Comptroller Dugan Tells House Panel that Goal of Basel II Capital Framework And Commercial Real Estate Guidance is to Address Risks Facing Banking System

WASHINGTON -- Comptroller of the Currency John C. Dugan told a House subcommittee today that the Basel II capital framework is intended not only to align capital requirements more closely to the complex risks inherent in large, internationally active banks, but to require those institutions to substantially improve their risk management systems and controls.

The inadequacies of the current Basel I capital regime for the largest internationally active banks are a matter of great concern to the OCC, he said, because the agency supervises the five largest banks in the United States, some of which hold more than $1 trillion in assets.

"These institutions have complex balance sheets, take complex risks, and have complex risk management needs that are fundamentally different from those faced by community and mid-sized banks," Mr. Dugan said in testimony before the House Financial Services Subcommittee on Financial Institutions and Consumer Credit.  The Comptroller’s testimony also covered proposed interagency guidance on commercial real estate lending.

Mr. Dugan stressed in his testimony that the OCC and the other agencies are interested in comments from all interested parties on both the Basel II proposal and the proposed guidance.

"The agencies have and will continue to foster an open process as we move forward with these proposals," Mr. Dugan said, adding that the agencies will "consider all comments, heed good suggestions, and address legitimate concerns."

Mr. Dugan also emphasized that the rule includes a number of precautions, including capital floors for the three year transition period, to make sure it does not result in unacceptable drops in capital levels.

 "If during this period we find that the final rule would produce unacceptable declines in the absence of these floors, then we will have to fix the rule before going forward – and all the agencies have committed to do just that," he added.

The Comptroller noted that while the Basel II proposal is complex, it is intended to be mandated for only a dozen very large banks.  For most banks, he said, the simpler Basel 1A approach that the agencies plan to issue soon will provide a way to more closely align capital with risk without unduly increasing regulatory burden.

Mr. Dugan told the subcommittee that the commercial real estate guidance was proposed for three reasons:  the painful experience of just 20 years ago that showed commercial real estate lending has the real potential to fail banks; the recent and dramatic surge in concentrations in commercial real estate lending among community and midsize banks; and the finding that risk management practices in many of these banks had not kept pace with the surge in concentrations.

Mr. Dugan said the basic premise of the proposed guidance is that where commercial real estate loan concentrations exist, banks should have risk management systems and capital appropriate to the risk of those concentrations.

"But our message to banks is not: Cut back on commercial real estate loans," the Comptroller said.  "Instead it is this:  You can have concentrations in commercial real estate loans, but only if you have appropriate risk management and capital to address the increased risk."

Related Links

• Oral Statement (PDF)
• Testimony (PDF)