Jan 11 (IFR) - Proposed new international banking standards
conflict with US legislation, and analysts say that could
further slow efforts to bring US banks in line with their global
The discrepancy concerns the use of credit agency ratings,
which many blamed for fuelling the financial crisis that
initially prompted the wave of new regulations.
The so-called Basel Committee, which is drafting new
standards intended to prevent another crisis, requires the use
of credit ratings to evaluate the assets that banks hold as
But under Dodd-Frank, the 2010 US legislation also aimed at
staving off another global market meltdown, US regulators are
prohibited from using agency ratings.
The issue came to light this week when the committee
announced that RMBS or residential mortgage-backed securities -
the same kinds of investment products, consisting of bundles of
home loans, that played such a key role in the crisis - can be
counted towards a bank's liquidity coverage ratio (LCR).
But the committee said the only RMBS that could be used were
those with a credit rating of double-A or higher - a distinction
that US regulators would not be allowed to impose on US banks.
It also allowed corporate bonds rated BBB- to A+.
"While US regulators have generally agreed to implement the
standards published by the Basel Committee, the Basel
Committee's publications are not international treaties and
therefore are not legally binding," said Stephanie Collins, a
spokeswoman for the Office of the Comptroller of the Currency.
"In fact, where the Basel Committee standards conflict with
US law, we cannot implement them," she said.
One key component of the financial crisis was the collapse
of mortgage-related bonds that had been given top ratings for
creditworthiness but turned out to be riddled with bad loans.
US lawmakers who were crafting Dodd-Frank after the crisis
then banned the use of agency ratings.
As a result, US regulators have had to improvise complicated
formulas that replicate - and in some cases essentially
duplicate - the calculations performed by the credit agencies.
That task was massively complex, and the Federal Reserve
Board did not finalize the first set of formulas, regarding how
to assess the creditworthiness of risk-based capital, until
This week, however, the Basel Committee issued new
guidelines allowing RMBS and other securities to be counted
toward LCR - a specified amount of high-quality liquid assets
(HQLA) that banks must hold to guard against periods of
sustained crisis and stress in the market.
Now US regulators may have to go back and painstakingly
revise those formulas to apply to liquidity provisions as well
as the risk-capital requirements - a necessity likely to delay
the process of implementing the eventual standards, known as
Basel III, even longer.
"Because Dodd-Frank prohibits the use of credit ratings, it
remains to be seen how this week's particular provisions will be
modified for purposes of the eventual US implementation of the
LCR," law firm Sullivan & Cromwell said in a client note this
Analysts say regulators have their work cut out for them.
"The regulators are generally under pressure to get the
implementation of Basel III wrapped up, and the rating piece is
one important part of that," said Dwight Smith, a specialist on
bank regulation and a partner at the law firm of Morrison
"The way that the regulators go about determining
alternatives for ratings for the LCR does not necessarily have
to be the same approach they used for determining rating
alternatives for purposes of risk weighting," Smith told IFR.
"Liquidity measures banks' ability to sell the securities,
and risk weightings measure the value of continuing to hold
them. They may want to approach it differently this time."
Barbara Hagenbaugh, a spokeswoman for the Federal Reserve,
said: "We fully intend to use other tools besides credit ratings
for the liquidity coverage ratio, similar to how we did it for
the Basel (risk) capital provisions."
Some experts say that the need to use an alternative to
credit ratings will seriously complicate the implementation of
new capital standards for banks in the United States.
One result, according to Kevin Barnard, a partner at law
firm Arnold & Porter, is that US standards could end up
significantly different than those implemented in other
countries because of differences in risk weighting frameworks.
Others say that banks will continue to use ratings as an
input in their internal liquidity models anyway.
"One can make the argument that Congress went overboard on
external credit ratings by mandating that they be removed from
all regulations," said Luigi De Ghenghi, a partner at law firm
Davis Polk & Wardwell.
"Many bank executives say external credit ratings are still
a useful metric. While you might be foolhardy to rely on it as
the sole creditworthiness metric, especially for more complex
structured paper, there's no point in throwing out the baby with
the bathwater," he said.
"It's a useful piece of information to have."
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