Comptroller Dugan Says Basel Proposals
Designed to Promote More Resilient Banking Sector
Comptroller of the Currency John C. Dugan said that the central challenge for bank regulators over the coming year will be to strike the right balance between capital and credit availability.
“On the one hand, we need to adopt the kinds of real prudential reforms – to capital, liquidity, and risk management – that will fortify the financial system to prevent inevitable future problems from mushrooming into the type of meltdown we sustained in the fall of 2008, with devastating effects on the real economy,” he said in a speech to the Institute for International Bankers.
“On the other hand, if we swing the pendulum too far too fast – requiring banks to hold too much capital and liquidity – we risk a significant and suboptimal restriction of credit, which can also have dire consequences for the real economy,” he said.
Mr. Dugan said it is important to make sure the system can stand up to shocks such as the ones that led to the recent financial crisis.
“We simply have to make the financial system more resilient to future shocks, which means we cannot let the mere possibility of reduced credit availability in the future thwart our efforts for change,” he said. “The issue should not be whether we strengthen the system, but instead, how much we do so, and how quickly we do so, given the credit tradeoffs we face.”
In his speech, Mr. Dugan said it is important to work on an international basis, given the global scope of the crisis, and cited recent work by the Basel Committee on Banking Supervision as providing a basis for addressing capital and liquidity issues.
Two papers issued in July describe final changes to the international Basel II framework, while two December papers outline additional proposed changes. “Taken together, they are intended to promote a more resilient banking sector by strengthening the standards for capital, liquidity, and risk management,” he said.
Of particular importance, Mr. Dugan said, the Basel Committee is focusing on the quality of capital, as well as the amount of capital banks must hold. “This is a very important change that will place a much greater focus on holding higher proportions of the most loss absorbing capital, i.e., common stock,” he said.
Also important is the focus on liquidity. “A key characteristic of the financial crisis was a massive withdrawal of liquidity and the inability of banks to deal with the liquidity shortage,” he said. The Basel Committee attempted to address that issue by proposing a global minimum liquidity standard for internationally active banks that includes both a 30-day liquidity coverage ratio and a longer-term structural liquidity ratio.
“This new regime is designed to strengthen liquidity risk management, measurement, and supervision, but in many ways, designing a widely applicable liquidity standard is more challenging than designing a capital standard, because liquidity risk can be much more idiosyncratic,” he said.
The Basel Committee has also begun a new Quantitative Impact Study that will be used in conjunction with the comments received on the December consultative papers to better evaluate and assess individual aspects of the proposals.
“But more importantly, its purpose is to help answer the critical ‘how much’ questions,” Mr. Dugan said. “How much additional capital and liquidity should be required for each of the proposed new standards, and how much higher should overall capital and liquidity be for each bank? And how do the myriad new proposed standards fit together and work together?”
“This ‘calibration’ exercise, as it is sometimes called, will be a hugely difficult and important challenge for the Basel Committee as it moves forward,” Mr. Dugan said. “But this is the right approach, because considering how the proposals work together as a whole will give us a better understanding of how the reforms will work in practice. It should also help us fine tune the rules to ensure that they really are appropriately reflective of risk.”
Most important, he said, the calibration exercise will help regulators squarely confront the tension between capital and liquidity on the one hand and credit availability on the other. “As policymakers make decisions on how much capital and liquidity banks should be required to hold to make the system stronger and safer, they will need to assess how much such actions could inappropriately restrict the flow of credit to individuals, businesses, and governments that is so important to economic growth,” he said.
Mr. Dugan said the Basel proposals generally strike the right balance, but added that much work lies ahead in fine tuning and implementing them.
“Getting them right won’t be easy, and calibrating them correctly will be more difficult still,” he said, urging bankers and others to comment on the proposals. “We need the best possible input to make our financial system strong, resilient, and able to safely provide the funding fuel that is so critical to all parts of the global economy.”