roger w ferguson, jr : concerns and considerations for the practical implementation of the new basel accord remarks by mr roger w ferguson, jr, vice chairman of the board of governors of the us federal reserve system, at the icbi risk management 2003 conference, geneva, switzerland, 2 december 2003. * * * i am pleased to participate in this conference on such an important subject as the proposed new basel accord. your topical agenda and the expertise of your speakers are impressive, and i am sure that the discussions will provide new insights. i have been asked to talk today about some of the issues associated with the practical implementation of basel ii. before i start, let me reiterate that i remain optimistic that a new accord will emerge from the basel committee in a timely fashion, so that national review procedures can go forward. although i will discuss concerns and considerations, these will not, in my judgment, threaten the basic momentum of the process. basel i there is no better place to begin a discussion of some of the practical concerns and considerations of the new accord than at the beginning - with basel i. many have forgotten that the first accord had its origins in complaints that the globalization of banking had distorted competitive balance. banks domiciled in jurisdictions whose supervisors required a more prudent level of capital perceived that they were disadvantaged, certainly in their home markets, by banks whose home supervisors were less aggressive in their minimum capital standards. basel i was intended to level the playing field for banks that operated across national boundaries by establishing consistent standards on how minimum regulatory capital was to be determined in individual countries and what was to constitute capital. we should not lose sight of the continuing imperative, both economic and political, to ensure that a revised accord is perceived by all to maintain a level playing field for banks operating not only across national boundaries but also domestically. i will return to this issue later. basel i - on which the world ’ s regulatory capital regime has been based for more than ten years - was a genuine step forward for most countries ’ capital rules and a watershed for international cooperation among the world ’ s supervisors. but it is certainly clear to those of you at this meeting that globalization, technology, and innovation have accelerated so dramatically that basel i cannot provide the industrial world ’ s largest and most - complex banking organizations with a regulatory capital requirement that reflects their underlying risk exposures. basel i, with its modest risk sensitivity, treats most loans as if they come from one quality category. it ignores techniques that the largest banks

or that choose to adopt the basel ii rules in the united states will have only one option : the a - irb approach for credit risk and the advanced measurement approach ( ama ) for operational risk. neither the standardized and foundation approaches for credit risk nor the basic indicator and standardized approaches for operational risk will be available in the united states. the authorities in the united states proposed the bifurcated application of basel ii ( with one group under basel ii and most banks remaining under the current capital requirements ) and rejected the trifurcated approach ( with banks choosing for themselves among the three basel ii variants for credit risk, as well as three variants for operational risk ), which looks to be preferred in other countries, for three basic reasons. first, basel ii, as i noted, requires that those adopting it apply it to their internationally active banks. the data to which i referred are evidence that the u. s. framework for applying basel ii would meet that test. second, as i also noted earlier, basel ii capital requirements are intended not only to be more sensitive to risk but also to link that risk - sensitivity to a significant increase in the standards for risk measurement and management at larger banks. only the a - irb and the ama approaches fully impose that prerequisite on the large entities. the u. s. authorities believe that the largest u. s. banking organizations should adopt best - practice risk measurement and management for reasons of safety and soundness. third, basel ii is not without cost. most of the thousands of u. s. banks that are neither in the core set nor in the likely opt - in set have operations that, in the u. s. authorities ’ view, would not require the dramatic changes in credit risk measurement and management associated with either the a - irb or the foundation approach. additionally, the increased risk sensitivity of the standardized version seemed modest to us relative to the additional costs of system changes. regarding operational risk, the arguments are even stronger that the ama would impose undue burden on smaller banks. in short, basel ii does not seem to have a favorable cost - benefit ratio for most american banks. the decision that most banks would remain under the current regime in the united states was also conditioned on some institutional facts that were perhaps not well known elsewhere. minimum basel i requirements are not the only capital regulations in the united states. they are supplemented by benefits established by statute for banks with higher tier 1 and tier 2 capital ratios and by legislatively imposed minimum