While bankers are busy protesting planned additions to the pending Basel III capital regime, regulators are still arguing over the current Basel II standards.

The agencies jointly issued a final rule ensuring that the nation's largest banks never hold less capital than what is required for smaller domestic banks, but sharply disagreed Tuesday over its potential impact.

Federal Deposit Insurance Corp. Chairman Sheila Bair said the rule, required by the Dodd-Frank Act, corrects mistakes made before the crisis, when regulators developed Basel II's so-called advanced approach that effectively allowed them to determine their own capital requirements. She called the new rule "the single most important provision of the Dodd-Frank Act for strengthening the capital of the U.S. banking system."

"Looking back over the crisis, it seems surprising, frankly, that we ever developed the advanced approach," Bair said at a board meeting. "Those were different times, however, when reliance on banks' risk models went almost unquestioned."

But John Walsh, the acting Comptroller of the Currency, continued to defend the advanced approach, calling it a "more sophisticated and risk-sensitive approach to risk management" than Basel I. While he supported the final rule, he said he worried it will hurt large banks' international competitiveness and remove incentives to implement the advanced approach.

"We remain committed to full implementation of the advanced approaches because we do hope that we will obtain the benefits of improved risk management," Walsh said.

Bair, who plans to step down on July 8, acknowledged that the advanced approach is used internationally, but said she hopes regulators fix problems with it.

"While there is growing recognition that the advanced approach tends to produce risk-based capital numbers that are both low and highly subjective, large banks around the world still use it," she said. "Frankly, this concerns me. With their risk-based capital set by management assumptions, and no hard limits on leverage in those countries as of yet, the conditions exist for adverse surprises down the road in the world's banking system.

"I encourage my fellow board members who will remain after my departure to make the correction of this situation a priority through the implementation of the international leverage ratio and reduced reliance on banks' own models in setting risk-based capital."

But Walsh struck a decidedly different tone. He said the Collins amendment interferes with U.S. banks implementing Basel II.

"This is a move away from international consistency since large internationally active U.S. banks will face a two-tiered test unlike comparable foreign banks," Walsh said. He added: "The advanced approaches are costly and complicated to implement. The incentive to implement them rigorously, I worry, is reduced if the simpler Basel I approaches that are already in place will suffice to determine capital."

In the heightened regulatory atmosphere, companies that qualify for the advanced approach have not lowered their capital below industry norms. But Basel II provided flexibility for large institutions to reduce capital in more favorable times.

Sen. Susan Collins, R-Maine, added a provision to Dodd-Frank that was meant to ensure that even under Basel II, U.S. banks and bank holding companies could never reduce their capital below the typical levels used by domestic regulators for other depository institutions, known as "generally acceptable risk-based capital requirements."

The Collins amendment, approved by the FDIC board on Tuesday, was issued jointly with the Federal Reserve Board and Office of the Comptroller of the Currency. The regulation, which was unchanged from the agencies' December proposal, will become effective 30 days after publication in the Federal Register.

Under the policy, large banks would not have to raise their capital per se, since all are generally above the minimums used by other institutions. The rule simply sets limits on how much they could reduce capital in the future.

"The final rule removes the transitional floor periods in … the advanced approaches rule and sets the generally applicable risk-based capital requirements as a permanent floor for the advanced approaches," FDIC staff said in the final rule.

The amendment also blocked firms from including trust-preferred securities in Tier 1 capital, but that ban is expected to be addressed in a separate rulemaking.

Yet while the Collins measure received ample attention in the debate over Dodd-Frank, it may be less relevant now as international regulators draft plans for a stronger Basel III regime and consider adding capital charges for systemically important financial institutions.

"In this environment, generally everybody is talking about increasing capital requirements. … In that sense, you could say the Collins amendment basically is just putting a floor in place," an FDIC official said. "In some sense going forward, you could argue that it's not a binding floor, because capital is going to go up anyway."

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