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FDIC director calls Basel III fundamentally flawed

Basel III is the continuation of a poor record of fundamentally flawed Basel systems, but with more complexity, Thomas Hoenig, director of the Federal Deposit Insurance Corp. said Friday.

Hoening delivered the remark at The American Banker Regulatory Symposium in Washington, adding that Basel III will not improve outcomes for the largest banks since its complexity reduces rather than enhances capital transparency.

“Basel III will not improve the condition of small- and medium-sized banks,” he said. “Applying an international capital standard to a community bank is illogical, particularly when models have not supplanted examinations in these banks. To implement Basel III suggests we have solved measurement problems in the global industry that we have not solved. It continues an experiment that has lasted too long.

Hoenig has an alternative to Basel. He calls it the “tangible equity to tangible assets ratio. Tangible equity is simply equity without add-ons such as good will, minority interests, deferred taxes or other accounting entries that disappear in a crisis. Tangible assets include all assets less the intangibles.”

The tangible capital measure does not remove the complexities from the balance sheet, does not differentiate risks among assets and doesn’t tier the measure into any number of refined levels, he said.

Hoenig’s measure accepts that firms quickly shift their allocation of assets to take advantage of changing risks and rewards. He said the simpler, but stronger measure clearly reflects the losses that a bank can absorb before it fails, regardless of how risks shift, and provides a consistent and comparable measure across firms.

Since the federal safety net of deposit insurance is a substitute for capital in protecting the depositor, the supervisor should expect the same minimum capital as the market would without the net, the FDIC director said. The equity ratio for the banking industry before the safety net was implemented ran between 13% and 16%. 

“Therefore, the starting point for any discussion of an acceptable level of tangible equity for all banking firms should be well above the 3.25% level now implied by the Basel III proposal,” Hoenig said.

Assessing individual institutional risk more precisely and judging whether the minimum capital is adequate is a challenge in Hoenig’s approach.  He feels the judgment should be determined through the periodic examination process, which for the largest banks has become deemphasized in favor of stress tests. 

“This is no simple task,” Hoenig continued. “However, it is through this process, properly conducted, that supervisors can best assess a financial firm’s fundamental operations, liquidity, asset quality and risk controls.”

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