News Release 2007-114 | October 23, 2007

Comptroller Dugan Tells Conference of Basel II Capital Accord Forward Progress

NEW ORLEANS, La.—Comptroller of the Currency John C. Dugan said today Federal bank regulators are nearing completion of the supervisory and regulatory framework for Basel II in the United States, with tangible progress to report as it relates to both rulemaking efforts regarding Pillar 1—minimum capital requirements and Pillar 2—supervisory review of capital adequacy at individual firms. Equally important, Mr. Dugan indicated that the banks and agencies are moving into a new stage in the Basel process – a stage that focuses on institution-specific implementation efforts and the supervisory scrutiny of those actions.

"I am delighted to say that my overall Basel II message can be summarized in two words: 'forward progress'," said Mr. Dugan in a speech today to the 2007 RMA Annual Risk Management Conference in New Orleans, Louisiana.

Mr. Dugan said that on July 20, the banking agencies announced their agreement on a final U.S. regulation on the advanced approaches and reiterated the intent to preserve unique U.S. safeguards that are critical for safety and soundness. The final rule will retain the proposal's more stringent transitional floor periods and the Prompt Corrective Action Regime of existing law, including leverage ratio requirements, and the agencies will undertake a study during the transition period to assess whether the U.S. Basel framework is working as intended, he said.

"The stringent transition safeguards will allow the agencies to analyze the implementation of Internal Ratings Based Approach and Advanced Measurement Approach systems in a fully supervised environment where sharp regulatory capital declines are not permitted," Comptroller Dugan said. "That, in turn, will enable supervisors to determine whether the fully implemented regime results in capital charges that accurately reflect differences within and among banks, which is, of course, the fundamental objective of Basel II."

Mr. Dugan said that agencies have worked very hard to translate the agreement in concept on the advanced approaches into the actual text of a final rule which will become publicly available in early November.

The agencies are also drafting a proposed rule that would provide all non-core banks with the option to adopt a standardized approach under the Basel II Framework and would replace the "Basel 1A" proposed rule that was issued last year, he said.

"We expect this proposed standardized option to be published in the next several months, with the final rule issued before the advanced approaches become operational for the first year of the transition period," Mr. Dugan said.

Mr. Dugan also discussed U.S. efforts to implement Pillar 2 of the Basel II Framework – the supervisory review of capital adequacy. Pillars 1 and 2 of the Basel Framework were designed to be complementary, Mr. Dugan said.

"One way to think about the basic difference between these two pillars is this: Pillar 1 is about minimum regulatory capital requirements, based on stylized measures of some of the most important risks banks face, while Pillar 2 addresses whether actual capital held by a particular bank is adequate for all of its material risks, regardless of how they are addressed under Pillar 1," Comptroller Dugan said.

The ultimate aim of the Pillar 2 process is the comprehensive supervisory assessment of capital adequacy for an individual bank that must include an assessment of risk management processes, controls, risk profile, and existing capital position, he said.

Mr. Dugan said that the comprehensive supervisory assessment also incorporates consideration of a bank's Internal Capital Adequacy Assessment Process and stressed that it is a process, not a model.

For risks that are deemed measurable, a quantitative approach should form the foundation of risk assessment, he said. Less tangible risks, such as reputational and strategic risks, should be taken into account when assessing capital adequacy, but are not readily addressed by existing models.

The Basel process is entering a new stage that focuses on institutional specific efforts and the supervisory scrutiny of those actions, Mr. Dugan said. Before starting the parallel run, each banking organization adopting Basel II should have in place an effective governance program to support its Board-approved implementation plan that identifies necessary resources and actions the bank must take to qualify for the advanced approaches for credit risk and operational risk.

In the assessment of a bank's readiness to move toward qualification for advanced approaches, examiners will also focus on the other major features of a sound Basel II governance program, including the bank's validation process, audit functions, and reporting framework, Mr. Dugan said.

"Qualification for Basel II will not be a single 'big bang' event," Comptroller Dugan said. "We envision the parallel run period will be an iterative supervisory process where IRB and AMA data and risk qualification are assessed through numerous discussions, review, and examination activities.

Mr. Dugan expressed optimism on the new stage in the Basel II process. "While it has been a long time coming, we welcome this forward progress, and look forward to even more of it in the weeks and months to come."

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