Comptroller Dugan Says Basel II Capital Framework Will Substantially Enhance Safety and Soundness

WASHINGTON — Comptroller of the Currency John C. Dugan told the Senate Banking Committee today that the goal of the Basel II Capital Framework – and a separate initiative for smaller institutions — will substantially enhance safety and soundness.

"Basel II will promote significant advances in risk management that will benefit supervisors and banks alike and substantially enhance safety and soundness," Mr. Dugan said in testimony before the Senate panel.

However, the Basel Framework will inevitably require adjustments to address supervisory concerns, Mr. Dugan said. While the recent Quantitative Impact Study 4 (QIS-4) of the Capital Framework's impact on large U.S. banks showed widely different results for participating institutions and suggested the possibility of substantial reductions in capital, the Comptroller said it is important now to see how live systems operate in a transition period.

"We need to observe live systems in operation – and subject them to rigorous supervisory scrutiny – before we will be able to rely on Basel II for regulatory capital purposes," he said.

To accomplish that, Mr. Dugan said, the upcoming Basel II rulemakings will provide a meaningful transition period during which regulators can observe and scrutinize Basel II systems while strictly limiting, through a system of simple and conservative capital floors, potential reductions in capital requirements.

"I believe that, once the Basel II framework is implemented completely and rigorously supervised in the controlled environment of the transition period, and once we have had the opportunity to make necessary changes to the framework based on the knowledge we gain during that period, the concerns raised by QIS-4 will be addressed," he said.

For smaller banks, the banking agencies have proposed a separate process to increase the risk sensitivity of our risk-based capital rules without unduly increasing regulatory burden. The "Basel 1A" framework would increase the number of risk-weight categories to which credit exposures may be assigned, expand the use of external credit ratings, and employ a range of other techniques aimed at increasing the risk sensitivity of capital requirements.

Comptroller Dugan said he believes that Basel II and Basel IA should be subject to overlapping comment periods, which he said is essential for regulators to assess the potential competitive effects of these proposals on the U.S. financial services industry.

The Comptroller said that safety and soundness considerations demand that capital regulations move from today's measurements to a system that more closely aligns capital with risk.

"Doing nothing to revise our capital rules would, over time, threaten the safety and soundness of the banking system, especially with regard to our largest banks that engage in increasingly complex transactions and hold increasingly complex assets," he said.

"Although both processes [Basel II and Basel IA] will take time and will inevitably change to address supervisory concerns, I believe both will substantially enhance safety and soundness." Mr. Dugan said.

Related Links

• Oral Statement (PDF)
• Testimony (PDF)