Although the Bank for International Standards unveiled what's intended to be the final draft of the new Basel II accord, professionals on both sides of the Atlantic believe there may be some further tweaking before the year-end 2006 implementation date.

The 250-page document replaces the 1999 framework for bank capital adequacy (Basel I). Basel II incorporated changes adopted through several consultative papers released for commentary over the years, and three "quantitative impact studies."

Meanwhile, it's understood that the U.S. agencies have stated that they will not consider the guidelines final until they are subject to comments from the U.S. bank regulators, which will follow another round of rule exposure and commentary. Specifically, the regulators are preparing a fourth quantitative impact study (QIS-4) to be initiated later this year, followed by a notice of proposed rule making (NPR) in early to mid-2005.

An official at the Federal Deposit Insurance Corp. confirmed that the regulators are initiating a QIS-4 and NPR as part of its implementation of the Basel II framework (as all European governments are required to adapt respective risk-based capital rules that adhere to the framework). However, the FDIC spokesperson did not acknowledge that the U.S. regulators have stated they do not consider the currently released Basel II as final.

"If the U.S. regulators don't accept it as final, how could it be?" said one source. "There is international politics involved in this."

In any event, the U.S. regulators' timeline is slightly extended compared to what is set forth in the existing Basel II. The Basel committee expects banks to implement the new framework as of year-end 2006. Banks taking the "advanced approach" will be afforded another year (implementation as of year-end 2007). While there's no doubt the U.S. will follow the advanced approach, the FDIC spokesman projected that a final rule from the regulators may not be effective until 2008.

Meanwhile, European markets sources are hoping that BIS will be open to accommodating unforeseen risks or disproportionate capital calculations as they appear. "The [European Union] appears steadfast in its interest in codifying these new rules into law, which may set European banks at a disadvantage vis- -vis other jurisdictions, especially if the laws prove rigid," said analysts at Royal Bank of Scotland. "Also [International Accounting Standard 39] remains a looming concern for many issuers, which may impact capital and may not be fully incorporated into these new Basel II rules."

The BIS release

For securitization market participants, most of the current accord has not changed significantly from what was introduced earlier this year.

Most notably - though not entirely unexpected - the Supervisory Formula Approach for Internal Ratings Based (IRB) has been rolled back to the more complicated format. Responding to industry feedback, in January the BIS considered simplifying the treatment of securitization-related exposures by simplifying the SFA. The third consultative paper included an "easier" formula introduced in the January 2004 report.

According to analysts at the Royal Bank of Scotland, this was primarily motivated by a shift in interest among bankers who recognized that simplified formula would introduce added capital charges for higher-rated holdings.

"The final accord is out, and I think that for the most part it's what we had been expecting," said one European industry source. "Now the focus turns to the [European Union] and to the individual regulators from country to country, tying the new standards into existing banking regulations."

Banks have a choice from the standardized approach (SA) or internal ratings based (IRB) approach. The more complex IRB formula allows banks to use internal risk estimates and to analyze historic performance data when calculating risk.

"IRB banks benefit from lower capital charges on high-quality issues at the expense of capital penalties for poorer-quality assets," explained analysts at RBS. "Banks must apply the chosen methodology at group level and across all business lines unless supervisors can be persuaded otherwise. Implementation of the final rules will likely increase ABS as a proportion of bank trading assets as senior tranches attract extremely low capital charges."

"The final form of Basel II actually seems quite accommodating to securitization," writes Nomura Securities research head Mark Adelson in his mid-year summary. "Most notably, the Basel Committee adopted an internal assessment approach' (IAA), which would allow a bank to achieve favorable capital treatment based on its own determination of risk exposure to an ABCP program. That change is extremely favorable for the banks that sponsor ABCP programs."

While Nomura generally approves of the framework, Adelson notes that certain aspects of Basel II are overly complicated and "too mathematical."

"It likely will produce countless migraines and will enrich armies of lawyers and regulatory specialists," he writes. "For some kinds of risk, even the best mathematical

models cannot produce reliable results - results, yes, but not reliable ones."

Copyright 2004 Thomson Media Inc. All Rights Reserved.

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