The marathon-like process to make the existing Basel I risk-based capital framework more risk-sensitive is entering its gun lap. For non-Basel II banks, bank holding companies and savings associations that are neither “core banks” nor “opt-ins,” the final lap started Dec. 26, 2006, with the publication in the Federal Register (pages 77446 to 77518) of a notice of proposed rulemaking (“NPR”) by the the federal bank regulatory agencies (OCC, FRB, FDIC and OTS) (“the Agencies”) to put in place an alternative to Basel I and the proposed Basel II. This alternative is designed to address the competitve concerns that the non-Basel II banks raised. Comments on this joint rulemaking proposal must be submitted by Monday, March 26, 2007. The comment period on the Basel II plan has also been extended from Jan. 23 to March 26.

In general terms, the Basel IA proposal will: expand the number of risk weight categories, allow the use of external credit ratings to risk-weight certain exposures, expand the range of recognized collateral and eligible guarantors, use loan-to-value ratios to risk-weight most residential mortgages, increase the credit conversion factor for certain commitments with an original maturity of one year or less, assess a charge for early amortizations in securitizations of revolving exposures, and remove the 50 percent limit on the risk weight for certain derivative transactions. The Agencies are also seeking further comment on alternatives for implementing Basel II in the United States. The proposal incorporates 22 questions and subsets thereto, on which comments are being requested.

The spur to create a Basel IA alternative for depository institutions and their parenty holding companies, other than the 20 or so that will likely use the Basel II capital approach, is a consequence of a quantitative impact study that the Agencies conducted in late 2004 and early 2005 (QIS 4) by 26 of the largest U.S. banking organizations. The study indicated that the minimum risk-based capital requirements of potential Basel II banking organizations could drop by about 15.5 percent. In reaction to the concerns expressed by the non-Basel II banking organizations that Basel II banks will be competitively advantaged (through lower product costs and freed-up capital for acquisitions), the Agencies issued an advanced notice of proposed rulemaking Oct. 20, 2005. They received 73 public comments. This proposal is intended to address those comments.

The Agencies propose to allow non-Basel II banking organizations the voluntary choice of adopting all of the revisions in this proposal or continuing to use the existing risk-based capital rules. The riskbased capital charges proposed in this NPR continue the implicit coverage for interest rate, operational, or risks other than credit risk, which is specifically covered. Thus, there is no explicit charge for operational risk as there is in the Basel II proposal. The Agencies will closely monitor the level of risk-based capital at those banking organizations that choose to opt in to Basel IA. However, any significant decline in the aggregate level of risk-based capital for these banking organizations may cause the Agencies to modify the risk-based capital rules. It should be noted that the Agencies are not proposing to change the existing leverage ratio requirement (i.e., the ratio of Tier 1 capital to total assets).

It should also be noted that FRB Gov. Susan Bies has been the FRB's point person on the Basel II process from almost the time she joined the FRB, in December 2001. She has also been assigned responsibility by the Board of Governors for bringing to closure the lengthy negotiations with the SEC about that Agency’s proposed Regulation B, which was accomplished with the recently proposed Regulation R (see Reed Smith Client Bulletin 2006-35). Gov. Bies has been able to draw on her 22 years of practical banking experience at First Tennessee National Corporation, during which time she served in many senior capacities, including EVP for Risk Management, Auditor and CFO, to accomplish these yeoman efforts. Assuming these marathon regulatory items get resolved effectively, Gov. Bies will have achieved some major accomplishments.