simultaneously. 

Without this, the contradictory capital rules will invariably lead to 

pricing advantages and shifts in market share. 

It’s crucial that all banks in a given market competing for similar assets have similar capital charges, especially when implementing a menu of capital rules. A menu of options could address 

effectively the international and domestic competitive issues. 

We encourage the regulators to consider both the so-called Basel 

IA approach and the standardized approach under Basel II. 

Regardless of the options provided, banks of all sizes and levels 

of sophistication should be able to select an approach that is both 

appropriate for them and that doesn’t place them at a competitive 

disadvantage relative to one another. 

Turning to the guidance on commercial real estate, I’d like to 

leave you with one point. The guidance as proposed could inappropriately choke off the flow of credit. 

How many commercial real estate loans a bank makes is not the 

issue, it’s how well that bank manages the risk, and a ‘‘one size fits 

all’’ approach as proposed simply doesn’t address the risk management issue. 

Moreover, there’s a danger that an examiner will require more 

capital, regardless of how effectively a bank is managing the risk. 

This could tie up funds that otherwise would be supporting additional lending and it could also lead a bank into riskier activities 

to earn a return on that capital. 

Community and regional banks are likely to be hit the hardest 

by this guidance, as commercial real estate lending is a particularly important activity for them. 

It’s not enough to soften the tone of this guidance. Examiners, 

hoping to avoid being second-guessed with problems that arise in 

their banks, may apply the guidance more harshly than the agency 

heads intended. To avoid this, the regulators should instead deal 

with problems on a bank-by-bank basis. 

If, however, final guidance is issued, it should first be changed 

to clear up questions concerning the scope of the guidance and the 

role of capital when a bank has a commercial real estate concentration, and the bosses in Washington must ensure that the examiners in the field understand how the guidance is to be applied. 

The ABA remains committed to working with the agencies on 

both the capital rules and CRE lending issues. I appreciate the opportunity to appear before you on behalf of the ABA and I look forward to answering any questions you may have. 

Thank you. 

[The prepared statement of Mr. Simmons can be found on page 

253 of the appendix.] 

Chairman BACHUS. Thank you, Mr. Simmons. 

Mr. Meyer. 

35

STATEMENT OF F. WELLER MEYER, CHAIRMAN, PRESIDENT, 

AND CEO, ACADIA FEDERAL SAVINGS BANK, FALLS CHURCH, 

VIRGINIA, AND CHAIRMAN, BOARD OF DIRECTORS, AMERICA’S COMMUNITY BANKERS, WASHINGTON, D.C., ON BEHALF OF AMERICA’S COMMUNITY BANKERS 

Mr. MEYER. Chairman Bachus, my name is Weller Meyer, and I 

am chairman, president, and CEO of Acacia Federal Savings Bank 

in Falls Church, Virginia, but I appear today on behalf of America’s 

Community Bankers, where I serve as chairman of the board of directors. Thank you for this opportunity to present our views. 

Let me thank the committee for its substantial oversight of the 

Basel rulemaking process. Your interest has been instrumental in 

the progress made in ensuring the public interest is served. We 

also appreciate the thoughtful modifications made by the agencies 

to the initial proposals. 

However, ACB remains concerned about unintended competitive, 

safety, or soundness consequences that might arise from the rulemaking. Basel II should not be implemented unless changes are 

made to Basel I to more closely align capital with risk for other depository institutions. 

We are pleased that a proposal on Basel IA will soon be released 

by the agencies in response to this concern. We hope that the final 

capital standards will not add significant new regulatory burdens. 

Flexibility is key to creating a successful new capital regime. 

This flexibility should include the option for Basel II banks to chose 

between the standardized approach and the advanced approach as 

contemplated in the international Basel II accord. 

It also must include the establishment of a Basel IA standard 

that would permit the majority of banks to more accurately manage their risk and capital requirements, including additional risk 

buckets to more accurately measure credit risk. In short, the system must result in banks of all sizes having equivalent capital 

charges against equivalent risk. 

Moreover, Basel I banks should have the option of continuing to 

comply with the current capital requirements, because that will be 

less burdensome for many community institutions. 

Finally, we strongly support the regulators’ intentions to leave a 

leverage requirement in place. A regulatory capital floor must be 

in place to mitigate the imprecision inherent in internal ratingsbased systems. 

Turning to another topic of today’s hearing, we are concerned 

that the CRE guidance could create competitive burdens for community banks with substantial commercial real estate assets. 

In particular, we see no need for potential capital surcharges for 

institutions that are well managed and well supervised. Any 

changes in capital requirements should be considered only as part 

of the Basel rulemaking and not through guidance. 

We also have suggested two other substantial adjustments to the 

guidance. First, the threshold test for commercial real estate concentrations must be adjusted to focus only on those types of lending 

that are likely to reflect significant risk exposure. Second, the guidance should not establish a ‘‘one size fits all’’ standard for management of commercial real estate lending. 

36

We thank the committee for its attention to these important 

issues, and I will be pleased to answer any questions. 

[The prepared statement of Mr. Meyer can be found on page 185 

of the appendix.] 

Chairman BACHUS. Thank you. 

Mr. Garnett, I’m going to recognize Ms. Maloney just very briefly. 

Mrs. MALONEY. Thank you so much. It is an honor to introduce 

Mr. Garnett, whom I have the honor of representing in New York. 

He is the head of risk architecture for Citigroup, where he is responsible for the oversight of group-wide market and operational 

risks. In addition, he is responsible for Citigroup risk performance 

reporting and measurements for all risks, including economic capital and credit risk rating, processes risk systems and implementation. He also receives all market risks for the Global Consumer 

Group, and we’re delighted to have him here today. 

I look forward to your testimony. Thank you. 

Chairman BACHUS. Thank you. Mr. Garnett, that’s why I didn’t 

go into where you were from. 

STATEMENT OF JAMES M. GARNETT, JR., HEAD OF RISK ARCHITECTURE FOR CITIGROUP ON BEHALF OF THE FINANCIAL SERVICES ROUNDTABLE 

Mr. GARNETT. Thank you very much. Chairman Bachus, and 

members of the subcommittee, my name is Jim Garnett. Thank you 

for inviting me to testify today. I’m responsible for the implementation of Basel II for Citigroup, but I’m here today on behalf of the 

Financial Services Roundtable. 

I would like to begin my testimony by emphasizing that the 

Roundtable strongly supports the implementation of Basel II in the 

United States. The Basel II accord is intended to better align regulatory capital to underlying economic risks. It is also intended to 

promote equality in the international regulatory capital standards. 

Last month, the Roundtable wrote to the Federal banking agencies expressing concern over inconsistencies between these goals 

and the proposed U.S. version of the accord. In its current form, 

the Roundtable believes that the U.S. version of the accord: one, is 

not appropriately risk-sensitive; two, disadvantages American 

banks against foreign competitors; and three, creates significant 

compliance cost issues. 

The answer to our concerns is twofold. First, harmonize the U.S. 

version of the accord with the internationally negotiated text. Second, offer all U.S. banks the same options for compliance that are 

available internationally. 

Harmonization of the accord would prevent foreign banks from 

gaining a competitive advantage over U.S. banks and better align 

risk and capital. Offering U.S. banks compliance options such as 

the advanced approach, the standardized approach, or Basel IA is 

equally important. 

Giving all American banks, large and small, a choice of methods 

for risk-based capital compliance has several benefits. Choice gives 

banks of all sizes access to simple and transparent methods. Choice 

assures a competitive marketplace, both domestically and internationally. 

37

And finally, choice promotes safety and soundness by ensuring 

appropriate minimum regulatory capital requirements. 

In summary, the Roundtable supports the development of modern risk-sensitive systems. The international accord is such a system. 

The proposed U.S. version of the accord, however, is inconsistent 

with the international accord. This creates significant risk, competition, and compliance concerns. 

We urge the harmonization of the U.S. version of the accord with 

the international version and we recommend that all banks be 

given a choice of compliance options. We hope Congress can endorse these objectives as the rulemaking progress moves forward. 

Thank you. 

[The prepared statement of Mr. Garnett can be found on page 

138 of the appendix.] 

Chairman BACHUS. Mr. McKillop. 

STATEMENT OF JAMES H. McKILLOP, III, PRESIDENT AND 

CEO, INDEPENDENT BANKERS’ BANK OF FLORIDA, LAKE 

MARY, FLORIDA, ON BEHALF OF INDEPENDENT COMMUNITY 

BANKERS OF AMERICA (ICBA), WASHINGTON, D.C. 

Mr. MCKILLOP. Thank you, sir. Mr. Chairman, Ranking Member 

Maloney, and members of the subcommittee, I am Jim McKillop, 

president and CEO of the Independent Bankers’ Bank of Florida, 

but I appear today on behalf of the Independent Community Bankers of America. 

ICBA appreciates this opportunity to testify on the bank regulatory agencies’ proposed guidance on commercial real estate lending and on the agencies’ proposal to implement Basel II rules. I 

want to compliment the subcommittee for taking up these difficult 

regulatory issues so late in the Congressional session. These proposals deeply affect community banks in their ability to serve their 

communities. 

IBB, my bank, serves over 270 community banks in Florida, the 

southern portions of Georgia and Alabama. We have CRE loans in 

excess of 600 percent of capital. As a bankers’ bank, we serve only 

community banks, not the general public. This unique focus gives 

me an opportunity to hear and address the business challenges 

faced by community banks throughout the region. 

ICBA believes that the proposed commercial real estate guidance 

is seriously flawed, and we have strongly urged banking agencies 

not to go forward with its current form. Nearly 1,000 commenters 

filed letters with the agencies expressing grave concerns. Many 

community banks see it as a call to cut back on CRE lending. 

If a community bank must cut back, it means cutting back on 

one of its more profitable business lines, but we fear that it will 

also lead to an artificial credit crunch in the CRE sector, with less 

money being available to support community growth. A mentor of 

mine once said, ‘‘You grow your community to grow your bank, not 

vice versa.’’ 

Existing real estate lending standards, regulations, and guidelines are sufficient to guide banks through any weakness in the 

CRE market, and have already provided examiners with the tools 

needed to address any unsafe and unsound practices. 

38

Banking regulators state that they have identified problems in 

some banks, yet they would apply this guidance across the entire 

industry. Instead, examiners should identify and address these 

problems bank-by-bank. 

The proposed thresholds of 100 percent of capital and 300 percent of capital are seriously flawed; they do not give a clear picture 

of the risk; they do not take into account underwriting, risk management, and other practices of individual banks; and they do not 

recognize the different segments of the CRE markets that have different levels of risk. Market analysts could misapply the guidance 

from these sorts of CRE ratios, giving investors an inaccurate picture of a bank’s level of risk. 

Community banks conservatively underwrite and manage CRE 

loans, requiring more and more down payments or taking other 

steps to control collateral. They must carefully inspect what’s going 

on at all steps of the occasion. They know their community and 

they know how to underwrite. 

I thank you for the time, sir. 

[The prepared statement of Mr. McKillop can be found on page 

162 of the appendix.] 

Chairman BACHUS. Thank you. 

Mr. Lackritz. 

STATEMENT OF MARC E. LACKRITZ, PRESIDENT, SECURITIES 

INDUSTRY ASSOCIATION (SIA) 

Mr. LACKRITZ. Thank you, Mr. Chairman. Mr. Chairman, Ranking Member Maloney, and members of the subcommittee, on behalf 

of the SIA and the securities industry, I appreciate the chance to 

testify today on Basel II as incorporated in the SEC’s framework 

for consolidated supervised entities, and we commend the subcommittee for holding this timely hearing. 

As the number of large financial conglomerates has grown steadily over the last several decades, regulators and market participants realized that a form of consolidated supervision was necessary to obtain a comprehensive view of the entirety of a firm’s 

activities and not just individual lines of business. Consequently, a 

Joint Forum on Financial Conglomerate was formed to focus on the 

oversight of those institutions, financial conglomerates. 

In turn, the European Union’s financial services action plan used 

portions of the Joint Forum’s work to develop a directive, the financial conglomerates directive, and that mandates that any financial 

firm with significant operations in Europe demonstrate that it is 

subject to and in compliance with a regime of consolidated supervision. 

Under the terms of this directive, any non-E.U. firm must prove 

that it’s subject to consolidated supervision by its home regulator 

that is, ‘‘equivalent,’’ to that required of E.U. firms, and a failure 

to demonstrate that equivalency would require that that firm’s European operations would be fenced off or ring fenced, as the term 

is used, from the remainder of its global activities. In response to 

this initiative, the SEC undertook to craft a new regulatory framework for consolidated supervision of major independent investment 

banks not otherwise subject to consolidated supervision; this is so 

that they could compete in Europe. 

39

Under the CSE framework, the SEC supervises certain brokerdealer, their holding companies, and affiliates on a consolidated 

basis, focusing on the financial and operational status of the entity 

as a whole. 

Parallel with the requirements of other global consolidated supervisors, the CSE framework incorporates significant elements of 

Basel II. In reviewing a CSE application, SEC staff assess the 

firm’s financial position, the adequacy of the firm’s internal risk 

management controls, and the mathematical models the firm will 

use for internal risk management purposes and regulatory capital 

purposes. 

Following approval, the SEC staff reviews monthly, quarterly, 

and annual filings containing financial, risk management, and operations data on the CSE registrant. To date, the SEC has approved five CSE applicants. 

Shortly after publication of the final framework by the SEC in 

July 2004, the E.U. provided general guidance indicating that the 

framework is equivalent to the form of consolidated supervision required under the financial conglomerate directive, and with the 

U.K.’s financial services authority acting on behalf of the E.U., that 

finding has been subsequently affirmed in its having made equivalence decisions for each of the individual CSE registrants. 

We congratulate the SEC on the implementation in a timely 

fashion of this framework and all the work that went into it. It required an enormous effort by the agency in a relatively short period 

of time, and we regard it as an excellent example of prudential supervision. 

The CSE firms also wish to thank this committee, Mr. Chairman, 

and members of the Administration, particularly the Treasury, for 

their interest in learning about the CSE framework and, most importantly, in ensuring the process of finding of equivalency by the 

E.U. was both fair and timely. That permits our firms to compete 

globally and specifically to compete in Europe. 

Thank you, Mr. Chairman, very much. 

[The prepared statement of Mr. Lackritz can be found on page 

155 of the appendix.] 

Chairman BACHUS. Ms. Petrou. 

STATEMENT OF KAREN SHAW PETROU, CO-FOUNDER AND 

MANAGING PARTNER, FEDERAL FINANCIAL ANALYTICS, INC. 

Ms. PETROU. Thank you, Mr. Chairman. It is a real honor to appear before this committee again. It’s an honor to appear before 

you again on the Basel rules, having first been a witness at your 

first hearing, and to have seen the significant difference in the 

rules, as under the leadership of you, Chairman Bachus, Ms. 

Maloney, and the Financial Services Committee, the regulations 

have changed for the better, particularly with regard to the recognition now of the potential competitiveness impact. 

However, as this panel makes clear, there are some ongoing 

issues which I would like briefly to raise before you. 

All of them, I think, are occasioned by the unique nature of the 

U.S. financial system, and our rules must therefore be crafted to 

recognize our own reality, not some abstract set of rules devised 

who knows where sometimes. 

40

We’ve talked a lot about the risks of different provisions in Basel 

II. If I may, I’d like to point to another one, which is the risk of 

the United States staying too long under Basel I. We are now lagging behind everyone else towards adoption of a modern capital 

framework, and this poses significant risks, not just because of the 

competitiveness concerns that have been voiced, but actual risk 

ones. 

I would suspect that one of the reasons the banking agencies put 

the CRE guidance out as is, as you rightly said earlier today, Mr. 

Chairman, as a blunt instrument, is because we don’t have regulatory capital standards that can appropriately distinguish between 

high risk and low risk forms of commercial real estate, so blunt 

asset limitations have been proposed instead. 

Similarly, I think because our rules do not recognize risk properly, we have seen a huge buildup in high-risk mortgage structures 

because our regulatory capital system does not well recognize those 

and the agencies are now scurrying to try to remedy this, in part 

again because our risk-based capital rules are woefully out of date. 

We must move quickly. I think we must adopt as much of the 

modern Basel II framework as quickly as we can, leaving the disputed pieces aside, resolving those quickly, because again, the 

longer we stay under Basel I, the greater our competitiveness 

issues, but even more distressing, the higher the risk our system 

will run as the business cycle starts to turn. 

Now, I know that many of the agencies testifying this morning 

discussed the leverage standard as one they think will allay some 

of the risks they see in Basel II. 

I believe that that would be a false safety net, and in fact, would 

make the financial system here riskier if their leverage standard 

is retained. 

This committee well remembers the thousands of banks and 

S&L’s that failed in the early 1990’s, and before that throughout 

the 1980’s, when a leverage standard was fully in effect. 

A leverage standard, particularly if applied to the parent holding 

companies, creates incentives to take risk, not to reduce it, because 

banks must find a way to make regulatory capital and economic 

capital align as best they can, and an arbitrary leverage standard 

forces them to take on more risk. 

It also forces more reliance on complex off-balance-sheet assets 

that escape the leverage rule, exacerbating potential risky complexity. 

I’ve testified many times on the operational risk standard. I’d 

like again to remind the committee that it is an unfortunate aspect 

of both the Basel II accord and now of the U.S. Basel II NPR. Happily, it is out of the 1A proposal and should stay out. 

There is no agreement on methodology or measurement for operational risk and a capital charge will distract banks and supervisors from urgent work to ready our systems, our contingency 

plans, and disaster preparedness for the manmade, and sadly, for 

the terrorist risks we must continue to face. 

With regard to the standardized option, I would suggest that it 

be put on the table for U.S. banks. I think it is up to the banks 

to pick the capital regime right for them, not for the regulators arVerDate 0ct 09 2002 13:05 Apr 10, 2007 Jkt 031549 PO 00000 Frm 00048 Fmt 6633 Sfmt 6633 K:\DOCS\31549.TXT HFIN PsN: TERRIE
41

bitrarily to specify one or another for different types of banks based 

solely on size. 

If the banking agencies do not like the choice an institution 

makes, they have Pillar 2, safety and soundness, and Pillar 3, market discipline powers to review these decisions and, if necessary, 

reverse them, but an arbitrary distinction about which capital option should be provided to whom is, I think, top down decision 

making that exacerbates regulatory burden and competitiveness 

concerns. 

Thank you, very much. 

[The prepared statement of Ms. Petrou can be found on page 239 

of the appendix.] 

Chairman BACHUS. Thank you, Ms. Petrou. 

Mr. White. 

STATEMENT OF ROBERT M. WHITE, JR., PRESIDENT AND 

FOUNDER, REAL CAPITAL ANALYTICS, INC., NEW YORK, NEW 

YORK 

Mr. WHITE. Thank you, sir. Thank you for the opportunity to 

speak to this subcommittee and to address several concerns I have 

relating to the proposed guidance for CRE concentration risk. 

The premise of the proposed guidance is that real estate is 

among the most volatile of assets, but this premise is faulty. Real 

estate remains a cyclical business, but it is no longer subject to the 

extreme boom and bust cycles that were experienced in the 1980’s. 

The capital market for commercial real estate has evolved into one 

that is sophisticated, transparent, disciplined, and national, if not 

international, in scope. 

Moreover, the transformation of both the debt the equity markets 

has occurred only recently, primarily in the past decade, and the 

changes are secular in that they have permanently changed the nature of this industry. 

The level of information currently available concerning real estate prices, mortgage terms, development activity, rental rates, and 

occupancies make the 1980’s look like the dark ages. 

In the capital markets, this new level of transparency translates 

into greater liquidity and a diversity of capital sources, many of 

which did not exist in the 1980’s. 

For example, real estate investment trusts, or REIT’s, while created in 1960, only became a material component of our capital market in the mid-1990’s. The growth of the REIT industry has not 

only expanded the investor base for real estate but brought a whole 

new level of scrutiny to the industry. In 1990, there were less than 

a handful of Wall Street analysts covering REITs and the commercial real estate industry. Now there are approximately 500. 

The introduction of public capital into the real estate debt markets in the form of commercial mortgage-based securities, or 

CMBS, has had an even greater influence. The CMBS market helps 

illustrate that a concentration of CRE loans is not inherently bad 

if the portfolio is intelligently underwritten and diverse geographically and by property type. 

Current subordination levels in the CMBS market approximate 

15 percent, meaning that up to 85 percent of the bonds secured 

solely by commercial mortgages would be awarded a AAA rating. 

42

The proposed 100 percent and 300 percent thresholds do not differentiate between a portfolio that is well diversified and a portfolio 

that is not. 

The CMBS market has also revolutionized transparency and imposed much-needed standards regarding underwriting, documentation, and reporting for commercial mortgages. There is also another 

aspect to the proposed guidance that troubles me. The 100 percent 

threshold for construction loans could impede economic growth and 

restrict capital for new housing and other development since commercial banks are the chief source of construction loans. 

Equity of all reporting bank holding companies totalled less than $1 trillion according to the latest out data from the Federal Reserve. However, private construction spending also equates to an 

annual rate of just under $1 trillion, although construction spending represents only a portion of overall development costs. 

Thus, the 100 percent threshold outlined in the guidance would 

be restrictive, even at current levels of construction activity, and 

may have unintended consequences of creating a problem where 

none currently exists. 

Thank you for your time, and I welcome any questions. 

[The prepared statement of Mr. White can be found on page 281 

of the appendix.] 

Chairman BACHUS. Thank you, Mr. White. 

Dr. Mueller. 

STATEMENT OF GLENN R. MUELLER, Ph.D., PROFESSOR, UNIVERSITY OF DENVER, FRANKLIN L. BURNS SCHOOL OF REAL 

ESTATE & CONSTRUCTION MANAGEMENT AND REAL ESTATE INVESTMENT STRATEGIST-DIVIDEND CAPITAL GROUP, 

INC. 

Mr. MUELLER. Thank you. My name is Dr. Glenn Mueller, and 

I’m a professor at University of Denver. I have a Ph.D. in real estate and I was called here by the Committee for Sound Lending 

and the Real Estate Roundtable to help educate you on some of the 

problems that we have today. 

The proposed banking agency guidance on commercial real estate 

lending concentration appears to be predicated on some fundamental misconceptions of how the commercial real estate industry 

functions today as opposed to 20 years ago when we had our major 

problems. Today, the commercial real estate industry is a very different one than existed in the 1980’s and the early 1990’s. 

The real estate asset class has two major groups—residential 

home ownership real estate and commercial income-producing real 

estate such as office, warehouse, retail, apartment, and hotel. 

Residential real estate markets and commercial real estate markets are fundamentally different. Residential ownership, housing, 

is not connected or highly correlated with commercial income-producing real estate. 

The commercial space market is local in nature, driven by local 

employers for demand and builders for supply. Demand and supply 

drive occupancy rates that drives rent growth. Occupancy rates and 

rents drive earnings that make mortgage payments. 

The real estate space markets today are different for every metropolitan market, for every major property type. Thus, a Chicago 

43

office market and a Chicago retail market are in very different 

places in their cycles and the Chicago retail market is in a very different place from the Miami or New York retail market. 

In my written testimony, I have a copy of the market cycle report 

that I do on a quarterly basis that goes out to most people in the 

industry, that explains those differences. 

The space cycle of the 1970’s was 10 years long, peak to peak, 

while the next cycle was 21 years long, 1979 to the 2000 peak. The 

current economic space market hit an occupancy bottom in 2003, 

but price declines and loan defaults did not happen in this down 

cycle as they did in the 1990’s. 

Today’s space market is still in the recovery phase for most property types and probably won’t peak until after 2010. The growth 

phase of this cycle probably doesn’t start until 2008. 

The severe cycle downturn that occurred in the commercial real 

estate market during the 1980’s and early 1990’s was triggered by 

factors that are not present in today’s environment, such as the 

changes in the internal revenue code that allowed people to make 

tax investment and tax shelter deals. 

These deals were not based on underlying profitability of the 

project as well as we had expansion of lending powers to thrifts 

that allowed commercial real estate loans to be made for the first 

time by people who were inexperienced in the marketplace. These 

factors led to over-building. Then regulatory guidance in the early 

1990’s shut down all capital flows to commercial real estate and 

the problem was exacerbated, and hurt a healthy real estate industry for many owners with good properties. 

The agencies should gain a better understanding of the changes 

in the marketplace today and develop guidance that addresses the 

diversity and low risk of today’s real estate. They should also consider an analysis of property type and metropolitan area concentrations when they analyze risk. 

We hope that the committee will think about, or rethink, the 

need for these arbitrary thresholds that they are proposing. 

Thank you. 

[The prepared statement of Dr. Mueller can be found on page 214 

of the appendix.] 

Chairman BACHUS. Thank you. 

Mr. Hensarling, thank you for your attention on this matter, and 

for your involvement. It’s been invaluable. 

Mr. HENSARLING. Thank you, Mr. Chairman. I offer an apology 

to almost every witness. I was on the Floor engaged in debate and 

frankly missed most of the testimony. I think I heard about half 

of yours, Mr. White, and much of Dr. Mueller’s, which actually hit 

upon a key point that I wanted to explore with our regulators and 

ran out of time on the earlier panel. And that is really to compare 

and contrast the underlying conditions in our risk assessment tools 

we have today vis-a-vis roughly 15, 20 years ago, in the late 1980’s 

and the early 1990’s. 

One thing I guess I heard you say, Dr. Mueller, which rings very 

loud to me, is that there was a lot of real estate that was built that 

was essentially tax code driven, and to me that is obviously a very 

fundamental difference we have in today’s economy versus that 

which preceded the real estate bust of that time. 

44

But I’d be curious in exploring with any of the other witnesses, 

as we get concern from the regulatory community, what is it that 

your industry is doing differently today than it was 15 years ago 

that should somewhat ease the concerns of members of this committee? How do we know it’s not going to be ‘‘deja vu all over 

again?’’ Whoever would like to hop in. 

Mr. MCKILLOP. I’d love to give it a try. In relationship to community banks, we are seeing that there is a much, much closer correlation to the banker understanding cash flow needs of the borrower, the cyclical needs of that borrower, and their capacity to 

pay. 

The community banker goes to church and the Rotary Club and 

the grocery store with these folks that they’re making loans to. It’s 

not mystique. But in this cycle, we are not driven by a tax-laden 

incentive to get things going. 

We have been driven, however, by a low interest rate environment, which helped spur the economy out of the economic decline 

following 9/11, which recognized that was the case. 

The Federal Reserve led us to very low interest rates. It spurred 

the economy along as prime dropped to 4. Prime is now back up 

to slightly above 8. And that helped the economic cycle. There will 

be some repercussions from negative cash flow as interest rates 

have gone higher. 

But the bankers are understanding the valuations, they’re taking 

strong loan to value precautions, they are taking a guarantor or a 

co-borrower position behind the collateral in addition to that and 

monitoring on a monthly or quarterly basis. 

Mr. HENSARLING. Anybody else? 

Mr. LACKRITZ. Yes, Congressman. We don’t have a direct dog in 

this particular fight concerning real estate loan regulation, but 

talking about the capital markets and how that’s changed significantly over the last 15 years, I can speak to the evolution of deep, 

rich, liquid capital markets that in fact help to finance all the 

mortgages and real estate loans that end up being made. 

While they’re made at the front end by the banks, they end up 

being laid off back into the capital markets and sold in the capital 

markets and securitized, basically. And the capital markets have 

grown dramatically in the last 15 years to provide additional liquidity to the sector, but in addition to that, with the evolution of 

financial engineering, portfolio theory, and a number of other factors that go into managing risk more effectively, there are far better products in the marketplace now to hedge that risk. There are 

structured products to in fact try and provide some balance and 

some risk. 

And so while you’ve got evolution of technology and you’ve got 

evolution of marketplaces, you still have human nature, which 

hasn’t changed, and which will still cause boom and bust cycles, 

but I think the capital markets have evolved in such a way that 

it helps to cushion those ups and down a lot more significantly 

than they used to. 

Mr. HENSARLING. I’m being mindful of my time, and wanting to 

slip in at least one more question. 

Dr. Mueller, did you have one quick comment? 

45

Mr. MUELLER. Yes. Very quickly. In 1990, there were very few 

real estate programs in the country. Today there are over 30 of 

them. We have 500 students at the undergraduate and graduate 

level in our program. We have people who are well-versed and understand the marketplace. 

In the 1970’s, when I first went to work for a bank as a loan analyst, there were no standards for appraisal. Now we have appraisal 

licensing. 

And many times, banks didn’t even have good information about 

the loans that they had made when they went bad. Today, we have 

much better standards and much better underwriting and we’re 

underwriting economic deals that actually have tenants and leases 

in place. 

Mr. HENSARLING. A second question. 

As I listened carefully this morning to the chairman of the FDIC, 

I thought I heard her say that with respect to the CRE guidance, 

that we do not have limits, we just have increased scrutiny. I’m not 

sure all the bankers in my district feel thusly. 

Do you feel that there is a de facto limit out there, and if so, 

what evidence do you have of it? 

How about you, Mr. Simmons? 

Mr. SIMMONS. I guess I’d say that we found regulators, starting 

about 3 years ago, really focusing on commercial real estate concentrations. 

We are very active through the Southwest, Texas, Arizona, Nevada, and Southern California, where it’s a major activity, and I’d 

say first of all, to their credit, they have focused on strengthening 

risk management, and I think the industry is doing a much better 

job of that. 

But I do think that there is a risk when you try to get the word 

down to the examiners in the field, that it does turn into a very 

prescriptive kind of approach that has a risk of really shutting off 

credit to projects that are deserving of credit. 

And so that’s—you know, we have yet to see how this will play 

out, but I think we’re all nervous about the possibility of it really 

becoming a great tightening. 

Mr. HENSARLING. With the chairman’s indulgence, could the 

other panelists answer the question? 

Chairman BACHUS. Yes, sir. 

Mr. MEYER. Mr. Hensarling, I would just add to that, not something different, but just a slightly additional perspective. And that 

is that, in the hands of an examiner, the tendency is to interpret 

guidance from Washington in the most severe fashion, and as I 

read through the guidance, in fact, I used a highlighter, because 

they make a very grand distinction between the word ‘‘should’’ and 

the word ‘‘must,’’ which on a regulatory basis has significant implications. 

If you count the number—I gave up. My yellow highlighter was 

wearing out in terms of the number of ‘‘shoulds’’ that were contained in the guidance. And I’m afraid what happens in the real 

world is that the examiners tend to read that as ‘‘musts,’’ the 

‘‘shoulds.’’ Also, I would say that beginning with an examination 

which we were undergoing when this guidance was first issued on 

a proposal basis, that the examiners who were examining our instiVerDate 0ct 09 2002 13:05 Apr 10, 2007 Jkt 031549 PO 00000 Frm 00053 Fmt 6633 Sfmt 6633 K:\DOCS\31549.TXT HFIN PsN: TERRIE
46

tution immediately started evaluating our performance using the 

thresholds outlined in the guidance, and while we protested, they 

said, ‘‘You might as well look at it from this perspective, because 

here’s what’s coming.’’ 

So I think the real world application may be different from what 

is intended in Washington. 

Mr. HENSARLING. Did anyone else wish to address the question? 

Mr. MCKILLOP. I’ve been through an examination. I have 270 

banks that I work with. Since January when these guidelines went 

out, every banker that I’ve spoken with has been directed to be 

using the new guidelines. My most recent exam used the guidelines 

in August. 

Mr. HENSARLING. Thank you. And I am very much out of time. 

Chairman BACHUS. Thank you. 

Ms. Maloney. 

Mrs. MALONEY. Thank you. I thank all of you for your insights. 

I’d like to ask Mr. Garnett, on the QIS–4, it led the regulators to 

add their additional safeguards to the U.S. version of the accord. 

And my question is, do you think the QIS–4 is an accurate measure of risk? 

Mr. GARNETT. The direct answer to your question is no, and I 

think we probably heard that same answer from at least one or two 

of our regulators this morning, and let me describe why that is the 

answer. 

The QIS–4 was performed long before the practices in the various banks were in compliance with Basel II. We’re still working 

on that as we speak. As I think Comptroller Dugan mentioned, 

there was no supervision to that exercise. 

Most importantly, there was no assessment of what we call Pillar 

2, and that is a very important part of the Basel II process. This 

is the supervisory examination process where they sign off on your 

process. So I would describe QIS–4 as a dress rehearsal without 

the director in the house. 

Unfortunately, we’ve drawn some conclusions, or conclusions may 

have been drawn from that and have resulted in adjustments to 

the advanced approach from the Basel accords which are obviously 

now causing us some very serious competitive and cost burden concerns. 

Mrs. MALONEY. Would anyone else like to comment? 

Ms. PETROU. I would. I would strongly agree with that. Indeed, 

initially, the regulators expected that the QIS–4 exercise would be 

very flawed and they intended to have supervisors at everybody’s 

side, double checking all the entries. That quickly became impossible and the survey results are just wholly unreliable as a result. 

Mrs. MALONEY. I’d like to ask you, on your earlier statements, 

you said, Ms. Petrou, that many of the industry—and you—stated 

and others stated that the fact that the United States is behind 

other countries in the implementation of the Basel II accord would 

put U.S. banks at a disadvantage. And can you quantify that? In 

other words, to what extent should we value implementing a rule 

quickly over making further adjustments? 

Mr. MCKILLOP. I think it’s impossible to quantify, because you’re 

really asking me to judge when is the search for the perfect the 

enemy of the good. And I think the Basel exercise, from its incepVerDate 0ct 09 2002 13:05 Apr 10, 2007 Jkt 031549 PO 00000 Frm 00054 Fmt 6633 Sfmt 6633 K:\DOCS\31549.TXT HFIN PsN: TERRIE
47

tion, when your committee first held these hearings in 2002, until 

now, has often been one in which model builders wrestle each other 

to the ground on what a probability of default is on a Tuesday, and 

the larger scheme gets lost. 

I was very honored to testify before this committee last year that 

a lot of Basel debate has been among the ‘‘how to’’ people, both in 

the regulators and in the banks, and the ‘‘should we.’’ 

What does it mean for a financial system debate is only now coming out as again your committee has forced the regulators and the 

industry to really confront these issues. 

If foreign takeovers occur in the United States, or we have bank 

non-bank takeovers where institutions decide to lose their banking 

charters because they see this as a necessary market evolution, so 

be it, but if we have further consolidation or similar changes, more 

non-bank charters, for example, creating new risks solely because 

of an arbitrary regulatory capital charge, that I think would be a 

most unintended consequences of the search for the perfect capital 

accord. 

Mrs. MALONEY. Building on what you said, are there parts of the 

accord that could be adopted now while leaving room for further 

adjustments, and would that make sense? 

Ms. PETROU. With modifications for the United States, yes. For 

example, the operational risk-based capital rule is ill-designed and 

inappropriate around the world, and we should not impose it here, 

especially in light of the many non-banks that are key competitors 

in segments like asset management, and our leverage rule is problematic for the same reason. 

I would note that the SEC did not impose a comparable standard 

in the CSE charter, so big commercial banks like Citigroup are on 

day one against a competitive challenge with big investment banks 

like Goldman Sachs, as a result. 

Mrs. MALONEY. Going to another point, I was really shocked at 

the testimony this morning by some of the regulators where they, 

if I heard them correctly, they said that if there were any problems, then they’d let the international community work it out. 

Now, I don’t see the international community trying to protect the 

American financial interests. I found that very troubling. 

I also found it very troubling where no one would affirm or come 

forward—I said, are American banks disadvantaged in the capital 

requirements, and I got the impression that, ‘‘Yes, but don’t worry 

about it, the international community will work it out.’’ Now, I 

found that a troubling statement, but I invite anyone on the panel 

to make a statement on it, or do you trust the international community to work out any problems that may be disadvantaging the 

American financial institutions? 

I’ll go to Mr. Garnett. I’ll pick on him, since he’s my constituent. 

But I really invite anyone else to make a statement. But I found 

that, quite frankly, a shocking statement. 

Mr. GARNETT. I think the approach to fixing a significant problem that is unearthed, and quite frankly, I have yet to be made 

aware of a significant problem that can’t be corrected through the 

powers that the regulators have been granted in Basel II, particularly through Pillar 2. 

48

But if there is a particular flaw that is found after a period of 

time, we would obviously prefer that flaw be fixed universally, so 

that we don’t find ourselves with an uneven or a disjointed regime 

for regulatory capital. 

I think that’s about all I can add to your thought. 

Mrs. MALONEY. And if I could add to it, there’s significant differences between the proposed U.S. version of the accord and the 

version being implemented in the E.U. and other countries. I don’t 

understand why we have this difference. 

But there’s a different implementation schedule, there are overall 

more conservative rules leading to a harsher decision, no choice of 

compliance methods. There’s artificial definition of default not consistent with current banking practices. These are a few differences 

that we pulled out, but why should we have these differences? 

As you said in your testimony, Mr. Garnett, why don’t we harmonize it and move forward so that everybody is on a fair playing 

field and that everybody has a competitive equality? 

And my question to you, we should not put our banks at a disadvantage to foreign banks. At the same time, I am concerned 

about safety and soundness, and is it possible to strike a balance 

between these two policy issues? And again I’ll start with Mr. Garnett, and if anyone else would like to add anything. 

Mr. GARNETT. As you stated, in our testimony, we think it’s extremely important to be operating from a consistent set of standards. 

Again, if there appears to be a significant flaw in those standards, I think that flaw ought to be resolved within the Basel community at large, so that if there are—I am not aware of any significant flaws. We are implementing as we speak, as a company, in 

many locations, and we are not at this point aware of any significant concerns that are being raised to us with regard to this implementation. So we feel, obviously, very comfortable with the safety 

and soundness. That was a critical, critical piece of the objective of 

Basel II, safety and soundness, and I want to underscore that, in 

level of importance. 

Chairman BACHUS. I thank the gentlewoman from New York. 

Let me start by saying that the risk management procedures at 

banks must be working, because I don’t think we’ve had a bank 

failure—we’re at historic lows. No, we’ve had, you know, much advertised busting of the residential housing market in certain areas, 

although as the testimony has been, you know, it’s different from 

area to area. But the banks are obviously doing something right. 

The regulators—the present regulatory scheme must be pretty 

good. That having been said, what is proposed—let me ask the 

bankers, I’m going to start with the bankers. This question will go 

to Mr. Simmons, Mr. Meyer, and Mr. McKillop. 

What the regulators are proposing as far as the regulatory model 

that they’re setting up under Basel, how does it fit with the 

present-day banks’ procedures, risk management procedures? 

Would it force a change in what you’re doing, and what would be 

the cost or the result of those changes? 

Mr. SIMMONS. Thinking about different sizes of banks, I think 

you’ll find that the very largest banks are well down the road toward developing economic capital models and risk management 

49

systems that are very compatible with the concepts underlying 

Basel II. As you get to community banks, that would be less the 

case. 

But nevertheless, I think the standards have risen across the 

board, over the last couple of decades, since we last had some real 

problems in the industry, in terms of the structure internally in institutions, the risk management checks and balances, and appraisal review functions as it pertains to commercial real estate, 

etc. 

But it’s important, I believe, that we have options, that the very 

largest banks have a regime that’s compatible with their complexity and the work that they’ve already done, and that the community banks, that we not add to the regulatory burden. 

At the same time, we believe that it’s really important that we 

not create capital allocations and charges for different classes of assets that vary by size of institution. 

So at the end of the day, I think it’s going to be really important 

that we allow every size bank to apply the same type of capital 

charge to the same type of asset. Otherwise, you’re going to find 

a great deal of arbitrage, shifting of market share, and I think a 

great deal of risk that will arise as a result of that. So that’s going 

to be important as we build new capital frameworks going forward. 

Chairman BACHUS. Mr. Meyer. 

Mr. MEYER. I’m not sure that I would differ with anything. I 

would like to re-emphasize the point about similar charges for similar assets. I think that’s terribly important. 

I think what’s going to happen, and I think what has happened, 

as Harris was saying, is that we have seen a vast improvement and 

change in modeling that banks do in their risk management practices, and I think that is universal, to a higher degree perhaps in 

the more sophisticated larger institutions, and if you get to the 

smaller community banks, less so. 

But nonetheless, it has been a subject of concern and interest for 

virtually everybody, and I think that the longer the good times 

have gone on, and we’ve all enjoyed some pretty good times, I think 

that the degree of scrutiny within institutions has risen because we 

all realize that good times don’t necessarily last forever. 

I think that the opportunity to have a bank choose the system 

that best fits its business model and its risk parameters from having available to them in the future Basel I, IA, and having the advanced approach as well as the standardized approach, it fits what 

I think institutions are gravitating towards, and that is, choose the 

model that best fits your institution and your risk model, your risk 

parameters going forward as an institution. 

And I think universally that will tend to strengthen the risk 

management practices even further than it has in the past, as people have broader opportunities. 

Chairman BACHUS. Anyone else? 

Mr. MCKILLOP. Yes. 

In trying to speak for community banks, I’d have to say that 

there is a tremendous uncertainty in regard to whether or not it’s 

going to make sense for a $100 million or $200 million or $300 million bank to spend the money necessary on the computer side of 

the business, which they don’t own—they don’t have the DP system 

50

inside, they don’t have the programmers inside. They have to go 

out to an advisor and get a program written and get it run and pay 

for it—the tradeoff. Where’s the tradeoff? I’m going to spend 

$100,000 for this program to get $10,000 more in revenue, or not? 

So the community banker really needs the opt-out provision, the 

capacity to keep running like they’re running right now, as long as 

they’re well-capitalized and well-managed. If, down the road, there 

is a clear and directed economic bias that says that if I adopt these 

standards, I can make a better business plan, then that community 

banker could opt-in. They’re smart enough to be able to do it, and 

hey’re independent enough to want the choice. 

Chairman BACHUS. All right. And Mr. Garnett, the larger institutions, do you have any comment on this? 

Mr. GARNETT. As far as we’re concerned, the most effective way 

of managing cost burden, or cost benefit we should be thinking 

about, and level playing field, competitive marketplace, is permitting options that fit the right shoe. 

And I think by having on the table Basel I, Basel IA, standardized and the advanced, and of course those last two approaches 

need to be consistent with the international accord, I think provide 

the marketplace here in the United States with the right balance 

of options. 

Chairman BACHUS. All right. If we had not only advanced but a 

standardized approach option, would it in many cases for the 

banks—and I’ll ask the bankers this again—would it reduce the 

cost, or what would be the—what do you see as a cost prediction? 

Mr. MCKILLOP. If I could just start, the standardized option is 

clearly easier to adopt. 

Chairman BACHUS. It’s more cost-efficient? 

Mr. MCKILLOP. That’s correct. 

Chairman BACHUS. And the smaller the bank, the more difference— 

Mr. MCKILLOP. The more likely that they would move in that direction. 

Chairman BACHUS. Mr. Simmons? 

Mr. SIMMONS. Yes, I would agree with that. The standardized approach is going to be much more cost-effective and lead to approximately the same kind of result. 

Chairman BACHUS. Thank you. Let me shift to the analytic and 

our academic witnesses. 

I guess, Mr. Mueller, what you said is something a lot of people 

don’t appreciate. I think they lump real estate together. They talk 

about a bubble, and they’ll be talking about a residential housing 

bubble; in another place, there may be an overabundance of commercial property or over-building. 

But I would think that really, the people who can make the best 

judgment of that would be the local institutions that are loaning 

their money, as to whether it’s profitable. 

I think that if you’re a local bank, you’re going to make a judgment on whether you think you get your money back, and it probably depends more on who you’re lending it to and how deep their 

pockets are, and they may even lose their investment, but at least 

they would probably pay their loan off. 

51

But I just—what would you—I read your testimony. Would you 

elaborate on the difference in the residential market and commercial market again? 

Mr. MUELLER. Sure. I guess one of the key things is that a residential loan to a homebuilder has a risk to it that, when the house 

sells, the bank gets paid off. 

In commercial real estate, and I put apartments in the commercial real estate income-producing category, you basically pre-lease 

space prior to building, and therefore you know that you have revenue coming in that will help pay the loan. As a matter of fact, of 

all the property sectors, of all the commercial property sectors, 

apartments have shown to be the least volatile of all the property 

sectors in history, and yet they’re very different, and let me give 

you an example from my recent quarterly report. 

Orlando, Florida, has an apartment vacancy rate that is under 

2 percent today. It is one of the strongest apartment markets in the 

country, because obviously the economy is doing well. A loan to an 

apartment building in Orlando would be perceived to be extremely 

low risk. 

On the other hand, if you look at Hartford, Connecticut, their vacancy rate is above 10 percent, and it’s not a community that’s 

growing, it’s not a community that needs more apartments, and 

therefore a new building in Hartford, Connecticut, probably is not 

economically justified. 

Banks know that. Banks can look at it and say office buildings 

today can’t be built unless at least 50 percent of the space is preleased. That’s pretty standard in the banking industry today, so 

there is much better understanding of what’s going on. 

Banks, when they are doing larger loans, typically will syndicate 

participations to other banks so that they aren’t just concentrated 

in their own community, they actually are spread out. 

They can also sell their commercial loan if they’re making a permit mortgage into the commercial mortgage-backed securities market and buy back the same amount of loan in the CMBS market 

that is a pool that’s diversified across the country. 

So what happened in the early 1990’s is very, very different from 

what’s happening today. 

Chairman BACHUS. I think in your testimony you mentioned that 

the Middle Atlantic region consists of both Washington and Philadelphia, although those markets right now are diametrically opposed— 

Mr. MUELLER. That is correct— 

Chairman BACHUS.—their characteristics. 

Mr. MUELLER. That is correct. As a matter of fact, even here locally, the downtown Washington, D.C., market is literally the best 

in the country, and yet if you go out west towards Dulles Airport, 

that market, that sub-market, if you will, is still kind of coming 

through recovery and just beginning to go into growth. So even by 

sub-market, there can be major differences. 

Chairman BACHUS. How do you generally define a CRE market? 

Is it a region? Is it a State? Is it a city? 

Mr. MUELLER. It’s typically done by metropolitan area, is the 

way that most people look at it, because the base industries that 

52

drive employment growth, for instance, between Seattle, Washington and Detroit, are completely different. 

As the oil industry goes, so goes Detroit, but Seattle is done by 

both technology and the airline and aircraft building. So metropolitan areas are driven by the local economics and employment, and 

the commercial property types follow those cycles, and that’s why 

in the report it shows that they’re very, very different. 

Chairman BACHUS. But even a bank examiner trying to determine a threshold or a cap could make a mistake reviewing a loan 

portfolio. 

Mr. MUELLER. Right. Well, I think if they looked at diversity of 

loans within different metropolitan areas and just by different 

property types as well—you can have a very good market for apartments in Chicago, but a not-so-good office market, and so the different cycles by property sector make sense. 

I think one of the biggest problems is that regulators and the 

general public, when they hear real estate, they think of that one 

thing, or the past 2 years every time, and on a weekly basis I get 

a call from a reporter, ‘‘Will you give me some quotes for the real 

estate bust?’’ 

And my first question is, ‘‘Do you understand that there is a difference between the residential home ownership and the commercial real estate market?’’ 

Chairman BACHUS. Okay. Mr. White, you mentioned the condo 

converters. We obviously—I have a property on the Hill, and I’m 

constantly getting letters from these converters asking to buy my 

property. And I’ve noticed the regulators have actually expressed 

some concern about that. 

But, you know, in my opinion, it actually adds liquidity to the 

market, and I’m not getting as much—they’ve adjusted pretty well 

to the market, because I used to be getting two or three, you know, 

a month, and now I’m getting maybe once every—it’s been probably 

2 months since I’ve got a solicitation. But would you comment on 

that? 

Mr. WHITE. Sure, I’d be glad to. The condo conversions reached 

a frenzied pace about a year ago. It was truly an area that everyone in the industry was looking at, and if there was a bubble in 

the commercial sector, it would probably be in that area, and the 

lending to the condo converters was the most aggressive out there, 

throughout the industry. 

But while we are all looking at that, and thinking back to the 

1980’s, it actually turned out to be a great example of the lender 

discipline that’s out there. 

At the first sign that the housing market started slowing, condo 

conversion activity started to slow down, and it has come to almost 

a complete standstill in just a matter of months, and that is really 

a result of lender discipline out there. 

Chairman BACHUS. So a lot of efficiency in the market is what 

you’re saying? 

Mr. WHITE. Very much so. 

Chairman BACHUS. Okay. Based on your research, do you see a 

bubble in the commercial real estate market? 

Mr. WHITE. Absolutely not. I don’t. Prices, if you look at them, 

on a relative basis, relative to replacement cost, are still very much 

53

in line. Construction costs have been rising as fast, in fact faster, 

than properties have been appreciating. 

The yields on real estate, while low, and almost low on a historical basis, the spread between yields on real estate and 10-year 

Treasuries, that risk premium there is not the lowest that it’s been. 

There’s still a healthy cushion there. I see the buyers and the investors being very rational. 

Chairman BACHUS. Let me conclude. And this is not so much a 

question, but if anybody wants to respond to this bit of philosophy, 

they can. I know Mr. Hensarling, I know where he comes from, so 

I know he’ll agree with me on this. 

But one of my greatest problems with these guidelines is that I 

think unintended, in an unintended way it will cause—it may 

cause banks to shift their lending pattern to comply with what the 

regulator wants them to do as opposed to what the market dictates, 

which could have consequences for the economy. It could actually 

dry up lending in an area where lending ought to occur. 

And I’m not sure that the government should be in the business 

of telling a bank where it ought to loan money. What I think it 

ought to be in the business of doing is reviewing the portfolio to 

see that it’s sound and the default rate is low, and that each loan, 

on itself, is—or the percentage of loans are good loans. Any response to that? 

Mr. MCKILLOP. I would just like to respond from the standpoint 

that CRE guidance has for the first time a capital kicker, a requirement, a possible requirement for capital. 

There are no other regulations or rules promulgated that direct 

the necessity of additional capital. The regulators have all the tools 

necessary to take care of these various aspects of CRE and portfolio 

management and risk control. The addition of this capital component really is quite bothersome, especially without clear guidance 

on how it would be administered. 

Chairman BACHUS. Do any of you share my concern that it could 

actually drive the type of lending by the banks? And I’m not talking about, if they’re concerned about interest only, or certain types 

of loans, or the number of adjustable rate mortgages, I can see that 

as a valid concern. 

But to tell banks that they may have too many commercial loans 

or too many residential loans, in and of itself, as long as those 

loans are being repaid, is to me an unnecessary intervention. Is 

this an imaginary fear on my part or is there any basis for it? 

Mr. MCKILLOP. No, sir, it’s not imaginary. Out of about 270 

banks, 10 percent have modified their policies and procedures implementing those caps and, in essence, mandating a change in their 

policies on where they are going to put loans. 

Mr. MUELLER. If I may, you know, just a historic example. Back 

in 1991, when basically the banking regulators said, ‘‘No more real 

estate loans, period,’’ there were many very profitable, good companies. ChemCo would be one example out of New York City. 

It forced them to take their company public to get capital to pay 

off bank loans on loans that they had never missed a payment on 

that were in complete compliance, but because there, you know, 

was a 10-year loan that was coming due, and the bank couldn’t 

redo the loan. They were forced by the regulators to foreclose on 

54

them and get out of it. It did change the real estate industry because of that. 

But that kind of thing potentially could happen again, and in 

many cases, it’s a very unintended consequence. 

Chairman BACHUS. Thank you. I’ve been advised that we only 

have about 5 minutes left on the vote. 

Ms. Maloney. 

Mrs. MALONEY. I think you’ve raised a lot of issues that really 

merit another hearing on how financial policy impacts on the real 

estate industry, in many cases unfairly, in driving the markets. 

But fundamentally, this hearing is about Basel II and where we 

go from here, and I would like to ask the panelists, what’s the next 

step? 

Chairman BACHUS. Let me say this. What you can do is, we can 

direct a question to them, if that’s okay. 

Mrs. MALONEY. Okay. I’m directing a question right now. 

Chairman BACHUS. All right, go ahead. Well, let me— 

Mrs. MALONEY. If i could just say that it’s clear that, from the 

testimony today, that the standard is a higher standard in capital 

requirements for the American financial institutions, which I think 

is unfair in a global market. 

We as a Congress, as a country, as a Federal Reserve, should be 

fighting to have our financial industry on the same playing field. 

But what we’ve heard today is that there’s a different standard, 

a stronger standard, a higher standard for American financial institutions. I think that that’s unfair. And we should be fighting to 

make sure that our institutions can compete fairly and equally. 

And so my question is, what is the next step? Where do we go from 

here? I hope that the Federal Reserve and the committee that is 

working on this will listen to the testimony and make the proper 

adjustments as we go forward in the implementation of moving forward with Basel. 

I welcome any comments, and maybe you should send them to 

me in writing, because I’m going to miss a vote if I don’t go. 

Chairman BACHUS. Thank you, Ms. Maloney. And I’ll just conclude by this: I think what she asked is the very essence, where 

do we go from here? 

I would start by saying that this hearing has been very valuable. 

I think it’s highlighted the need to develop a greater consensus on 

how to regulate particularly real estate commercial lending. I think 

Mr. Frank got to the bottom line in noting that the regulators need 

to be careful in defining their buckets and what should go into 

them. 

I would encourage the regulators to meet with some of the panelists—Dr. Mueller, Mr. White—in the process of refining their guidance, as well as with the bankers and the industry. 

The market seems to have changed significantly, and we want to 

make sure that the bankers understand that, understand the market as it exists today, and not as it existed in the past. 

Given their expertise and the experience in the commercial real 

estate market, I think this panel could play a significant role in 

further defining and advising the regulators as they develop the 

guidance. 

55

So I, for one, am going to try to encourage some discussion between the first panel and the second panel. So with that, I will conclude. 

That has been my basic policy as a subcommittee chair, is to try 

to get the parties together, and to communicate, to resolve some of 

their differences, if they can. 

I’m going to discharge this panel, but before I do so, I have to 

do two or three bookkeeping things. 

I’m going to introduce testimony—I see no objection—the institutional risk and analytics testimony—a statement by the Risk Management Association and a statement from the Real Estate Roundtable. 

The Chair notes that some members may have additional questions for this panel, which they may wish to submit in writing. 

Without objection, the hearing record will remain open for 30 days 

for members to submit written questions to these witnesses and to 

place their responses in the record. 

This hearing is adjourned. 

[Whereupon, at 3:21 p.m., the hearing was adjourned.] 

(57)

A P P E N D I X

September 14, 2006

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