One of the longest running dramas in bank regulatory history is finally drawing to a close. Led by the FDIC, which issued a draft of its final rule this past week, U.S. regulators are completing work on a risk-based capital proposal that was first presented in 1994. It appeared that completion of this task would await the international risk-based capital proposal from Basel. But apparently U.S. bank regulators decided to produce a final rule even before the Basel rules were completed. The impetus was a desire to set up new capital rules for residuals as soon as possible. Some of the biggest hits to the FDIC's insurance fund have come from banks with large exposures to residual risk - usually from mortgage-related products, such as hi-LTV or sub-prime. And with the economy headed for a serious recession, regulators wanted new residual rules in place tout suite.
Changes for residuals were only first proposed in September 2000, whereas broad risk-based capital changes were proposed in 1994, in 1997 and again in March 2000. Because the separate rules for residuals overlapped the broad risk-based rule changes in several key areas, it was decided to finalize both proposals at the same time. Over the past few years, residual valuation problems (as part of gain-on-sale accounting) helped re-make the home equity and hi-LTV industries. Now, after seven years of debate, they have helped push regulators to produce a final rule on risk-based capital changes.