Board of Governors of the Federal Reserve System

June 26, 2008

Thank you, Mr. Chairman. Let me begin by saying how delighted I am that the Board of Governors is today considering the standardized framework notice of proposed rulemaking.  

Recent market turbulence has underscored the importance of a solid capital foundation for the banking and financial system as well as the importance of sound risk management. A main goal of the Basel II framework, including both the advanced and standardized approaches, is to better align regulatory capital requirements with the actual risk exposures that banking institutions face. This closer alignment enhances the stability and resiliency of the banking system. The increased risk sensitivity of the standardized framework is aimed at both enhancing safety and soundness for the wide range of institutions that will not be adopting the advanced approaches of Basel II and fostering competitive equity for these institutions. Recognizing the diversity of banking organizations in the United States, we want to provide these banks the option of using a more updated capital framework without unduly increasing regulatory burden.   

The proposed standardized framework is largely consistent with the standardized approaches in the international Basel II capital accord, modified in a few areas to better suit the United States banking system. The standardized framework is designed to enhance risk sensitivity most notably by increasing the number of risk-weight categories to which a bank would assign credit exposures. It increases capital requirements for certain off-balance sheet exposures, such as liquidity commitments, and allows for broader recognition of credit risk mitigants, such as collateral. 

With regard to residential mortgages, the framework improves risk sensitivity by using loan-to-value ratios to risk weight individual mortgages. The loan-to-value ratio is a meaningful indicator of potential loss and borrower default. I believe that this represents a significant improvement over a single risk weight for most mortgages and involves little increase in regulatory burden because the loan-to-value ratio is information already obtained by banking organizations in their underwriting processes.  

The proposal also includes an explicit capital requirement for operational risk to provide a cushion against the risk of loss associated with inadequate or failed internal processes, people, and systems or from external events. This would include, for example, losses due to fraud or litigation. In addition, the proposal emphasizes the importance of a bank's assessment of its overall risk profile and capital adequacy, and provides for enhanced transparency through comprehensive disclosure requirements to complement the minimum capital requirements.   

Banks not required to adopt the advanced approaches would have a choice about whether to opt in to the standardized framework. Some of the banks that will consider the standardized option are fairly sophisticated institutions that exhibit sound risk management, but may not wish to undertake the additional effort and expense to meet the various qualifying requirements of the advanced approaches. Consistent with comments we received on an earlier proposal, our existing Basel I-based regulatory capital framework is still an option for those banks that would prefer to remain under that regime. 

The proposed rule that is being considered today will be issued jointly by the four federal banking agencies--the Federal Reserve, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision--after all agency approval processes are complete. The proposal will be then published in the Federal Register for a 90-day comment period.

I want to thank the staff at each of the banking agencies for their efforts in developing this proposal. They have demonstrated remarkable cooperation and dedication--from carefully assessing issues to reaching consensus on the proposal. I believe this commitment has paid off with a risk-sensitive, robust proposed capital framework that addresses industry concerns and enhances the resilience of our financial system. I want to thank personally Barbara Bouchard, as well as so many people on Banking Supervision and Regulation staff, as well as Mark Van Der Weide and numerous people on the Board Legal staff for their truly tireless efforts to bring us to this next step in the process.   

We are keenly aware that our capital frameworks must address the safety, soundness, and competitiveness of our wide range of institutions. At the same time, we remain sensitive to the principle that our multiple regulatory capital frameworks must work together to support the safety and soundness of our entire banking system. I encourage all interested parties to review and comment on this proposal once it has been issued.  I would now like to turn the floor over to Bill Tiernay.