A new capital adequacy plan for U.S. banks under the Basel II framework will improve disclosures for risks in light of the recent financial market turmoil and try to ensure prudent capital levels, Federal Reserve Governor Randall Kroszner said on Tuesday.
In a speech to a Standard and Poor's conference on banking, Kroszner said a key mechanism of Basel II will focus on communications with market participants about risk profiles and related levels of capital.
"Recent market events highlight why a robust and independent assessment of risk on the part of banks is so important," he said without discussing the economy or interest rates.
More attention is being drawn to capital levels at U.S. banks as they figure out how to tackle problems that originated with mortgage lending and then resulted in a lack of liquidity for credit and other financial products.
"There will be now more emphasis put both by the regulators and by the individual banks on market-wide liquidity events than particular institution liquidity events," he said in response to questions at the conference.
As banks implement Basel II rules, regulators will monitor results of the implementation to make sure that capital levels remain prudent, Kroszner said.
"We will respond if we see unreasonable declines in capital requirements at individual institutions," he said.
Stresses banks are feeling stem from mortgage delinquencies and markets have reacted with anxiety as several large U.S. financial institutions have reported billions of dollars in write-downs due to exposure to high-risk home loans.
Kroszner said that Basel II rules are more sensitive than current capital rules, and will provide incentives for banks to lend to more-creditworthy counterparties, against good collateral, and to hold more capital against higher risks.
For example, under Basel I banks must weigh risk for different mortgage exposures the same way regardless of the creditworthiness of the borrower. The new rule will assess risk associated with creditworthiness differently, he said.
Unlike Basel I, the new rule will also require banks to hold capital in line with the actual risks of certain transactions such as highly structured asset-backed securities, he added. "A bank is expected to hold adequate capital against all of its material risks, particularly those risks not covered or not adequately quantified in the risk-based capital requirements," Kroszner said.
Included are "liquidity risks or interest-rate risk," in the bank's book, he said.
This month U.S. regulators approved a final Basel II rule to ensure banks worldwide meet similar requirements for matching capital reserves to the risks they face. Basel II applies to the biggest, most internationally active U.S. banks, but more than the top dozen institutions will be affected.
The biggest banks include Bank of America, Citigroup, JPMorgan Chase and Wachovia. They will have up to six months to adopt an implementation plan, Kroszner said.