Fed may shun global risk rules banks spent billions to meet

Wed Jun 4, 2014 11:56am EDT
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By David Henry and Emily Stephenson

NEW YORK/WASHINGTON (Reuters) - The Federal Reserve may scrap elements of international measures aimed at assessing bank health in favor of imposing its own rules, frustrating bankers who have spent billions of dollars retooling their books to meet global standards.

Fed officials are concerned that parts of a key tool that regulators have developed to measure banks' riskiness—known as "Basel III capital rules" -- are flawed and can be gamed by the companies.

Under Basel, banks can determine how much debt they can take on by using their own models and computer systems to calculate how risky their assets are, among other methods. The higher the risk, the less money banks can borrow and lend, in turn cutting income banks can earn. In other words, this part of the Basel rules, known as the "internal-ratings based approach," give banks a chance to monkey with their risk models to boost profit.

In a May speech, Fed Governor Daniel Tarullo condemned the latitude that Basel III gives banks to use their own models. While he was expressing his own views, a source familiar with the matter told Reuters that Tarullo's opinion is held by other governors.

Instead of using banks' own models, Tarullo promoted relying on the Fed's own yardstick of bank health, a test of how bank assets would perform during market turmoil or an economic slump. That process, which the Fed has developed separately from the Basel regulations, is known as the "stress test."

"As a practical matter, it is our binding capital standard," said John Dugan, former U.S. Comptroller of the Currency and now a partner at the law firm of Covington & Burling in Washington.

The Fed's decision to emphasize a different process for evaluating risk is maddening to banks, who complain that the Fed's tests are opaque. The regulator fears that banks would find ways to cheat the tests if they knew too much about the methodology, so it gives them little detail about it. Every year, the Fed can also change the stressful situations it tests for.

Wall Street says it's getting mixed signals about Basel III from the Fed. Tarullo's remarks come less than three months after U.S. regulators gave the green light to eight big U.S. banks to use their own risk models.   Continued...

A general view of the U.S. Federal Reserve building in Washington, July 31, 2013.  REUTERS/Jonathan Ernst