FDIC's Bair seen on target with bank accord

WASHINGTON (Reuters) - Credit market turmoil and the subprime mortgage crisis have vindicated the chairman of the U.S. Federal Deposit Insurance Corp, who was seen as holding up an international capital adequacy plan on concerns it would not properly cushion U.S. banks against financial shocks.

In June, a few key senators complained that regulators were putting the biggest U.S. banks at an international competitive disadvantage by failing to reach an agreement on the much-delayed Basel II plan.

The criticism was squarely aimed at the FDIC's Sheila Bair, whose agency holds a $50 billion purse that will cover depositors if any of the 8,500 insured U.S. banks fail.

"We can see now that if anything, they needed more capital rather than less," said Edward Kane, professor of finance at Boston College. "She was right all along."

Bair was at odds for months with her counterparts at the Federal Reserve, Office of Thrift Supervision and the Office of the Comptroller of the Currency. She worried that the Basel II plan might lower capital too quickly, too soon for major U.S. banks, which are now reeling from steep losses from the subprime mortgage meltdown.

In reaching an eventual compromise in July, Bair dropped a demand for an automatic review of the entire framework if the aggregate of capital among core banks fell by 10 percent.

The Basel II agreement allows banks to lower cumulative capital levels by no more than 15 percent over three years. Regulators also agreed to require status reports after the second year of the three-year transition phase, which could lead to another showdown among regulators and Congress if the regulators do not like what they see.

"The banks needed excess capital and they're using it now and that's what it's there for, to be a shock absorber when you get into situations like this with unexpected losses," Bair told Reuters in a recent interview.

BASEL II BEGINS SOON

The accord, which is to be implemented starting in April, applies to a dozen big banks, like Bank of America Corp (BAC.N), Citigroup Inc (C.N), JPMorgan Chase & Co (JPM.N) and Wachovia Corp WB.N. Each has more than $250 billion in total assets or $10 billion in assets overseas.

While Bair and other regulators saw Basel II as improving risk management practices at the most complex U.S. banks, the banks themselves had been eager to cut the amount of capital they hold so they could invest it to make more money.

Even before Basel II is implemented, Bair is already signaling that the plan might need some tweaks to better address off-balance sheet transactions, such as structured investment vehicles, or SIVs.

Many big U.S. banks are grappling with how to deal with SIVs tied to mortgage debt. Some, such as Citi, have shifted SIV assets onto their balance sheets, while other SIVs are selling assets or otherwise restructuring.

U.S. regulators will take a close look in coming months at how banks apply the Basel II framework. But some experts caution that too many changes could create problems in carrying out the costly framework.

"The thing you want to avoid is changing something too many times, too often, because it makes it hard to implement," said Richard Spillenkothen, a former director of bank supervision and regulation at the Federal Reserve.

Experts agree that U.S. banks entered this era of the mortgaged-induced credit market seizure with more than enough capital after several years of profitable business.

"Banks were so highly capitalized going into this current trough," of the economic cycle, said Mark Tenhundfeld, director of regulatory policy at the American Bankers Association.

However, the deteriorating credit market problems have eaten away that capital and forced some banks, like Morgan Stanley and Citi, to sell sizable stakes to sovereign wealth funds in China and Abu Dhabi.

As the first step in carrying out the Basel II plan, U.S. banks this year will launch a one-year parallel run in which they apply complex computer models while maintaining their current capital.

After the parallel run, banks will be allowed to start lowering their capital levels based on what the models show.

At the same time, Wall Street analysts expect big U.S. banks to take additional big write-downs, on top of the more than $70 billion in write-downs already announced by financial companies due to the global credit crisis. U.S. banks' loan-loss provisions surged to a 20-year high of $16.6 billion in the third quarter and analysts are bracing for more bad news in the fourth quarter.

Bair said the delay in finalizing the Basel II plan helped U.S. banks.

"I think we are very fortunate that we went slow with Basel II, that we kept the capital levels very high," she said.

(Reporting by John Poirier; Editing by Dan Grebler)