US FDIC's Bair says hard getting Basel right

(Adds bank trade group comment, paragraph 12)

By John Poirier

WASHINGTON, Feb 26 (Reuters) - A top U.S. bank regulator on Monday expressed concern that a race to the bottom of capital standards could put U.S., and perhaps global, financial system at risk if an international bank capital plan is implemented in its current form.

With the public comment period on how U.S. regulators should implement the Basel II bank capital accords about a month away from closing, Federal Deposit Insurance Corp. Chairman Sheila Bair warned it could make banks more vulnerable to unexpected shocks.

"Getting it done right is going to be difficult," Bair said in prepared remarks for a speech to the Global Association of Risk Professionals.

"If the result of Basel II is much less capital supporting the risks in the banking system, then Basel II may make the banking system more vulnerable to shock -- not safer," she said.

Her warning came the same day as Federal Reserve Governor Susan Bies said the proposed rules covering bank trading positions under Basel II could be delayed a year.

Under U.S. proposals for a three-year phase-in period starting in 2009, large banks would be allowed to lower capital by 5 percent each year as long as regulators approve.

But some foreign banks, which are expected to start as early as 2008, will be allowed 10 percent reductions over two years.

"I remain very concerned about what would happen under this proposed regulation when the floors come off," Bair said. "The safety-and-soundness of the U.S. banking system would not be well-served by unconstrained double digit reductions."

"In my judgment, the same could be said of the global banking system."

Small and large banks have complained about the disadvantages of Basel II. For example, small banks in the United States fear a competitive disadvantage if larger banks can hold less capital and use it to enhance their business.

Large U.S banks have been complaining about the cost of implementing Basel II, which also could put them at a disadvantage against their international competitors. Some overseas banks have already started their own test runs.

"The regulators should never consider putting our entire banking system in jeopardy because a few banks claim that they need lower capital requirements to compete internationally," Camden Fine, president of the Independent Community Bankers of America trade group, said.

HEDGE FUNDS One of the issues posing a problem for regulators and banks in determining potential risks is the role hedge funds play in providing liquidity and credit in the marketplace.

Banks are key counterparties to the $1.3 trillion lightly-regulated hedge fund sector, providing loans, margin credit, derivative products, collateral management and clearing, settlement and custodial services.

"However, hedge funds' lack of transparency makes it more difficult for banks and regulators to accurately determine the potential risks from individual funds," Bair said.

Earlier this month, the U.S. Government Accountability Office urged U.S. regulators, including the Office of the Comptroller of the Currency and Office of Thrift Supervision, to implement the capital adequacy rules.

Basel II would be able to be applied to about a dozen of the biggest and internationally-active U.S. banks. They account for nearly half of the U.S. banking assets.

Smaller domestic U.S. banks would be allowed to adopt an alternative, simpler model called Basel IA.

((Editing by Tim Dobbyn; Reuters Messaging: john.poirier.reuters.com@reuters.net; E-mail:john.poirier@reuters.com +1 202 898 8399))

(C) Reuters 2007. All rights reserved. Republication or redistribution ofReuters content, including by caching, framing or similar means, is expresslyprohibited without the prior written consent of Reuters. Reuters and the Reuterssphere logo are registered trademarks and trademarks of the Reuters group ofcompanies around the world.nN26334110