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PRIVATE SECTOR PRIORITIES

FOR BASEL REFORM

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

FIRST SESSION

SEPTEMBER 28, 2005

Printed for the use of the Committee on Financial Services

Serial No. 109–57

(

(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 

PETER T. KING, New York 

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 

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 28, 2005 .......................................................................................... 1

Appendix: 

September 28, 2005 .......................................................................................... 25

WITNESSES 

WEDNESDAY, SEPTEMBER 28, 2005

Ervin, D. Wilson, Managing Director and Head of Strategic Risk Management, Credit Suisse First Boston, also representing Financial Services 

Roundtable ............................................................................................................ 6

Marinangel, Kathleen, E., Chairman and CEO, McHenry Savings Bank (IL), 

representing America’s Community Bankers .................................................... 5

Petrou, Karen Shaw, Managing Partner, Federal Financial Analytics, Inc. ...... 9

APPENDIX 

Prepared statements: 

Oxley, Hon. Michael G. .................................................................................... 26

Bachus, Hon. Spencer ...................................................................................... 32

Ervin, D. Wilson ............................................................................................... 35

Marinangel, Kathleen ...................................................................................... 45

Petrou, Karen Shaw ......................................................................................... 52

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Bachus, Hon. Spencer: 

Basel II Accord: A Guide for the Perplexed, Barnett Sivon & Natter, 

September 21, 2005 ...................................................................................... 64

Letter to Hon. Alan Greenspan, Septembeer 13, 2005 .................................. 74

Frank. Hon. Barny 

Conference of State Bank Supervisors, letter, September 7, 2005 ............... 78

International Community Bankers of America, prepared statement .................. 82

(1)

PRIVATE SECTOR PRIORITIES 

FOR BASEL REFORM 

Wednesday, September 28, 2005

U.S. HOUSE OF REPRESENTATIVES, 

SUBCOMMITTEE ON FINANCIAL INSTITUTIONS

AND CONSUMER CREDIT, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The subcommittee met, pursuant to call, at 10:00 a.m., in Room 

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

Present: Representatives Bachus, Biggert, Feeney, Garrett of 

New Jersey, Neugebauer, Maloney, Sherman, Moore, Waters, Carson, Ford, Baca, Green, Clay, and Frank (ex officio). 

Also Present: Representative Kennedy. 

Chairman BACHUS. Good morning. The Subcommittee on Financial Institutions and Consumer Credit will come to order. 

Just to give you a brief history of this committee and what we 

have been doing with regard to Basel, on May the 24th we conducted a joint hearing with Congresswoman Pryce, or Chairwoman 

Pryce’s committee on this legislation, and we heard from the regulators. In addition, the subcommittee heard from the former Fed 

economist who left the Fed after their study of Basel’s impact on 

residential mortgages was rejected, which we found quite alarming. 

The prior March, this last March we—a bipartisan group of 

Members induced the same legislation we did in the previous Congress, H.R. 1226, the United States Policy Committee for Fair Capital Standards Act, which required the regulators to reach agreement before moving forward on Basel II. H.R. 1226 currently has 

38 cosponsors, including Mrs. Maloney, Chairman Oxley, and 

Ranking Member Frank. 

Today, we hear from the private sector. Our subcommittee will 

hold another hearing with the regulators after they return from the 

Basel Committee meetings in Europe next week, and that is why 

we did not have the regulators. We wanted to hear from the private sector today and then the regulators later. 

I think the thing I would stress most about this hearing and 

about Basel II is that I believe there is a strong consensus from 

this committee that we want the regulators to understand that the 

committee is very concerned about the Basel II proposal, and I 

strongly believe they should first issue a Basel IA proposal and 

only after doing that address Basel II by extending the effective 

date for Basel II. 

2

At this time I will recognize the ranking member of the full committee. 

[The prepared statement of Hon. Spencer Bachus can be found 

on page 32 in the appendix.] 

Mr. FRANK. I thank the chairman. I appreciate the leadership 

that both he and the chairman of the full committee have given 

this committee. I think this committee is—well, yesterday, in fact, 

we were congratulating ourselves legitimately for the role we have 

played—again, the gentleman from Alabama was a major player in 

this—in pushing for debt relief for the poor countries. I think the 

agreement that was recently reached for debt relief for the highly 

indebted poor countries owes a lot to the bipartisan work of members of this committee. 

Today we are talking about another area involving international 

economic activity where this committee has taken a role. And at 

first, when we began to look into the Basel issue, to be honest, we 

were treated by some—including many at the Federal Reserve—as 

ignorant peasants I guess would be the best phrase. We were dealing with something beyond our understanding and we were being 

parochial. 

What we found was that the way this was structured; serious 

reservations from bank regulators other than the Federal Reserve 

were being minimized, serious concerns from the financial services 

community were being ignored, and the more we looked into this, 

the more we became confident that we were, in fact, doing something very important and very constructive. And I think, again, 

this committee deserves some credit in a wholly bipartisan way. It 

was the chairman of the full committee, the chairman of the subcommittee, myself, the gentlewoman from New York, Mrs. 

Maloney, and others, who had worked on this. And it became clear 

to us that the Federal Reserve was going ahead without fully considering implications and expecting a degree of deference that is inappropriate in our society. 

What we now have, I think, is a genuine examination of the 

issues. In fact, along these lines, I would ask, Mr. Chairman, to put 

into the record the letter to the Federal Reserve, the Comptroller 

of the Currency, the Director of OTS, and the Chairman of the 

FDIC; and it is a letter from the Conference of State Bank Supervisors dated September 6th. And just to quote briefly, We strongly 

urge the Federal banking agencies to obtain a much better sense 

of the real-life ramifications of executing Basel II prior to giving 

any indication to our foreign counterparts about implementation. 

And in the conclusion, Basel II makes a large impact for the future of the U.S. financial system. Accordingly, CSBS strongly urges 

the Federal banking agencies to conduct further analysis of potential capital changes that would ensue from adopting the proposal. 

So we have the Conference of State Bank Supervisors saying, 

slow down; we have heard that from the head of the Federal Deposit Insurance Corporation; the new Comptroller of the Currency 

recently appointed by the President—recently appointed and recently confirmed, also has concerns. So we have very serious concerns. 

3

And originally we were worried about the capital charge on people who were holding securities. Now we have very widespread concern about the impact on the differential and capital requirements. 

One of the things that we are all agreed on, I think, here is that 

while large banks are very nice to have, we don’t want to see the 

trend towards them being the only banks accelerated. You know, 

we are doing this as the Committee on Banking; in Massachusetts, 

the corresponding committee is called the Committee on Banks and 

Banking. And someone said, are you ever going to change your 

name? I said, yes, but by the time we do, we may call it the Committee on the Bank because there will be one. 

We don’t want to see this, and it does appear that there is a 

broad consensus that, as now proposed, Basel II accelerates a trend 

towards consolidation. If consolidation happens naturally through 

economic forces, that is one thing; regulations shouldn’t be encouraging it. 

And the last thing I would say is this, Mr. Chairman: One is that 

I hope we will hear from the Fed. We have heard from a number 

of responsible, knowledgeable people, both from the bank industry 

and the bank regulators—again, the Conference of State Bank Supervisors, the Comptroller of the Currency, the FDIC board. We 

have heard about their concerns. 

I am unclear today as to what Basel II is trying to correct. What 

are the great problems that need this attention? It is arguable that 

it may make things somewhat better, but I see concern on the one 

hand about what the consequences would be, and I have not yet 

seen any dire picture of the consequences of inaction. And I guess 

I think it is incumbent on those who are the advocates of prompt 

action on Basel II and the advocates of those who would disregard 

a lot of these requests for slowdown that we have gotten and for 

reconsideration, I would like for them to tell me what it is that is 

giving them this sense of urgency because as I look at the record 

and I think back about our hearings, I don’t see it. 

So I think it is one more useful step, Mr. Chairman, in our trying 

to get this process done right, and I appreciate your continuing this 

initiative. And I ask, as I said, that this be put in the record. 

Chairman BACHUS. I thank the ranking member. 

At this time we are going to hear from the panel. And Mr. Manzullo, I am going to recognize you to introduce—

Mr. MANZULLO. Thank you very much. I am not a member of 

your subcommittee, but I have plotted myself here because one of 

our witnesses is my constituent. And I could take this time just to 

introduce her; then I have to leave at 10:30. 

Kathy Marinangel comes from McHenry County, which is in the 

far eastern portion of our congressional district. And when I was 

first appointed to the Banking Committee some years ago, I got 

this excited call. And I stopped by her office and she began to share 

with me all the concerns going on in the banking industry. And I 

said, my gosh, I need to go to banking school; I just can’t keep up 

with the extent and width of her knowledge. In fact, when I first 

heard of Basel, I thought it was the sweet basil that my dad put 

on his pasta in the Italian restaurant that the family owned. 

But Kathy has taken an extraordinary amount of time to inform 

me and instruct me on the issues, and I am absolutely thrilled that 

4

she is coming here all the way from McHenry County, Illinois, to 

share with this committee her thoughts and her wisdom. 

And, Kathy, welcome to Washington. I appreciate your coming 

here, and I guess we are getting together later on today. Thank 

you. 

Ms. MARINANGEL. Thank you, Congressman. 

Chairman BACHUS. Thank you. I appreciate that, Chairman 

Manzullo. 

Congressman Manzullo is the chairman of the Small Business 

Committee and also an important member of our committee, so 

thank you. 

Our two other panelists are Mr. Wilson Ervin, managing director 

and head of Strategic Risk Management for Credit Suisse First 

Boston. And you are here representing The Financial Services 

Roundtable? 

Mr. ERVIN. Yes, sir. 

Chairman BACHUS. As well as, I guess, Credit Suisse First Boston. 

And Mrs. Karen Petrou, Managing Partner of Federal Financial 

Analytics. And you testified before this committee prior, have you 

not? 

Ms. PETROU. Yes, sir. 

Chairman BACHUS. So at this time we will hear from our witnesses. 

The one thing I did not say in my opening statement—I had the 

wrong opening statement. When I got ready to read my opening 

statement, it was for the committee hearing tomorrow, so this usually goes a little smoother. And that was my fault, it was—

Mr. FRANK. Will the gentleman yield? Does that mean we won’t 

have to listen tomorrow? 

Chairman BACHUS. But I could go ahead and have given that. So 

that was a total ad lib. 

But one thing I did not say, that was in the statement that I intended to read was that several months ago the regulators announced plans to delay the Basel notice of proposed rule making 

in response to the Qualitative Impact Study 4, which showed huge 

swings in capital. Despite all that, the Fed says they are still committed to the January 2008 date for full implementation of Basel. 

And that is what disturbs us, the fact that we have gotten a lot 

of information which the regulators didn’t expect, we didn’t expect, 

and there is disagreement among the regulators. 

We still don’t have our Basel IA proposal and we are still moving 

forward with Basel II with all these uncertainties. 

And as I mentioned, the former Fed economist that issued a 

study to the Fed—and the Fed chose to reject it—from folks that 

had been there for years and years, and they testified before our 

committee and Chairwoman Pryce’s committee back in May. So 

we—and as Congressman Frank, Ranking Member Frank said, we 

are very concerned about this. We are hearing from numerous institutions about concerns they have also. 

So at this time we will start with Ms. Marinangel, and welcome 

all three of you to the committee. 

5

STATEMENT OF KATHLEEN E. MARINANGEL, CHAIRMAN, 

PRESIDENT AND CEO, McHENRY SAVINGS BANK, McHENRY, 

ILLINOIS, AND MEMBER, BOARD OF DIRECTORS, AMERICA’S 

COMMUNITY BANKERS 

Ms. MARINANGEL. Thank you, Chairman Bachus. 

Chairman Bachus, Ranking Member Sanders, and members of 

the subcommittee, my name is Kathleen Marinangel. I am chairman, president and chief executive officer of McHenry Savings 

Bank located in McHenry, Illinois. We are a $250-million community bank focused on retail customers and small business owners. 

We compete head to head with many large national and regional 

banks. 

I appear today on behalf of America’s Community Bankers where 

I am a member of the board of directors. Thank you for this opportunity to present our views. 

ACB and its members have taken a lead for some time now in 

raising issues about Basel II and requesting simultaneous changes 

to Basel I. ACB does not oppose implementation of Basel II. 

As we testified before this subcommittee last spring, we support 

the efforts of U.S. And global bank supervisors to more closely link 

minimum capital requirements with an institution’s risk profile. 

However, prior to adoption, legislators, regulators, and the industry 

need to evaluate the complexity of the proposal, its competitive impact, and the ability of regulators to monitor compliance. 

We believe that a regulatory capital floor must remain in place 

to mitigate the imprecision inherent in internal ratings-based systems; however, the precise level of the leverage requirement should 

be open for discussion. 

Institutions that comply with Basel II, and possibly institutions 

that comply with a more risk-sensitive Basel IA, may not achieve 

the full benefits of more risk-sensitive capital requirements because 

they may push up against the leverage ratio. We understand that 

the European Community is pushing ahead to implement Basel II 

and is pressing for agreement on certain issues. 

The U.S. regulators attending a quarterly meeting next week in 

Basel should make no commitments to their foreign counterparts 

in light of the still evolving nature of Basel II implementation in 

the U.S. 

The complexity and cost of development and implementation of 

a risk-based model likely will preclude all but a small number of 

banks from taking advantage of the more risk-sensitive capital regime in Basel II. The best available evidence suggests that this will 

open the door to competitive inequities. 

The most recent quantitative impact study on Basel II showed 

significant reductions in capital requirements for many of the participants. Capital requirements for mortgage loans dropped by 

more than 70 percent for some organizations. These results caused 

the regulators to delay further action on Basel II while they conduct additional analysis. No further information about this ongoing 

analysis has been released. 

As a community banker, I, along with ACB, strongly believe that 

Basel I must be revised to have more risk-sensitive options at the 

same time that Basel II moves forward. A revised Basel IA needs 

to include more baskets and a breakdown of particular assets into 

6

multiple baskets to take into consideration collateral values, loanto-value ratios, and credit scores. Credit mitigation measures and 

other revisions could be incorporated into the framework. 

Advances in technology and the availability of more sophisticated 

software would make implementation of Basel IA relatively 

straightforward for most community banks. For my bank, there 

would be no burden and a lot of benefit. The bank regulators also 

could adopt a simplified risk-modeling approach that is consistent 

with the less complex operations of most community banks. 

The smallest of community banks should have the option of continuing to comply with Basel I as it is currently constituted if they 

would prefer to remain compliant with the less risk-sensitive capital scheme. 

The bank regulators have listened to our comments and suggestions and are moving forward to develop a Basel IA. ACB would 

like to commend the regulators for initiating a dialogue with representatives from the industry this summer about possible Basel I 

changes. Our understanding is that an advance notice of proposed 

rulemaking addressing possible changes to the framework may be 

issued as early as next month. ACB will continue to be actively engaged in this process to develop Basel IA. 

I wish to thank Chairman Bachus, Ranking Member Sanders, 

and the rest of the subcommittee members in giving ACB this opportunity to present our views. There is no more important issue 

to community banks than the implementation of Basel II and longoverdue changes to Basel I requirements. 

I would be happy to answer any of your questions. Thank you. 

Chairman BACHUS. Thank you. 

[The prepared statement of Kathleen E. Marinangel can be found 

on page 45 in the appendix.] 

Chairman BACHUS. Mr. Ervin. 

STATEMENT OF D. WILSON ERVIN, ON BEHALF OF CREDIT 

SUISSE FIRST BOSTON AND THE FINANCIAL SERVICES 

ROUNDTABLE 

Mr. ERVIN. Good morning, Mr. Chairman; thank you. I want to 

thank you for holding these hearings today and inviting me to appear before the committee. 

My name is Wilson Ervin and I am a managing director of Credit 

Suisse First Boston. I am head of their Strategic Risk Management 

Department and am presenting testimony today on behalf of the 

CSFB and The Financial Services Roundtable. 

CSFB employs approximately 20,000 people, primarily in the 

United States, and is a major participant in the capital markets. 

We have submitted written comments, but I will try and summarize those in my testimony today. 

The Basel II capital proposals have been the topic of intense discussion and debate in the financial and regulatory community for 

the past several years. The industry supports the objectives of the 

Basel process to better align regulatory capital to underlying economic risks, to promote better risk management, and foster international consistency in regulatory standards. The impacts of these 

seemingly technical discussions will affect banks, markets, and the 

7

economy in a deep way, and the committee is wise to consider the 

effects carefully before implementation. 

Before I start, I would like to note that I have personally developed tremendous respect for the diligence and stamina of the regulators who have worked on Basel II, as well as a review provided 

by Congress. They have had to address a great many complex and 

challenging issues and have been tenacious in trying to develop a 

best-practice solution for each. 

I wish to express appreciation for Federal Reserve Governor Bies 

and Vice Chairman Roger Ferguson, who met with CSFB and The 

Roundtable on a number of occasions to listen to our concerns. The 

OCC, FDIC, and OTS have also had open doors during this process. 

Basel II has considerable momentum, and most people believe 

that it will be likely implemented in the near future. However, as 

in all complex undertakings, the Basel document in its current 

state, it is far from perfect. On balance, we believe the advantages 

of the reform substantially outweigh the drawbacks, but further 

improvements are still possible and desirable. 

Today, without getting too involved in the technical details of the 

Accord, I would like to highlight three issues that we believe are 

particularly important as the Accord moves forward: number one, 

adjustments to the recent trading book review; number two, the 

practical implementation of complex cross-border regulation or the 

home-host issue; and number three, principles-based interpretation. 

The first topic I want to discuss is the recently completed trading 

book review. For several years now the discussion regarding Basel 

II has focused primarily on credit risk capital, and this area has 

been continually reviewed and reshaped in an open, transparent 

process. For a combination of reasons, it was recently determined 

that a separate discussion of capital charges for market risk inherent in traded credit and equity portfolios would also be necessary. 

Because of the tight timetable, the new trading book proposals 

involving market risk, the so-called ′′Strand 3′′ of the trading book 

review, have been designed and evaluated over a period of just 

months rather than the period of years that the rest of the Accord 

has been subject to. 

The first draft of the new trading book standards was just seen 

in April, with one round of comment and the final version in July. 

Not surprisingly, there remain many areas where regulators in the 

industry recognize that continued refinement will be necessary. 

During the development stage, regulators have had a number of 

sessions with the industry to discuss certain problems found in the 

trading book drafts. In these sessions, members of the BIS-IOSCO 

Working Group provided helpful guidance on their specific intentions. The industry appreciated this clarification greatly and concluded that the general final language could work in practice with 

the interpretation that they heard directly from senior regulators. 

Given the reliance placed by firms on the information provided 

in these sessions, we believe it makes sense to record these understandings. This will ensure transparency of the regulators’ intention and give industry participants greater confidence to move forward with the investments required to begin implementation of the 

trading book standards. 

8

In addition, it is worth noting that the new trading book requirements have only recently been published, and there remains work 

to be done to flesh out how they should be implemented in practice. 

In addition, no comprehensive impact statement has been performed to date; we believe this is a key gap that must be closed. 

We suggest that all regulators take advantage of the existing provision deferring the effective date of this portion of the Accord until 

2010 so that refinement impact analysis and final implementation 

can be done in an orderly, consistent manner. This timetable could 

be separate and apart from the rest of the trading book review and 

the bulk of the Accord, if necessary. 

The second topic I would like to address is the complexity of the 

new rules across jurisdictions, the so-called ′′home-host issue,′′ which poses particular challenges for an international bank that is 

regulated by supervisors in multiple countries. CSFB, for example, 

will be required to implement Basel II as a Swiss bank, a U.S. financial holding company, a U.K. Bank, and a regulated financial 

institution in more than 30 other countries. Our implementation 

will be governed primarily by the Swiss Federal Banking Commission in conjunction with the Federal Reserve in the U.S. and the 

FSA in the U.K., but also by many others. 

Most international banks face a similar set of interlocking regulations in which both home and host countries interpret and enforce rules. This can give rise to conflicts even under an international standard like Basel II. At times, we have been given conflicting guidance by both home and host regulators under the existing Basel I Accord, which makes compliance very difficult. It is a 

Catch-22. 

While we have been able to resolve these issues to date, the potential tension between home and host regulators will become a 

much bigger issue going forward, given that Basel II is much wider 

and much more detailed. If each country decides to require its own 

local rules and data for each of the many calculations in Basel II, 

the compliance burden will go from bad to impossible. 

The Basel Committee has formed an Accord Implementation 

Group to deal with these issues, but to date there has been very 

little tangible guidance. We believe that a stronger proposal should 

be developed to resolve these conflicts in a timely and predictable 

manner, and we have made some suggestions in our written testimony. 

The last area I would like to talk about is principles-based interpretation and the need for flexibility. 

The Basel rules are based on the financial markets as they work 

today, but they are so complex and heavily negotiated they will be 

difficult to update over time. We strongly believe that regulators 

ultimately will need to place a renewed emphasis on the principles 

behind Basel II, specifically those in the Pillar II section of the Accord, as a matter of either law or practice. 

This principles-based approach, subject to reasonable benchmarks and guidelines to maintain consistency, has some important 

natural advantages compared to Pillar I’s complex ′′black-letter′′

style. This permits steady evolutionary improvement to keep up 

with markets and should, therefore, be more durable and relevant 

than Pillar I rules that are designed with today’s market in mind. 

9

Addressing the question of an evolving Accord will not be simple. 

If the rules were all applied as black-letter law and interpreted 

strictly, the new rules will be both costly—since risk-management 

advances that led to Basel II won’t stop today—and potentially irrelevant to ongoing best practice. 

One example of this relates to operational risk, an area that is 

relatively new in terms of risk management discipline and quantification. There is a danger that certain approaches can be mandated as, quote, ′′best practice′′ by regulators in some jurisdictions, 

even though development in this area is far from complete. It is imperative that we avoid few fixed requirements where they arise 

solely from interpretations by certain examiners. 

We encourage an approach that emphasizes principles and simplicity as the rules are implemented and a less burdensome ′′trust 

but verify′′ approach to compliance. Specifically, regulators will 

need to emphasize that compliance with the rules will not be based 

on many layers of ′′box checking,′′ but with a spirit of the rules 

based on economic principles. 

We are at an important stage in the reform effort, perhaps the 

last leg of a long race. A lot of good, hard work in designing the 

framework and getting some political consensus has been accomplished. We have high regard for the efforts of the committee and 

the regulators who have worked so hard to capture best practices 

and risk assessment. 

CSFB and The Roundtable have tried to contribute to the specifics of those discussions in a constructive manner and submit our 

three proposals discussed today—trading book review, cross-border 

implementation, and principles-based interpretation—in that light. 

We believe that refinements are still possible and desirable and 

that these changes will help make the Accord more effective in 

practice. 

As a final comment, I believe that regulators will need to look 

beyond the detailed calculations embedded in the rules and focus 

on the overall quality, thoughtfulness, and the integrity of bank 

risk management to implement the Accord successfully. This will 

place the burden of responsibility back where it should be, on the 

shoulders of bank management, to demonstrate to regulators and 

the public that they are doing a good job. 

That is in the spirit of the Sarbanes-Oxley reforms in the United 

States, and I think that is a smart and durable way to improve financial discipline and live up to the origin goals of the Basel 

project. Thank you. 

Chairman BACHUS. Thank you. 

[The prepared statement of D. Wilson Ervin can be found on 

page 35 in the appendix.] 

Chairman BACHUS. Ms. Petrou. 

STATEMENT OF KAREN SHAW PETROU, MANAGING PARTNER, 

FEDERAL FINANCIAL ANALYTICS, INC. 

Ms. PETROU. Thank you, Mr. Chairman. It is a pleasure and an 

honor to appear before this subcommittee. I thank you very much 

for the opportunity, again, to talk about this important rule. 

The subcommittee, and indeed all of the Financial Services Committee, has done what is often so difficult: You have anticipated a 

10

problem and tried to step in with congressional leadership to solve 

it before it happens. And I think that has been of tremendous assistance as the regulators think through the Basel II Accord. 

My name is Karen Shaw Petrou. I am managing partner of Federal Financial Analytics, and we have done a considerable amount 

of work on the Basel II Accord for a variety of industry clients. 

As we look at the Accord and its current state, I really do think 

a very difficult decision awaits you and the U.S. regulators. As you 

have mentioned, Chairman Bachus, the agencies will be going to 

Basel next week. And I know there is strong impetus in many 

quarters to agree to the Basel II framework, but I do believe this 

will be very problematic, in part, because it remains still unclear 

what that is. 

The Financial Services Authority recently issued 50 pages of 

areas of national discretion in Basel II, and, therefore, it will look 

very different in each country that implements it. 

The U.S. has taken a particularly independent tack. We are, as 

you know, proposing to implement Basel II only for the largest institutions, and as your committee has established, this raises very 

serious competitiveness problems. 

We have a unique financial system with thousands of independent financial institutions that play a very important role in 

this Nation, and we must think that through very carefully. We 

have a leverage requirement, again unique, that throws Basel II 

into a very new framework, and it is one that requires quite careful 

consideration so that all of the work to go to make a risk-based 

capital rule is not made moot because of our leverage requirement. 

In short, we have a very different framework, and it will make 

it hard to take Basel II—whatever, indeed, that truly is—in whole 

or in part, and apply it only to our largest institutions. I do think 

that would be putting the square peg of Basel II into the round 

hole of our financial industry, not a good conclusion. 

On the other hand, however, I do also believe that we can’t just 

keep Basel I. We know Basel I is not a good risk-based capital system. It is very crude. It permits undue risk-taking, and that is why 

the agencies rightly started the Basel II process several years ago. 

More importantly, like it or not, Basel II is a done deal. With all 

the variations I have mentioned, it is still a final framework now 

everywhere but here. That means, starting January 1, 2007, banks 

in the EU, Canada, Japan, and elsewhere, many of which do considerable amounts of business here, will come under a new riskbased capital framework that could well make them merger-and-acquisition powerhouses. 

In short, if I may say so, I think we are in the midst of a 

′′damned if we do, damned if we don’t′′ dilemma. Going forward 

with Basel II as the agencies have proposed will not work; staying 

under Basel I will not work; and I think waiting is a dangerous 

strategy because the rest of the world will move on into this new 

capital framework regardless of what we do. 

If I may, then, I would like to offer what I hope is a middle 

course, things we could do now that I do not think pose the competitiveness problems brought about by either waiting and retaining Basel I or implementing Basel II for only the largest banks and 

only the most advanced forms on the schedule now on the table. 

11

First, I would suggest that the U.S. move quickly to adopt the 

credit risk provisions in the standardized sections of the final Basel 

II framework. These are relatively simple; they could be Basel IA. 

We—I think even small community banks that wish to take advantage of this could do so because the standardized option sets simple 

risk formulas, but has some very constructive incentives for recognizing risk mitigation and for penalizing high risk. 

We should do this for all institutions, not just some, to avoid the 

competitiveness problems. I understand that the standardized credit risk section is crude and in many ways imperfect and capital 

under it may still be too high, but I think waiting will lead us to 

the error of letting the perfect be the enemy of the good. And again, 

the longer we wait, the more Basel II elsewhere will become a potentially very serious competitiveness problem for banks here, even 

smaller ones. 

Second, I would suggest a hard look at the leverage ratio. I know 

that many feel that it would be both a competitiveness protection—

that if big banks must hold the 5 percent leverage requirement 

now in place even if their Basel II numbers dropped, they would 

not realize this and they could not be a competitiveness threat—

but I would say the leverage requirement is very easy to game; it 

is a simple requirement of capital for on-balance sheet assets. 

Large institutions can securitize assets or create so-called synthetic ones. This is not hard to do, and it is easiest, of course, for 

the largest institutions. It is a game, but it is one that they are 

good at, so keeping a leverage requirement in place will not protect 

small institutions. 

It will also, I think, have unanticipated safety and soundness 

problems. One can make the leverage requirement work on a lowrisk book of business by topping it off with what one might call 

′′toxic waste,′′ and then the numbers work out fine, but I am not 

sure why the agencies want banks to do that. They have the flexibility under current law to go into a far more sophisticated leverage requirement and, hopefully, ultimately eliminate it; and I hope 

that is what we do in conjunction with implementing both Basel IA 

and Basel II. 

Thirdly, the operational risk-based capital requirement in Basel 

II will, I think, have unanticipated and perverse incentives that 

would undermine effective operational risk management. We 

should have a rigorous, enforced, supervisory framework that ensures that institutions engage in the contingency planning and disaster preparedness that not only proved themselves on 9/11, but 

again were so critical in the cleanup from Hurricane Katrina and 

Hurricane Rita. There is a lot left to do here, and a new capital 

charge would divert essential financial industry resources from 

emergency preparedness, clearly something we must remember to 

take very, very seriously. 

Finally, I do think the advanced options in Basel for credit and 

operational risk do make sense. They are more sophisticated than 

the standardized approach, and they do accomplish the valuable 

goal of bringing regulatory capital better in line with real risk. We 

should move forward on that to the degree we can in the Basel II 

framework, but we should do it for all institutions, not just for the 

big ones. And we should take careful heed of our own realities—

12

tax law here, for example; we should look at that as we define capital. 

We have a very proven risk mitigation environment with various 

forms of insurance and guarantees. Those should be reflected in 

capital. And perhaps we, because of the nature of our very sophisticated financial system, should take the lead in further recognition 

of internal models in a principles-based supervisory framework. 

But in closing, I would say that, like it or not, Basel II is about 

to be a reality, so we must make policy decisions to ensure that our 

institutions remain competitive and serve their customers in every 

community. 

Thank you very much. I would be happy to answer any of your 

questions. 

[The prepared statement of Karen Shaw Petrou can be found on 

page 52 in the appendix.] 

Chairman BACHUS. Thank you. 

Ms. Petrou, you mentioned near the end of your statement Hurricane Rita and Hurricane Katrina, which obviously have taken a lot 

of the focus of the Nation on responding to the devastation there. 

And you mentioned a possible tie between the Basel proposal, 

Basel Reform and Katrina and Rita. And I guess that is the issue 

of operational risk. 

Ms. PETROU. Yes, sir. 

Chairman BACHUS. If the operational risk charge in Basel II had 

been in effect presently, how would that affect the banks’ and the 

regulators’ ability to respond to what we saw in Texas and Louisiana? 

You know, they did a very good job, I think a wonderful job, but 

would Basel II—had it been in effect, would it have affected that? 

Ms. PETROU. I think it might have undermined the very good response we have seen that comes from, as you know all too well, 

backup computers, contingency planning, heroism, hard work, an 

array of factors that you can’t quantify and which cannot, I think, 

be turned into a capital charge. 

A capital charge is basically money in your pocket that the regulators say you must have so that if things you don’t expect happen, 

you can protect your institution from failure by virtue of that extra 

bag of coins in your pocket. But it takes away from the coins you 

have for backup computers, contingency planning, disasters, telecommunication structures, independent electricity, all of the things 

we know institutions have to have and which they still do not have. 

The agencies have moved forward with sound principles; they 

have done more work on contingency planning since 9/11, but there 

is a great deal left to do. And I do think a capital charge could divert resources from those essential tasks. 

Chairman BACHUS. Thank you. 

And I would direct the members of this committee’s attention to 

page 6 of her testimony, which deals with the standardized Basel 

II options and how it could have interfered. 

And I agree with the response, just the rigidity of the proposal 

in not anticipating something like this. 

In the time I have remaining, about 2 minutes, I want to address 

the competitive issue. We are all concerned about the adverse impact that Basel might have, Basel II on competition. And mainly 

13

because many banks will not adopt Basel II, others won’t be able 

to, will they be at a competitive disadvantage? 

Ms. Marinangel, you mentioned that in your testimony. The Federal—the former Federal Reserve economist testified before us that 

they believe it will have a negative impact on competition due to 

the differences in capital changes. 

And so I would ask Mr. Ervin and Ms. Petrou, would you address 

this issue? 

Ms. Marinangel, you did address it, I think, in your testimony, 

that you believe it will have a negative effect on many of our institutions. 

But Mr. Ervin and Ms. Petrou, would you all like to respond to 

that? 

And you also mentioned it, Ms. Petrou, but just elaborate.

Mr. ERVIN. If I may, I just want to—this goes a little bit to 

Karen’s ′′damned if you do, damned if you don’t′′ problem. 

There may well be some competitiveness issues within the 

United States from implementing Basel II. We also have to be 

mindful that for large institutions such as mine, there will be competitiveness issues with other banks around the globe. So there is 

no magic bullet with a go-slow approach; we do have to deal with 

the reality that the rest of the world is moving to Basel II and that 

competitive equity between U.S. institutions competing globally 

and other European or Asian institutions will be an important 

thing to keep in mind as we find the right path forward for the 

United States. 

Chairman BACHUS. What about what Ms. Petrou talked about, 

Basel and what I mentioned in my opening statement about a possible Basel IA proposal? 

And Ms. Marinangel, what about that? 

And I thought she put it very succinctly, that time is running, 

but other countries have adopted these standards. It could be a 

competitive disadvantage in our dealings with them, but then—

Ms. MARINANGEL. Well, I would like to state that, for example, 

in my town, I have approximately 18 banks and in the county 39 

different institutions; some of them are foreign banks. 

One of the competitive issues to think about—and I would like 

to do an analogy of four gas stations, one on each corner. If one 

of the gas station’s price of gas is 4 cents cheaper than the others, 

where will all the business go? 

Well, in the community banks world, as well, we are out competing with all of the foreign banks as well as large regional and 

national banks, and because of the economies of scale and guarantee fees and other issues just in the mortgage loan area, we have 

to be competitive to get assets on our books. And so it is a very 

critical disadvantage for us if we don’t have Basel IA modification 

so that we can remain competitive. And that is just in the mortgage area, not even considering the other assets where the banks 

would be able to hold less capital. 

And I agree, it is very critical because of the European countries 

adopting Basel II and the parliament approving the legislative 

issue on that. We really need to move quickly, but IA has to be considered for community banks. We need to deploy our capital as effectively—publicly traded banks need to do that, as well, to make 

14

their good—our rates to be competitive so that we do maintain a 

community banking system in the United States. 

I don’t believe the European countries, when I was called by 

David Keith from the Global Risk Regulator, do not understand the 

community bank system in the United States, and it is critical that 

we maintain the system. And I have nothing against large banks. 

However, we do serve a different need, I think, in the United 

States, and it has to be protected. 

Chairman BACHUS. Thank you. 

Ms. Petrou. 

Ms. PETROU. I certainly agree with all the comments today. I 

mean, the basic measure of bank profitability is return on equity, 

ROE. Equity is your capital, and you have to hold the higher of 

economic or regulatory capital. So when regulatory capital is higher 

than you have to have, or higher than other institutions are permitted by their agencies to have, you, if you are a large bank, small 

bank, sideways, suffer a significant competitive disadvantage, all 

other things held equal. And it is a hard one no matter how smart, 

how efficient you are to overcome. 

I know this committee is wrestling with the GSE reform issue, 

and I have been honored to testify before other subcommittees on 

that. And one of the key competitiveness advantages Fannie and 

Freddie have is their very low regulatory capital. We see it in the 

marketplace. So it is not a fiction; it is a reality that will hit us 

very soon if U.S. policy stays as is. 

Chairman BACHUS. Thank you. 

At this time, I recognize the ranking member, Mr. Frank. 

Mr. FRANK. Thank you, Mr. Chairman. 

I will confess that I may not have been paying enough attention. 

I am very disturbed. I appreciate Ms. Petrou pointing out that we 

are in this situation where Basel II, if it goes into effect, coerces 

us some. And I tell you, I am on the verge of charging the Fed with 

bad faith. 

During these conversations, when we raised issues, the Federal 

Reserve witnesses have consistently said to us, well, don’t worry; 

nothing is conclusive here. And indeed, even if we agree to this, 

you will then have to have it implemented domestically. And we 

have got a kind of bait-and-switch here. 

My recollection—and I see the May comments; I didn’t see them 

in time; we had other things going on, GSE legislation. But for 

Governor Bies now to tell us that we will be at a disadvantage if 

we don’t go ahead really seems to me to raise an issue of good faith 

because the Fed was telling us for several years that this was still 

being discussed and that even after they concluded an agreement, 

we would still have to have that implemented by domestic choices. 

We are now being told that that is really not true, that in fact 

they are—having gone ahead, ignoring our concerns, frankly poohpoohing us, and saying don’t worry about this—now they are going 

to turn around and say, now you have got to do these things. 

So I am going to recommend, Mr. Chairman, to yourself, the 

chairman of the full committee and all of the staff on our side, I 

think what is incumbent upon us now is to start preparing for that 

situation and do the best we can to minimize this. 

15

And I will say this: I will feel no—ordinarily, I think in this committee we have been very much interested in international cooperation. I know we have talked with, many of us, the European Union 

and others about how to harmonize accounting requirements, how 

to prevent Sarbanes-Oxley from causing divergence. 

As I mentioned earlier, you, Mr. Chairman, and others of us on 

the committee, the gentlewoman from New York and others, we 

have been very active with regard to the debt situation for poor 

countries. But in this situation, I do not feel coerced by the argument that we have to show good faith for international obligations, 

because I think the Fed frankly misled us in this regard. 

And I think it is entirely reasonable for the staff of this committee, majority and minority, to get together, and Ms. Petrou has 

set out the approach I think we should take. I think it is important 

for us now to figure out ways that we can blunt the effect of an 

agreement, domestically, to which we are not a party. 

And I do not believe the Federal Reserve ought to be considered 

the entity that can commit the United States Government. Someone should raise this issue. In the legislation we filed, we said we 

didn’t want the Fed to have this autonomy. They kept telling us, 

oh, don’t worry; this is only an agreement framework and you are 

going to have to fill it in. 

We are now being told apparently—and I don’t challenge this—

the fact of that agreement and given the ability of other financial 

institutions to operate fairly freely in the U.S., in fact, does coerce 

us, does have an impact on us. And I think we are now entitled, 

in self-defense, to figure out how to avoid that. 

So I will be studying what Ms. Petrou suggested. I will be looking for other suggestions. That is, I am not ready to say, oh, yeah, 

now that Basel II is there, we are going to, in effect, have to concede that it is there and adjust to it. The Fed consistently told us 

that that would not be the case, and I think we have every right 

now to deal with that. 

Obviously, we can’t ignore reality. What we then do is, I think, 

begin to deal with that reality. And I want to put them on notice. 

The argument that, okay, it is a done deal and you had better 

adjust to it will not persuade me. And instead, my instincts will be 

to try to resist what we didn’t like that was concluded over our objection. And I really am disappointed, and I confess error: I did not 

notice that Governor Bies said this in May, but it is directly contrary to what we had heard from her and from Governor Ferguson. 

And that is where we are. 

So I have no questions, but to say that I would invite all the witnesses and others to begin working with us to figure out how we 

deal with this situation. 

And I would also say to the Fed that they have lost a great deal 

of credibility with me in this regard to have assured us—and I 

have heard those assurances; don’t worry; nothing is conclusive; 

nothing is; this will still have to be implemented by U.S. policy—

and now to be told that is not really the case, you have got to do 

these things. I don’t accept that, and I think we should do everything we can to resist it. 

Chairman BACHUS. Thank you. And let me acknowledge that 

Ranking Member Frank has really led the effort on this committee. 

16

I think he is the most informed member of the committee on this 

issue. 

Mrs. Maloney has been very involved in this issue with Chairman Oxley, but it is something that members on both sides of the 

aisle, we have worked in a very bipartisan or nonpartisan way on 

this. And I think that your testimony here today actually kind of—

as Ranking Member Frank said, I think it has been very valuable 

to us. 

And to Mr. Ervin—you, I think, said it—it is not a question of 

large institutions trying to gain an advantage over the smaller institutions or those that Basel II will apply to; it is a question of, 

you want to maintain your competitiveness with international 

banks and your competition, worldwide competition. At the same 

time, it—as proposed, it will impact negatively on some of our 

smaller institutions. 

And I think, Ms. Petrou—you have, I think, in a very valuable 

manner said there is an option of fixing this thing, and I am very 

much—I think that this is some very valuable testimony. 

Prior to recognizing the gentlelady from Illinois, Mrs. Biggert, 

who is going to take the Chair in my absence, I wanted to introduce, without objection—if there is no objection, I ask unanimous 

consent to introduce, first, a letter to the Honorable Alan Greenspan signed by Ranking Member Frank, Chairman Oxley, Ranking 

Member Carolyn Maloney of the Subcommittee on Domestic and 

International Monetary Policy and myself, dated September 13th, 

which says: ′′Dr. Chairman Greenspan, we were disturbed by the attached 

American Banker article suggesting that Federal Reserve Board 

staff are actively discouraging Federal Reserve Bank staff from expressing independent views on the Basel II Capital Accord. This is 

a very important issue, as you know, and it is necessary for Congress to be fully informed. Clearly, it is inappropriate for there to 

be any effort to interfere with the information Congress receives. ′′if this article is accurate, we ask that you please take the necessary steps to ensure that no Federal Reserve official interferes 

with Congress’ access to information.′′

And without objection, I would like to offer that into the record. 

Secondly, I would like to offer some written testimony on the 

Basel II Capital Accord, and it is called, A Guide for the Perplexed, 

dated September 21, 2005, authored by Raymond Natter. He was 

the U.S. Deputy General Counsel at the OCC for many years and 

is presently with Barnett Sivon and Natter. And I would like to introduce that without objection. 

And so at this time I recognize Mrs. Biggert for her questions. 

Mrs. BIGGERT. Thank you, Mr. Chairman. And it is nice to see 

Mrs. Marinangel back from Illinois, and also Ms. Petrou for being 

back again to help us here. 

My first question, though, will be for Mr. Ervin. 

It appears that a big improvement has been made in Basel rules 

to cover only unexpected credit risk, which allows the reserves and 

earnings to cover unexpected loss. And this probably better reflects 

risks without adverse competitive impact. 

But why isn’t a comparable approach being taken for operational 

risk? 

17

Mr. ERVIN. I think in part it is because operational risk is a 

tougher nut to crack; it is a much newer discipline. There has been 

a desire that I have heard from various regulators to put, as Karen 

said, some coins in your pocket for those events in order to have 

the right amount of capital at institutions. But, to date, it is very 

difficult to actually quantify those sorts of things, it is pretty hard 

to quantify the impact of a Hurricane Katrina, to assess the probability of a terrorist strike, or a computer virus. 

So I would say right now we are working with cruder approaches, frankly, in operational risk. We are still finding our feet. 

Hopefully, we will be able to come up with the kind of improvements that you have seen in credit risks where you can be a little 

bit more precise about how you build the mouse trap, but today, 

in operational risk, we are trying to do the best with a difficult 

problem that is still, frankly, in its early days. 

Mrs. BIGGERT. Thank you. 

Ms. Petrou, do you see any improvements in the ability to manage and measure the operational risk and any time frame that this 

might take place? 

Ms. PETROU. I do. And I think that the Basel II Accord has been 

a good impetus for industry attention to operational risk management. 

The agencies have sometimes said that the reason they proposed 

the operational risk capital charge is to get people thinking about 

operational risk. I long thought they had a whole lot of other ways 

to get the banks they regulate to think about the things they want 

them to think about. And I would suggest that, again, contingency 

planning, disaster preparedness, backup systems, et cetera, are the 

first point of contact. 

Operational risk is very different from credit risk because institutions don’t take it for profit; they experience it as an adjunct to 

their businesses, and so they price for it, they hold reserves for it. 

And it needs, I think, to be treated very differently than credit risk 

as a result. 

Mrs. BIGGERT. Thank you. 

Then, Ms. Marinangel, I know that you are concerned about community bank competitiveness if Basel II applies to only the largest 

and biggest of banks. But it probably would be hard to bring Basel 

II to all institutions because of the cost and complexity. 

Would it make sense to proceed with a Basel I or IA approach 

for all the institutions in the U.S. even if Basel II is not ready to 

be implemented? 

Ms. MARINANGEL. Yes, absolutely. I agree that if Basel II is not 

ready to be implemented, a modified IA would serve all of the industry well, large and small, and it would make us all be still on 

a level playing field. 

Yes, it is critical to do that. 

Mrs. BIGGERT. How is that progressing? Who is working on Basel 

IA or modified? 

Ms. MARINANGEL. Well, just last month I was in Washington at 

the end of July with the four Federal regulatory agencies, and it 

was a very good session. They wanted a bank advisory group for 

input, so they took it very seriously. We were very happy that they 

wanted bankers’ input as well as the trade group input, and so I 

18

believe that they are working on it. As I—last time when I was 

here I had developed a formula that I gave you as a sample that 

could be used, somewhat simple but still a good change. So they 

are—the regulators are working on it with the industry. 

Mrs. BIGGERT. But this would just be a domestic policy. 

Ms. MARINANGEL. As far as I know, yes. 

Mrs. BIGGERT. Okay. Thank you. And I would yield back. 

Chairman BACHUS. Thank you. I appreciate your participation 

and willingness to chair the hearing, Ms. Biggert. 

At this time, I recognize Mrs. Maloney. 

Mrs. MALONEY. I thank the gentleman for calling the hearing. It 

is very timely with the October 3 meeting in Switzerland, and I 

would like to be associated with all the remarks that really show 

alarm that the regulators are not in agreement. They are not in 

agreement and that they are showing internal conflict. 

I do want to note the American Banker article that showed or 

said that the independent views on the Basel II Capital Accord 

were not being expressed and the dissenting views were not being 

expressed, and I find that very troubling. One of the things we are 

working on in Congress now is that dissenting views on whether 

or not you go to war within an administration, that the dissenting 

views should be made public. And I urge the chairman really to get 

the dissenting views that we asked for in our letter. They have not 

come back to us from the Fed, and certainly we should have them 

before going forward. 

I thank all of the panelists, and I would like to go back to Karen 

Petrou’s statement on page five that I found the most troubling of 

a lot of troubling, unanswered questions that came from all of the 

panelists, that our banks could be put at a disadvantage for merger 

and acquisition, making us likely targets because their capital requirements are lower than ours. I find that extremely troubling. I 

do not want to see our financial institutions bought by other international institutions, and I want to know what we should be doing 

about it. Would you elaborate on that? How can we protect ourselves or at least allow our institutions to be on an equal playing 

field with the international community? 

Ms. PETROU. Thank you, Mrs. Maloney. 

I think the goal would be to recognize economic capital to the 

best we can in a way that reflects our unique market. What concerns me very much is looking again, starting really January 1, 

2007, if not before, at regulatory capital incentives that will drive 

deals instead of the underlying market efficiencies that should be 

the cause of merger and acquisition activity. 

Mrs. MALONEY. So what can we do to protect our markets or to 

have our markets on an equal playing field? 

Ms. PETROU. I would suggest that we move as quickly as possible 

to the more simple approaches in Basel II, the so-called standardized credit risk framework, making changes if we need to reflect 

our unique reality but ensuring that our regulatory capital isn’t 

higher than regulatory capital applied to other competitors unless 

there is a sound safety and soundness reason. 

Mrs. MALONEY. I think that is completely and totally reasonable. 

We certainly don’t want to disadvantage our institutions with 

greater capital requirements. 

19

Actually, I thought your testimony was very good because you actually had good recommendations. You came forward with specific 

recommendations for Basel implementation. Why do you think the 

regulators have not adopted your recommendations on operational 

risk, and what do you think will be the consequences of that decision, of not adopting your recommendations? 

Ms. PETROU. I know they have listened to many voices. They are 

in a very difficult environment in which they are hoping for an 

international agreement and I think perhaps focusing on that. 

Sometimes the details of the Basel II Accord have taken precedence 

over, if I may put it, substance. These are very complex rules, and 

it is extremely easy, because of their profound impact, to get very, 

very distracted by how many basis points of this we need for that 

or what the K should be in the five-page formulas for securitization 

capital. It has been difficult sometimes to get back to the real policy impact because the models themselves are so complex. 

Ms. MARINANGEL. If I might add, I think, as Karen has said, it 

comes down to the leveraging of capital. If we can leverage our capital and remain competitive, then we will be able to stay in business. When—if we can’t—if the capital charges are greater for us 

than foreign banks, they would be able to buy our banks very 

quickly and deploy capital effectively and probably pay a higher 

price even for the bank, and it might be lucrative and attractive 

to the bank owners. So it is all a matter of leveraging capital. That 

is from my point of view. 

Mrs. MALONEY. But, so far, they haven’t made clear that position 

for our banks, so that is very troubling. And I think they should 

make that clear before they go forward. 

Ms. MARINANGEL. I think I agree. 

There are two approaches. One would be to try to implement a 

standardized approach, but I also believe that Basel IA would have 

the same effect, and it might be more easily and quickly established. 

Mrs. MALONEY. Thank you. 

Wilson Ervin, you mentioned the trading book in your testimony. 

Can you elaborate on that issue and discuss how it may impact 

your firm and similar firms under Basel II? 

Mr. ERVIN. This is a relatively recent development in the Basel 

process. As you know, the Basel discussions have been going on for 

a large number of years now. But it was really only this year that 

we saw some significant changes happening to the trading book, 

the books that broker dealers as well as large international banks 

like ourselves have, that provide liquidity in the securities markets. 

There was a concern that the rules which had previously been 

fixed under Basel I to assess capital and trading books were not 

consistent with all the new rules that were being developed for the 

credit side, so in some cases there were basically three strands of 

analysis in the trading book where this year they tried to come up 

with some changes to make those more in line. 

I can’t argue with the premise of trying to ensure consistency between trading and banking books, but they have had to do this 

under pretty tight deadlines. And, in particular, I think that the 

assessment of credit risks within traded market portfolios—think 

20

about bond trading. Any time when you are trading securities 

issued by U.S. corporations or foreign corporations that have a 

credit risk component to them, the cost of some of those positions 

is going to be going up, which will have an impact on the securities 

market. We think that those proposals could use some more time, 

some more specific guidance from the regulators, as well as some 

impact assessments to make sure we really understand what we 

have done in this area. 

Mrs. MALONEY. Well, my time is up, but I also was intrigued 

with your comments on the operational risk, and maybe in writing—my time is up now—if you could give specific recommendations and should it be in color one or two. 

And just—Chairman Bachus, I want to thank you for your leadership, but also to say that if they will not give us the dissenting 

views of the members of the Federal Reserve and the staff dissenting views, I think we should foil them. I think this is important and that we should have all the information before us. But I 

do thank all of you for your insight and for your work on this issue, 

and it has been very helpful. Thank you. 

Mrs. BIGGERT. [Presiding.] Thank you. 

The gentleman from Texas, Mr. Neugebauer, is recognized for 5 

minutes. 

Mr. NEUGEBAUER. Thank you, Madam Chairman. 

First of all, I want to thank America’s Community Bankers’ testimony today, Ms. Marinangel, for your testimony. 

I think one of the things that, as we kind of look at this issue, 

is that there seems to be a lot of concern whether this issue is ripe 

right now. What would be your perspective as to do we need to 

move in the direction we are headed or do we need to stop and 

really kind of rethink this, the whole issue? 

Ms. MARINANGEL. I think that we have to rethink the issue, look 

at all the competitive disadvantages that will occur. I think we 

need to really consider whether Basel II is appropriate or whether 

something in between is better for us. I think that the regulators 

and your committee are looking at this very closely, and I think we 

do have to take some action because of the foreign competition for 

the larger banks, especially here and others that are in our areas. 

And, yes, I think we do need to really study this quickly and come 

up with some conclusions as a group. 

Mr. NEUGEBAUER. One of the concerns I have is if community 

bankers, particularly in my district, are such an integral part of a 

source of capital for our small businesses and yet they compete on 

a head-to-head basis with some of the large banks that are also in 

those same markets—so my concerns are that we don’t want to create an unlevel playing field here for our community banks and hurt 

their ability to continue to do what they need to do in our communities. Do you see that that is a possibility? 

Ms. MARINANGEL. Yes, that is why I am so focused on this issue. 

The community banks currently can compete because we offer 

some, we feel, personalized service. We know our customers well. 

The large banks also do a good job, as I say. I don’t want to cause 

any disparaging remarks against them. 

However, some of the burdens that are placed upon us are the 

regulatory issues that cause us to spend a lot of our funds in that 

21

arena, and some are needed and maybe some are for us more burdensome because we don’t have the same amount of staff as the 

large banks. And the capital issue is really critical. The pricing of 

the assets that large volumes, where they have advantages in pricing, that hurts us tremendously. 

The public today is very aware of pricing because of all the 

media, and so it is hard to compete and our net interest margins 

might be squeezed a little more. So we have to look to other 

sources of income. 

In the same light, we can’t do the large credit card programs that 

allow the larger banks to have higher profit levels in the fee income area and some things. 

So, yes, it is extremely critical. I do believe the community banking world does serve a wonderful purpose in the United States, and 

I would hate to see them not be able to compete because of capital 

issues. 

Mr. NEUGEBAUER. Well, I agree with that. At the same token, 

though, we want to make sure we provide a financial environment 

in America that keeps all of our financial institutions competitive 

in a global economy because we are moving—whether some people 

like it or not, we are already involved in a global economy. So what 

are some of the suggestions that you would have as to allowing 

those institutions that want to be competing for more global—in a 

global market to be able to do that while allowing the community 

bankers to, you know, to set their sights on the marketplaces that 

they want to compete in? 

Ms. MARINANGEL. Well, Basel really concerns risk-based capital. 

The leverage ratio is another issue, but risk-based capital does 

have some constraints because I can’t run my bank the way I 

would like to because of capital constraints and I diversified my assets and I believe in repriceability for survivability. Therefore, I 

have to be able to compete in pricing our assets. 

When you have mortgage loans, for example, that are all weighted the same, whether they are 20 percent or 90 percent loan to values, and when you have commercial real estate loans, for example, 

that are all weighted 100 percent but maybe they are a 50 percent 

loan to value based on outside appraisals, these assets then cause 

us to have to do business in other ways because we have to weight 

them so highly and we can’t run our asset mix the way we want. 

So the true pricing of assets is critical for community banks; the 

risk weighting is really critical, and that is what this is about, riskweighted assets. We have to be able to hold capital based upon 

their true risk. That will allow us to be competitive, and it will 

allow us to hold less capital and leverage and be able to deploy our 

capital effectively and not be takeover targets. 

Mr. NEUGEBAUER. Thank you for your testimony. I think my 

time has expired. 

Mrs. BIGGERT. Thank you very much. 

The gentlewoman from California, Ms. Waters, is recognized. 

Ms. WATERS. Thank you very much, Madam Chairwoman. 

I would like to thank all of our panelists here today. 

I am very concerned about our community banks. I think they 

are extremely important, and they do provide personalized services. 

I wish them to be able to operate in a way that will allow them 

22

to continue to provide these services, and they, too, must be able 

to operate with a profit. 

I am very worried about something I heard this morning when 

you discussed Basel II and the potential for foreign banks to be 

able to buy out our community banks. That is precisely what I 

would not like to happen. I have been worried for some time that 

big banks—not just foreign banks but big banks—would increasingly become aggressive in buying out our community banks. At 

some point in time this may start to look attractive to our community banks and they may start to sell, and I certainly don’t want 

that to happen. 

So I guess my question is, who in the community banking world, 

who is working on Basel IA? Who is helping to put together the 

framework so that it can have some real discussion and our regulators can be forced to have to deal with an alternative to I and 

II? How is that developing? 

Ms. MARINANGEL. If you don’t mind, I would like to just take a 

first shot at that. I have been working on it since 1988 when it was 

first adopted. 

But America’s Community Bankers has taken the lead on this 

issue. They are the most informed. I know that ICBA represents 

small banks, but we have provided testimony and recommendations for many years now. But America’s Community Bankers, I 

think, is the most knowledgeable that I am aware of. They have 

helped me come forth in the forums here, and they are very aggressively pursuing changes. I think they are very respected by the regulators as well in their opinions. 

Now the other top-trade groups are also now starting to take an 

active role. But it has been America’s Community Bankers. I know 

that Charlotte Bahin is here and Greg Mesack and Diane CaseyLandry. That is who has helped me implement bringing this to the 

forefront. And since 1988, I have been upset because bankers never 

had input into this formula that constrains us that is currently existing as Basel I. 

Ms. WATERS. Thank you. I yield back the balance of my time. 

Mrs. BIGGERT. I am concerned about the schedule for adopting 

Basel II. The announced notice of proposed rulemaking has been 

postponed because of the results of the QIS 4. But we don’t know 

how long or whether the January 2008 implementation date is still 

firm. If the January 2008 date remains firm, it will have the effect 

of compressing the timetable by which implementing institutions 

will have to determine whether they will adopt Basel II or not. Do 

you see this as a problem? 

I will start maybe with Ms. Petrou. 

Ms. PETROU. Thank you, ma’am. 

I do. I think it is a problem if we are on a different time frame 

from the other Nations because of the competitiveness issues we 

have discussed. I also think it would be a problem if we then implemented Basel II advanced options as is on the January 1, 2008, 

schedule because the delays so far have given large institutions little time to develop models. We still don’t know what our rules are, 

and I know the banking agencies are running, asking mid-sized institutions now, for example, to choose between Basel II and Basel 

IA. But we don’t really know what either of them is, so I think 

23

right now it is a choice between, if I may, a rock and no place. Adding a Basel II 1/1/08 implementation date into all that uncertainty 

I think would be dangerous, and that is why I would suggest the 

more go-slow approach that still gives our banks the advantage of 

the standardized options as quickly as possible. 

Mrs. BIGGERT. Thank you. 

Mr. Ervin. 

Mr. ERVIN. Yes, I would say I guess my institution is in the rock 

part of that particular issue. As an institution regulated by over 30 

regulators, we have to move to Basel II I expect by January ’08 unless there is an international consensus to delay. It would be problematic for large global institutions to have to juggle two or three 

different regimes during that transition period. That just makes a 

difficult job that much harder. 

I do think there were a few areas where there are for the international group of banks, the larger institutions, some areas where 

a bit more time could be put into the process. Not all of this has 

to be implemented at the exact same time. We had some specific 

thoughts about the trading book review, the most recent of the 

changes for the advanced banks, that if that could be delayed to 

2010 I think that would give us time for real impact testing for memorializing how it would really be implemented and I think could 

be a big benefit in terms of smoothing the implementation of this. 

Mrs. BIGGERT. Thank you. 

Mrs. Marinangel. 

Ms. MARINANGEL. The question again was—just briefly. 

Mrs. BIGGERT. The question was, because of the advanced notice 

of proposed rule, rulemaking has been postponed. Is this going to—

and it is compressing the time for January 2008. Do you see this 

as a problem for different banks having to adopt Basel II or decide 

not to? 

Ms. MARINANGEL. Yes, thank you. Yes, I do see it as a problem. 

I know that the ANPR in Basel IA is projected to come out soon, 

and I think that will help. I know that Basel II is being delayed 

currently, and yet I think it will be a problem for the large banks 

that will be competing and will have to try to implement. It is 

going to make it harder to make a decision quickly. I know they 

are working on it now, but, yes. 

Mrs. BIGGERT. Okay. Thank you. 

Well, everybody seems to have left me, so I would note that some 

members may have additional questions for this panel which they 

may wish to submit in writing. And, 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. 

I would like to thank the panel, for the two of you that are returning, and Mr. Ervin for being here at this hearing, too. I think 

you have the expertise that we really need to help us as we move 

forward with our hearings on this and what is going to happen in 

this regard. So again thank you for coming. 

With that, this hearing is adjourned. 

[Whereupon, at 11:26 a.m., the subcommittee was adjourned.] 

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A P P E N D I X

September 28, 2005

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