Comptroller Dugan Says Basel II Transition Should Move Forward, But with Significant Safeguards to Protect Banking System

WASHINGTON – Comptroller of the Currency John C. Dugan told a conference of international bankers today that the continued safety and soundness of the banking system demands that regulators move away from the simplistic risk-based capital system now in use for internationally active banks to one that substantially enhances risk management and more closely aligns capital with risk.

"I say this not because economists have dreamed up complex capital models in an academic exercise that attracts kudos from quantitative experts," he said in a speech to a conference sponsored by the Institute of International Bankers.

"Instead, I say it as the head of an agency that supervises multi-billion dollar institutions – in some cases more than a trillion dollars – that take substantial levels of calculated risks as financial intermediaries to provide enormous amounts of funding fuel for our economy."

The Comptroller told the conference sponsored by the Institute of International Bankers that while he strongly supports the Basel II approach, the recent Quantitative Impact Study 4, or QIS 4, shows that additional work is needed. QIS 4 projected both a material drop in capital and a substantial dispersion of results across institutions and portfolios.

The agencies concluded, he said, that the questions raised by QIS 4 can be fully answered only by observing live Basel II systems based on a definite set of agency rules, subject to meaningful supervisory validation and scrutiny – but only with adequate safeguards.

The U.S. agencies, he said, have insisted that a stringent set of safeguards be applied during the transition period, including a one-year delay in the adoption of Basel II; an extension of the transition period to three years; and strict limits on potential reductions in capital requirements during the transition period.

Moreover, he said,  "if the agencies conclude during the transition period that the fully implemented Basel II rule does not adequately reflect risk, or results in unacceptable declines in capital requirements like what we observed in QIS 4, then we have committed to make further changes – and potentially fundamental ones, if necessary – to address those problems to fulfill our safety and soundness responsibilities."

The Comptroller also said the agencies will maintain the leverage ratio as a fundamental capital backstop for unanticipated risks faced by banks, including the risk that Basel II may not work as intended.

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