WASHINGTON The United States' ability to implement global capital rules is being made more difficult by a provision in the Dodd-Frank financial reform law, JPMorgan Securities said in a research note released on Friday.
The 2010 law bans the use of credit agency ratings, such as those provided by Moody's Corp and McGraw-Hill Cos' Standard & Poor's, in U.S. banking regulations.
That is a problem for bank regulators, who currently have no good alternative to the credit ratings they use to help judge the risk on banks' books when determining capital requirements.
In their note, JPMorgan analysts said the immediate result is likely to be a delay in implementing a rule before the end of the year that tweaks capital requirements based on market risk for banks that do a lot of trading -- dubbed Basel 2.5.
The ban on credit ratings in U.S. regulations will also likely make it more difficult to implement the latest sweeping global capital accord reached as part of the Basel III agreement, the note said.
That agreement does not have to be fully in place until 2019, but U.S. regulators hope to begin issuing draft rules by the end of this year.
The agreement on the Basel 2.5 market risk capital standards was agreed to by international regulators comprising the Basel Committee in July 2009 but has yet to be fully implemented in the United States.
The JPMorgan analysts put the chances of a delay beyond the end of the year at 80 percent. U.S. regulators released a draft rule in January but have not made much progress since then.
European regulators do not face the same problem with credit ratings. As a result, the JPMorgan analysts wrote they are "concerned about the potential regulatory arbitrage from difference in timing of implementation and lack of consistency in the capital standards between jurisdictions."
The brokerage said the delay was more beneficial for U.S. investment banks.
The difference in implementation of the capital framework in European and U.S. banks has already resulted in U.S. investment banks buying collateralized debt obligations from Europeans counterparts to benefit from the impending regulatory arbitrage, the brokerage said.
Last summer U.S. regulators sought comment on what could be done to replace credit ratings in their rules. They say good alternatives have yet to materialize.
The Dodd-Frank change has been a burr in their saddle.
"The Dodd-Frank Act's prohibition against the use of credit ratings also will impede our efforts to achieve international consistency in the implementation of Basel III," acting Comptroller of the Currency John Walsh told the House Financial Services Committee on June 16.
The Basel III agreement is a response to the financial crisis and aims to force banks to meet tougher capital standards so they can better withstand a financial shock.
Regulators have asked the U.S. Congress to amend the law to deal with the credit rating problem, but that seems unlikely for the foreseeable future.
One possible outcome is that regulators will require banks to perform their own risk assessments to replace the work of credit rating agencies, and the banks' assessments would be reviewed by a third party, said Karen Petrou, managing partner at Federal Financial Analytics, a regulatory policy consulting firm.
That third party could wind up being the credit raters, she said.
"This is a sort of halfway house," she said.
(Reporting by Aditi Sharma in Bangalore and Dave Clarke in Washington; Editing by Saumyadeb Chakrabarty and John Wallace)