Basel II rests on the New Basel Accord, which established a more risk- sensitive regulatory framework that was intended to be sufficiently consistent internationally but that also took into account individual countries’ existing regulatory and accounting systems. The U.S. bank regulators have been adapting the New Basel Accord for use by U.S. banks. In the United States, the four federal bank regulators oversee the implementation of Basel II for banks and SEC oversees the implementation of Basel capital rules for investment firms. The financial institutions that will be involved in the implementation of Basel II are organized as bank holding companies, thrift holding companies, or consolidated supervised entities (CSE). At a consolidated level the Federal Reserve supervises bank holding companies that are subject to Basel capital requirements, OTS supervises thrift holding companies that are not subject to Basel capital requirements, and SEC supervises CSEs that voluntarily choose to be subject to consolidated oversight including Basel capital reporting requirements. Each of these types of holding companies has subsidiaries that are depository institutions that could be required to adopt Basel II. Each of these banking institutions is regulated by a primary federal regulator according to the rules under which it is chartered. FDIC serves as the primary federal regulator of state chartered banks that are not members of the Federal Reserve System (state nonmember banks). It is also the deposit insurer for all banks and thrifts and has backup supervisory authority for all banks it insures. The Federal Reserve serves as the primary federal regulator for state chartered banks that are members of the Federal Reserve System (state member banks). OCC serves as the primary federal regulator for national (i.e., federally chartered) banks. Many of the nation’s largest banks are federally chartered. OTS serves as the primary federal regulator for all federally insured thrifts. Under the dual federal and state banking system, state chartered banks are supervised by state regulatory agencies in addition to a primary federal regulator. In 2004, SEC established a voluntary, alternative net capital rule for broker-dealers whose ultimate holding company consents to groupwide supervision by SEC as a CSE. This alternative net capital rule permits the use of statistical models for regulatory capital purposes. At the holding company level, CSEs are required to compute and report to SEC capital adequacy measures consistent with the standards in the Basel Accord, and SEC expects them to maintain certain capital ratios, though they are not required to do so. According to SEC, all CSEs have implemented Basel II. Primary U.S. broker-dealers affiliated with CSEs are required to comply with a capital requirement that SEC says is not identical to the Basel standards but makes use of statistical models in its computation. Depository institutions within the CSEs are subject to the same requirements as other banks of similar sizes and exposures including risk- based capital requirements, the leverage ratio, and PCA; however, there is no leverage requirement at the consolidated level for CSEs. Core banks face a range of competitors including non-core U.S. banks, other financial institutions, and foreign-based banks. Core banks that have varying business models—some focus on domestic retail banking activities, some on wholesale activities, and others are engaged in the full range of these activities—are overseen by a number of different bank regulators. Banks of different sizes that are likely to be under different capital regimes are more likely to compete with each other in retail markets, where they offer products such as residential mortgages to the same customers, than in wholesale markets. In certain wholesale markets, core banks often compete with U.S. investment firms. U.S.-based core banks also compete with foreign-based banks in foreign markets and in U.S. markets where foreign-based banks are very active. Since core banks compete with other financial institutions across various product and geographic markets, differences in capital rules or the implementation of those rules may have competitive effects by influencing such things as the amount of capital institutions hold, how banks price loans, and the cost of implementing capital regulations. Core banking organizations—those that meet the requirements in terms of asset size and foreign exposure for mandatory adoption of the Basel II advanced approaches—have adopted a variety of business models, but all compete with some other core banks. Some of the core banks are active in retail markets, some in wholesale markets, and some in the full range of banking activities. As illustrated in table 1, which is based on publicly available information, five core banking organizations—including one that is foreign-based—have at least 25 percent of their assets in retail markets and one of these, the only thrift that is a core banking organization (Washington Mutual Bank), has more than 60 percent of its assets in retail markets, while a few institutions have almost no activity in these markets. In addition, two core banks that appear less active in retail markets—with about 15 percent of their assets in these markets—may still have a major presence there because of their overall size. In wholesale markets, table 1 shows that some banks are active in making commercial and industrial loans while others hold a larger percentage of their assets as trading assets—assets held to hedge risks or speculate on price changes for the bank or its customers. However, the thrift institution has very little activity in these markets. The three smaller U.S.-based core banks, which are classified as core banks because they have large foreign exposures, engage primarily in custodial activities where they manage the funds of their clients. In this area they compete with the largest U.S. banks that are also engaged in these activities. Core banks are in some ways similar to non-core banks. For example, banks of all sizes continue to participate in some activities historically associated with banking, such as taking deposits and making loans. As table 2 shows, bank holding companies of different sizes hold similar proportions of certain loans such as residential mortgages and commercial and industrial loans. According to research conducted by Federal Reserve staff and other experts, banks of different sizes compete with each other for retail products such as residential mortgages. As illustrated in table 2, bank holding companies in all size ranges hold a relatively large percentage of their assets—from 15.5 to 23.1 percent—in residential mortgages. Customers can obtain mortgages from banks across the United States and generally can obtain pricing information from brokers or directly through the Internet or financial publications. For small thrifts, which make up a portion of the small non-core banking institutions in the United States but are not included in table 2, the proportion of mortgages is much higher. Unlike residential mortgages, only a few banks, including several core banks, are active in the credit card market, but some non-core banks are active in this market as well; and all credit card issuers generally compete for the same customers. For wholesale products, the competitive landscape is more complex. As table 2 illustrates, in some areas core banks differ substantially from non- core banks and are thus not likely to compete with them in those markets. For example, non-core banks hold a very small percentage of their assets as trading assets, an area where some core banks are very active, and core banks hold a relatively small proportion of their assets in commercial real estate, an area where non-core banks are very active. While table 2 shows that core and non-core banks are both active in the commercial and industrial loan markets, the market for loans from large banks may be quite different from those for smaller banks. According to a bank official and other experts, larger banks do not price commercial and industrial loans individually; instead, these loans generally are part of a package of products and services offered to major corporate clients. Financial market experts told us that often these loans are discounted to establish a relationship with the customer. Because smaller banks do not offer a full range of products and services, they likely are not competing for the same customers as larger banks. In addition, we and others have shown that smaller banks tend to serve the needs of smaller businesses with which they can establish a personal relationship. Because obtaining credit information on small businesses is difficult, community banks often have an advantage with these customers in that they may have better information about small businesses in their local market than do large national or internationally active banks. As a result, the largest banks are unlikely to be competing with community banks in these markets. At the same time, research conducted by Federal Reserve staff has shown that large non-core banks may compete with core banks for corporate customers. Core banks are much more likely than smaller or regional non-core banks to participate in activities often associated with investment banking. For example, core banks are much more likely to hold trading assets that typically are used to hedge risks or speculate on certain market changes either for the banking organization or its customers (see table 2). In addition, core banks are involved in international activities where they often provide investment banking products and services in the major capital markets around the world. In the United States and abroad, U.S.- based core banks, especially Citigroup and JPMorgan Chase, compete with the four major U.S. investment firms—Goldman Sachs, Merrill Lynch, Morgan Stanley, and Lehman Brothers. The core banks also are involved in custodial and asset management activities domestically and internationally. In this capacity, core U.S.-based banks compete with foreign-based banks, with investment firms, and with asset management firms that do not own depository institutions and are not subject to regulatory capital requirements. Basel capital requirements were established, in large part, to limit competitive advantages or disadvantages due to differences in capital requirements across countries; however, the New Basel Accord allows for certain areas of national discretion and this could create competitive advantages or disadvantages for banks competing in various countries. In addition, because a major part of Basel II involves direct supervision of the risk management processes of individual banks, further opportunities exist for differences across countries to develop as the new rules are implemented.