[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]





                         THE NEW BASEL ACCORD:
                      PRIVATE SECTOR PERSPECTIVES

=======================================================================

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
               FINANCIAL INSTITUTIONS AND CONSUMER CREDIT

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED EIGHTH CONGRESS

                             SECOND SESSION

                               __________

                             JUNE 22, 2004

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 108-96

                    U.S. GOVERNMENT PRINTING OFFICE
96-292                      WASHINGTON : 2004
____________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov  Phone: toll free (866) 512-1800; (202) 512ï¿½091800  
Fax: (202) 512ï¿½092250 Mail: Stop SSOP, Washington, DC 20402ï¿½090001


                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa                 BARNEY FRANK, Massachusetts
DOUG BEREUTER, Nebraska              PAUL E. KANJORSKI, Pennsylvania
RICHARD H. BAKER, Louisiana          MAXINE WATERS, California
SPENCER BACHUS, Alabama              CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware          LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York              NYDIA M. VELAZQUEZ, New York
EDWARD R. ROYCE, California          MELVIN L. WATT, North Carolina
FRANK D. LUCAS, Oklahoma             GARY L. ACKERMAN, New York
ROBERT W. NEY, Ohio                  DARLENE HOOLEY, Oregon
SUE W. KELLY, New York, Vice Chair   JULIA CARSON, Indiana
RON PAUL, Texas                      BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio                GREGORY W. MEEKS, New York
JIM RYUN, Kansas                     BARBARA LEE, California
STEVEN C. LaTOURETTE, Ohio           JAY INSLEE, Washington
DONALD A. MANZULLO, Illinois         DENNIS MOORE, Kansas
WALTER B. JONES, Jr., North          MICHAEL E. CAPUANO, Massachusetts
    Carolina                         HAROLD E. FORD, Jr., Tennessee
DOUG OSE, California                 RUBEN HINOJOSA, Texas
JUDY BIGGERT, Illinois               KEN LUCAS, Kentucky
MARK GREEN, Wisconsin                JOSEPH CROWLEY, New York
PATRICK J. TOOMEY, Pennsylvania      WM. LACY CLAY, Missouri
CHRISTOPHER SHAYS, Connecticut       STEVE ISRAEL, New York
JOHN B. SHADEGG, Arizona             MIKE ROSS, Arkansas
VITO FOSSELLA, New York              CAROLYN McCARTHY, New York
GARY G. MILLER, California           JOE BACA, California
MELISSA A. HART, Pennsylvania        JIM MATHESON, Utah
SHELLEY MOORE CAPITO, West Virginia  STEPHEN F. LYNCH, Massachusetts
PATRICK J. TIBERI, Ohio              BRAD MILLER, North Carolina
MARK R. KENNEDY, Minnesota           RAHM EMANUEL, Illinois
TOM FEENEY, Florida                  DAVID SCOTT, Georgia
JEB HENSARLING, Texas                ARTUR DAVIS, Alabama
SCOTT GARRETT, New Jersey            CHRIS BELL, Texas
TIM MURPHY, Pennsylvania              
GINNY BROWN-WAITE, Florida           BERNARD SANDERS, Vermont
J. GRESHAM BARRETT, South Carolina
KATHERINE HARRIS, Florida
RICK RENZI, Arizona

                 Robert U. Foster, III, Staff Director
       Subcommittee on Financial Institutions and Consumer Credit

                   SPENCER BACHUS, Alabama, Chairman

STEVEN C. LaTOURETTE, Ohio, Vice     BERNARD SANDERS, Vermont
    Chairman                         CAROLYN B. MALONEY, New York
DOUG BEREUTER, Nebraska              MELVIN L. WATT, North Carolina
RICHARD H. BAKER, Louisiana          GARY L. ACKERMAN, New York
MICHAEL N. CASTLE, Delaware          BRAD SHERMAN, California
EDWARD R. ROYCE, California          GREGORY W. MEEKS, New York
FRANK D. LUCAS, Oklahoma             LUIS V. GUTIERREZ, Illinois
SUE W. KELLY, New York               DENNIS MOORE, Kansas
PAUL E. GILLMOR, Ohio                PAUL E. KANJORSKI, Pennsylvania
JIM RYUN, Kansas                     MAXINE WATERS, California
WALTER B. JONES, Jr, North Carolina  DARLENE HOOLEY, Oregon
JUDY BIGGERT, Illinois               JULIA CARSON, Indiana
PATRICK J. TOOMEY, Pennsylvania      HAROLD E. FORD, Jr., Tennessee
VITO FOSSELLA, New York              RUBEN HINOJOSA, Texas
MELISSA A. HART, Pennsylvania        KEN LUCAS, Kentucky
SHELLEY MOORE CAPITO, West Virginia  JOSEPH CROWLEY, New York
PATRICK J. TIBERI, Ohio              STEVE ISRAEL, New York
MARK R. KENNEDY, Minnesota           MIKE ROSS, Arkansas
TOM FEENEY, Florida                  CAROLYN McCARTHY, New York
JEB HENSARLING, Texas                ARTUR DAVIS, Alabama
SCOTT GARRETT, New Jersey            JOE BACA, California
TIM MURPHY, Pennsylvania             CHRIS BELL, Texas
GINNY BROWN-WAITE, Florida
J. GRESHAM BARRETT, South Carolina
RICK RENZI, Arizona


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    June 22, 2004................................................     1
Appendix:
    June 22, 2004................................................    41

                               WITNESSES
                         Tuesday, June 22, 2004

Alix, Michael J., Senior Managing Director, Global Head of Credit 
  Risk Management, Bear Stearns, on behalf of the Securities 
  Industry Association...........................................    18
Dewhirst, Joseph, Treasurer, Bank of America Corporation.........    12
Elliot, Steven G., Senior Vice Chairman, Mellon Financial 
  Corporation....................................................     9
Gilbert, Adam M., Managing Director, Global Credit Risk 
  Management, JPMorgan Chase & Co................................    10
Jansky, Sandra W., Executive Vice President & Chief Credit 
  Officer, SunTrust Banks, Inc...................................    16
Marinangel, Kathleen, Chairman, President & CEO, McHenry Savings 
  Bank, on behalf of America's Community Bankers.................    14

                                APPENDIX

Prepared statements:
    Oxley, Hon. Michael G........................................    42
    Gillmor, Hon. Paul E.........................................    44
    Alix, Michael J..............................................    46
    Dewhirst, Joseph.............................................    60
    Elliot, Steven G.............................................    69
    Gilbert, Adam M..............................................    78
    Jansky, Sandra W.............................................    81
    Marinangel, Kathleen.........................................    90

 
                         THE NEW BASEL ACCORD:
                      PRIVATE SECTOR PERSPECTIVES

                              ----------                              


                         Tuesday, June 22, 2004

             U.S. House of Representatives,
             Subcommittee on Financial Institutions
                               and Consumer Credit,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to call, at 10:10 a.m., in 
Room 2128, Rayburn House Office Building, Hon. Spencer Bachus 
[chairman of the subcommittee] presiding.
    Present: Representatives Bachus, Gillmor, Biggert, Feeney, 
Hensarling, Garrett, Murphy, Maloney, Moore, Lucas of Kentucy 
and Frank (ex officio).
    Chairman Bachus. [Presiding.] Good morning. Call to order 
the Subcommittee on Financial Institutions.
    At the end of this week, financial regulators from around 
the world will release the newly negotiated Basel Capital 
Accord, or Basel II. This accord has been heavily negotiated 
over the past several years, and there has been significant 
progress along the way. However, it is the view of this 
committee there are still several critical changes that should 
be made before U.S. financial regulators adopt Basel II.
    Today, we will hold a hearing entitled, ``The Basel Accord, 
Private Sector Perspectives.'' This is the third hearing that 
the committee has held on the new accord. Prior hearings 
highlighted disagreements among the Federal financial 
regulators and led the subcommittee to the markup of H.R. 2043, 
the United States Financial Policy Committee for Fair Capital 
Standards Act, legislation which would mandate development of a 
unified United States position prior to negotiating at the Bank 
for International Settlements.
    Following subcommittee approval of H.R. 2043 by a vote of 
42 to zero, we have witnessed more cooperation among the 
regulators and increased sensitivity to the opinions and 
perspectives of all the stakeholders in the negotiations. I 
hope this cooperation continues and that the Federal regulators 
work together in the best interest of the United States banking 
sector, financial industry and the U.S. economy as a whole.
    There is broad agreement that the first Basel Accord needed 
improvement. The global financial banking system has changed 
significantly since Basel, and the old ways of measuring and 
managing risk are simply inefficient. What has developed 
through the Basel II process is state-of-the-art risk 
assessment and management. However, there are significant 
issues that still need to be addressed before the United States 
endorses Basel II.
    The leadership of the Financial Services Committee 
submitted a comment letter to the financial regulators raising 
several concerns with Basel II and the related ANRP. Concerns 
related to operational risk, the risk weight for commercial 
real estate loans and the impact this accord will have on 
competition in consolidation within the financial sector were 
all issues raised by this committee, and none have been 
adequately addressed to date, in my opinion.
    Under Basel II, banks will be required to take a new 
mandatory capital charge for operational risk. The new charge 
will require banks to hold capital against losses resulting 
from inadequate or failed internal processes, people and 
systems, or from external events. This definition includes 
losses resulting from failure to comply with the laws as well 
as prudent ethical standards and contractual obligations as 
well as litigation risk.
    I have heard from several financial institutions that there 
is no widely accepted way to measure these losses and that 
efforts to quantify operational risk losses are in the very 
early stages. I would recommend that the Basel Committee 
seriously consider not making operational risk charge a 
mandatory one but rather one that is set on a case-by-case 
basis by the regulator. Because operational risk is so 
difficult to define, it makes sense for the regulator to know 
it when they see it and then set a capital charge as opposed to 
mandating the charge.
    The Federal regulators often claim that the Basel II 
proposal will continue to evolve and be flexible. If that is 
true, the case should be an operational risk charge evolved 
from Pillar 2 treatment to Pillar 1 treatment once it has 
become easier to measure.
    The U.S. commercial real estate market has proven to be 
strong and is a key drive to our economy. Again, the committee 
is concerned that, as drafted, Basel II will require a 25 
percent risk weight increase for some acquisition development 
and construction loans. This is highly problematic as it will 
drive banks out of this type lending, stifling economic growth.
    There have been tremendous advances in the assessment of 
risk for this type of lending. Unfortunately, the Basel 
Committee is not taking into consideration these important 
advancements and is applying an unsophisticated standard for 
the risk associated with this important lending sector.
    I am concerned that the real goal here is to improve risk 
management in Europe, Asia and other parts of the world. 
However, U.S. lenders will be negatively impacted even though 
they follow state-of-the-art management techniques in 
acquisition, development and construction lending.
    Competition in markets is key to ensuring that innovation 
is encouraged, services are available and prices are kept low. 
The Basel II Accord is going to apply only to the largest 
financial institutions in the United States. However, there are 
some institutions that will see compliance as a requirement to 
remain competitive while others simply will not have the 
resources or expertise to comply with Basel II.
    My concern is that this two-tiered system will, through 
regulation, force banks to merge, sell or change their business 
models. This can mean a reduction in access to financial 
products and to some increasing costs for consumers, all 
because of a regulatory regime that was negotiated outside the 
political process.
    Basel II has the potential to radically change the way 
banking is done in the United States. I understand that the 
Federal Reserve has issued a white paper on this subject; 
however, it is my understanding that that white paper looks 
back at the effect of previous regulatory decisions on 
industrial consolidation--or industry consolidation, not 
forward. The fact is that none of the regulators actually knows 
what effect Basel II will have on the U.S. industry.
    I find it troubling that our regulators will be willing to 
consent to such an agreement before the conduct a fourth impact 
study, which is scheduled for this fall. Why not get the 
results of this study before agreeing to Basel II? What is the 
rush? If we are going to radically change the way banks assess 
their capital, shouldn't we look at what the impact will be on 
those institutions before signing on the dotted line?
    I want to thank the witnesses for appearing today. We have 
a diverse panel. I look forward to hearing your perspectives on 
the Basel II Accord.
    At this time, I will recognize Ms. Maloney for any opening 
statement.
    Mrs. Maloney. I want to thank the chairman, and I agree 
that this is one of the most important issues before this 
committee and that we should have the impact study before going 
forward.
    I, first, would like to defer to the chairman of the 
committee, Mr. Frank.
    Mr. Frank. Well, I wish that that is in fact what you were 
doing, but you are----
    Mrs. Maloney. Chairman for the Democrats.
    Mr. Frank. Thank you. I think pretender to the chairmanship 
is probably the actual title at this point.
    Chairman Bachus. I didn't see you down there. I apologize. 
I did recognize you now that I see you.
    Mr. Frank. I thank you, Mr. Chairman. I am very proud of 
the work this committee is doing on a bipartisan basis, and I 
thank the chairman of the subcommittee, the chairman of the 
full committee, the ranking member of the Subcommittee on 
Domestic and International Monetary Policy which is really one 
of the areas which this affects, although it is within the 
jurisdiction of the Subcommittee on Financial Institutions.
    When this whole process started, frankly, we were watching 
the Federal Reserve simply go forward and do what it wanted to 
do without a lot of input from anybody else, including the 
other bank regulators. And this committee and members of this 
committee were alerted to some problems by a wide range of 
people in the banking community, let's be clear. We had some of 
the large institutions that do custodial work who were worried 
about the operational risk. We have the small bankers who 
really now have reopened, fortunately, the whole Basel I 
question and the impact competitively of differential capital 
requirements.
    And we have also, I think, uncovered a floor on America's 
decision making, because these are very fundamental issues and 
they were being done not only without any congressional input 
but really without input from anybody outside the Fed, the way 
it had been structured. We found that the Controller of the 
Currency and the head of the FDIC and head of the OTS all felt 
that they had been somewhat marginalized in the process, and we 
now have a genuine process that is going forward, and I 
appreciate that.
    There is one flaw still there, or at least one problem, 
that makes me less reassured than I am told I should be. People 
have said, ``Well, don't worry because once Basel II is 
affirmed internationally, it still has to be implemented by 
each country's own laws.'' But with regard, certainly, to 
operational risk, that means the Fed, I assume. I think the 
entities that would be there would be the Federal reserves. So 
we know that the Federal Reserve won't simply go forward with 
it, and that is why it is important for us to focus on it.
    I must say that I think we should, once this is put aside, 
continue to look at the situation. We have a very 
unsatisfactory situation from the standpoint of good governance 
as to how America's position is formulated on these major 
international issues, and I thank the chairman for having moved 
that legislation, and I am certainly convinced that we should 
continue our interest in this even after this is resolved one 
way or the other specific of Basel II.
    As to operational risk, I remain convinced that it is a 
mistake to go forward with it. I think it is a case of doing 
something that is easy and quantifiable because what really 
ought to be done looks harder; that is, the management approach 
is the one that ought to be taken, that this is almost a 
disconnect in my mind between imposing a capital charge and the 
risks we are dealing with here.
    And I say that when we are talking about capital reserves 
for loan losses, et cetera, we know what we are talking about. 
We know a certain percentage of loans are going to go bad, you 
can deal with that. Operational risk is of course a simple name 
for a whole host of complex factors--of fraud, of physical 
damage, et cetera--and it does not seem to me that the analogy 
works, that the fact that you can put a capital charge for 
economic losses which over time you can calculate predict, that 
that translates into a whole bundle of unrelated kinds of 
specific issues.
    It is also the case that the experience, it does not seem 
to me, that we have had argues for the need for this. We have 
not had significant problems here which couldn't be handled 
under the normal rules, and you clearly have the problem of 
competitive disadvantage, particularly since we are talking 
here, by definition, about international activities. It is 
Basel II recognizing the international nature of this. So I 
believe that the case fails, as I have seen it, for a capital 
charge for operational risk, and I am concerned about the 
negative implications--the negative effect that will have.
    I also want to hear more about the argument that was raised 
by various of the smaller banks and confirmed by the chairman 
of the Federal Deposit Insurance Corporation, Mr. Powell, about 
the competitive disadvantage. Now, maybe the view is that we 
won't have to worry about that in 10 years because there won't 
be any small banks. We read about Wachovia now, we have read 
about B of A, we have read about Bank One and JPMorgan Chase. I 
mean when I came here this used to be called the Committee on 
Banking, Financial and Urban Affairs. We have now changed it to 
Financial Services. If we were to take back the House, we might 
go back to the old rule, because unlike our colleagues, we 
don't think Urban Affairs is like a bad word, so we would put 
it back in the title. But if we did go back, depending on when, 
we might have to change it. Instead of it being the Committee 
on Banking, Financial and Urban Affairs, in a few years it 
might be the Committee on the Bank, Finance and Urban Affairs, 
because I am not sure there will be more than a couple.
    But for as long as we do have small banks, they ought not 
to be at a competitive disadvantage. And, obviously, we believe 
there should continue to be small banks. They play a very 
important role. I will say I have had some good relations with 
the larger banks that have merged in my area. It has also been 
the case that when those merges have taken place, the small 
borrowers, the local retailers, the local home builders have 
said to me that they thought it was important that some local 
banks also be around, because they have found that this is 
their preference for dealing with them.
    So preserving the ability of the community banks, the local 
banks to perform their function is very important. It is not in 
competition with the others; they have different niches, it 
seems to me. But that issue also, I think, still is unresolved, 
and I am grateful to those who have brought it to our 
attention.
    So with that, Mr. Chairman, I appreciate your convening 
this hearing again, and I hope that we will get some 
understanding on the part of the executive branch, particularly 
people at the Federal Reserve, that it would be a mistake--let 
me say, finally, it would be a mistake for them to go ahead 
simply because they have the legal authority to do it in the 
face of a significant lack of consensus. That is not a good way 
to run regulatory affairs. You can't simply do that by fiat, 
and I think it is clear from this ongoing process we are not 
yet at the point of consensus that ought to precede a decision 
of this magnitude.
    Mrs. Maloney. Thank you very much. In the interest of time, 
I would like to put my opening remarks in the record, but I 
would just like to note my appreciation of the bipartisan 
leadership on oversight on this important issue. And as we all 
know, the discussions are now reaching a very critical stage 
where key issues must be hammered out and not just at a 
theoretical level but at a nuts and bolts level of detail that 
will really determine how the new accord will affect the 
financial services sector in the United States.
    And because the new accord will affect financial 
institutions differently, depending on their size and 
portfolio, we have asked a large spectrum of banks and others 
to attend and provide their view today. And our goal must be to 
encourage a fair, competitive field for U.S. institutions in 
the global market so that our institutions are not 
disadvantaged in any way in requiring higher capital standards 
or so forth. But we are also very concerned that banks within 
the United States are not unfairly disadvantaged or that one 
bank is not unfairly advantaged over another because of the 
type or the size.
    So we have asked each of you to address these points in 
your testimony and of course to offer any other points that you 
may have. As you may know, based on our concern on this 
important issue, Chairman Bachus as well as Mr. Oxley and Mr. 
Frank and myself, we have put forward and have introduced 
legislation requiring U.S. legislators to develop uniform 
positions in the negotiations and to report to Congress on any 
proposed recommendations of the Basel Committee before agreeing 
to it.
    Regrettably, our legislation did not pass, but I believe 
that our concern demonstrated--our legislation demonstrated our 
serious concern and played an important part in advancing the 
many hearings that we have had and the negotiations we have 
seen today.
    I join Ranking Member Frank and Chairman Bachus in really 
urging that the report at least be completed and reviewed by 
Congress before going forward and that no other consensus be 
reached before making any international agreements that will be 
binding on American institutions, on their safety and 
soundness, their ability to compete here and the foreign 
markets.
    So I look forward to the contributions of the committee 
today, of the witnesses today, and I thank them for being here.
    Chairman Bachus. You are going to yield back the remainder 
of your time? Okay.
    At this time, I know that Ms. Biggert and Mr. Murphy are 
going to introduce two of our witnesses, but, Mrs. Biggert, do 
you have an opening statement?
    Mrs. Biggert. I don't.
    Chairman Bachus. Mr. Murphy, Mr. Hensarling, any opening 
statements?
    Mr. Moore, do you have an opening statement?
    Mr. Moore. No, I don't.
    Chairman Bachus. All right.
    Mr. Lucas? Okay.
    If there are no other opening statements, we will introduce 
our first panel, in fact our only panel. So you all could be 
our last panel too. Our first witness is Mr. Steven G. Elliott, 
and I am going to recognize Mr. Murphy, the gentleman from 
Pennsylvania, to introduce Mr. Elliott.
    Mr. Murphy. Thank you, Mr. Chairman. Mr. Elliott is here by 
popular demand in a return engagement. He is senior vice 
chairman of Mellon Financial Corporation where he is 
responsible for the corporation's Asset Servicing, Human 
Resources and Investor Solutions. The corporation's Finance, 
Treasury, Technology, Corporate Operations and Real Estate and 
its Venture Capital Businesses also report to him.
    His travels have taken him around the country with various 
positions, everything from a degree from University of Houston 
and business administration from Northwestern, he is also 
worked with Crocker National Bank and Continental Illinois 
National Bank and First Interstate Bank of California, so I 
would say most of the States have probably seen his hand in his 
abilities.
    Mellon manages $3.6 trillion in assets under management, 
administration or custody, and so his skills and knowledge of 
these issues runs deep, and we are delighted to have him here.
    Thank you, Mr. Chairman.
    Chairman Bachus. Thank you, Mr. Murphy.
    We welcome you, Mr. Elliott, to the committee.
    Our next witness is Adam Gilbert. Mr. Gilbert is managing 
director of JPMorgan Chase. He is currently the chief operation 
officer for the Credit Portfolio Group, which is mandated to 
actively manage the firm's retained risk resulting from failed 
loan commitments and counterparty exposures.
    In addition, Mr. Gilbert leads firm-wide efforts on various 
public policy and industry issues, including revision of the 
Basel Capital Accord and advises business and corporate 
functions on supervisory and regulatory matters. He was a 
member of the Corporate Treasury Group where he oversaw the 
development of economic capital and transfer pricing policies 
and supported the firm's Capital Committee.
    He began his career in 1987 at the Federal Reserve Bank of 
New York where for over 10 years he held positions in the Bank 
Supervisory Group, Credit and Discount Department and Research 
and Market Analysis Group. Interestingly enough, among other 
things, he spent two and a half years in Basel, Switzerland as 
a member of the secretariat of the Basel Committee on Banking 
Supervision.
    He graduated a Master's degree from Harvard University's 
John F. Kennedy School of Government and Bachelor of Arts from 
Tufts University where he graduated Summa Cum Laude and Phi 
Beta Kappa. Is that a fraternity, Summa Cum Laude? No. All 
right.
    I hope you all know I am kidding.
    [Laughter.]
    When I campaign in some counties I say that is a 
fraternity.
    Our next witness--we welcome you, Mr. Gilbert. Our next 
witness is Joseph Dewhirst--Dewhirst, I am sorry. And Mr. 
Dewhirst is corporate treasurer at Bank of America. He is a 
member of the Management Operation Committee and Assets 
Liability Committee. He is responsible for managing corporate 
and bank liquidity and capital positions. He is also 
responsible for managing corporate insurance, economics and 
certain aspects of the management of corporate pensions and 
401(k) accounts.
    He joined Bank of America as corporate treasurer just, 
what, two months ago? Coming from Fleet Boston Financial where 
he had been corporate treasurer. So you were merged into the 
Bank of America.
    Mr. Dewhirst. That is right.
    Chairman Bachus. And he graduated also Harvard University--
I mean Harvard College, Harvard University in 1973 where he 
majored in psychology and social relations, earned a doctorate 
in social psychology from Harvard University in 1978. For the 
past 16 years, Mr. Dewhirst has coached youth soccer in Sharon, 
Massachusetts and served on the Board of the Sharon Soccer 
Association. For two years, he served as president of the 
association. I appreciate that.
    Our next witness is Ms. Kathleen Marinangel, and I am going 
to recognize Ms. Biggert from Illinois to introduce Ms. 
Marinangel.
    Mrs. Biggert. Thank you very much, Mr. Chairman. I am very 
happy to welcome Kathleen Marinangel to the panel today. There 
is an old adage that, ``Ask a busy person to do the job, and 
they get the job done.'' I think this certainly applies to Ms. 
Marinangel. She is not only the CEO and president of McHenry 
Savings Bank but also the chairman of the board of directors, 
and she serves on the board of the American Community Bankers, 
which she is representing today and serves on the Basel II 
Working Group Committee, along with many other committees.
    She also is on the board of directors of the Illinois 
League of Financial Institutions, Thrift Association's Advisory 
Council, board of the directors of the Federal Home Loan Bank 
of Chicago, Illinois Board of Savings Institutions where she 
was appointed by the governor and serves to the president, 
American Council of State Savings Supervisors, along with 
another list.
    She also has her pilot's license and community involvement 
at Suntraga Board of Governors, City of McHenry Economic 
Development Commission, McHenry Area Chamber of Commerce, along 
with many others. I would like to welcome her here today.
    Chairman Bachus. Thank you very much. Our next witness is--
and welcome you, Ms. Marinangel to the committee.
    Our next witness is Ms. Sandra Jansky, SunTrust Banks. She 
is executive vice president and chief credit officer. In this 
role, she oversees the company's credit-related functions, 
including credit policy, credit administration, credit and 
capital market risk, special assets, credit review, credit risk 
portfolio metrics and wholesale bank credit services. She has 
extensive commercial banking experience, including corporate 
and investment banking.
    She began her career at First Union National Bank, served 
there until 1981 when she joined SunTrust. She attended the 
University of North Carolina, graduated from the Louisiana 
State University Banking School of the South. She serves as 
executive committee member of the International Board of Risk 
Management Association and is immediate past chair. She is 
former chairman and board member of the Foundation for the 
Orange Public Schools in Orlando, Florida as well as various 
other civic organizations. So we appreciate your service on 
behalf of public schools there in Orlando, Florida and welcome 
you to the committee.
    Our final witness is Michael Alix. Mr. Alix is with Bear 
Stearns. He currently chairs the Security Industry 
Association's Risk Management Committee, and he will be 
testifying on behalf of Security Industry Association. He is 
senior manager and director and head of Bear Stearns Global 
Credit Organization. As such, he is responsible for overseeing 
independent counterparty credit risk management with focus on 
the firm's global fixed income and equity businesses. He chairs 
the firm's Credit Policy Committee and serves on its Risk, 
Operations and Principal Activities Committees. He is also 
active in the Bond Marketing Association.
    Prior to joining Bear Stearns, he held a variety of credit 
risk management positions at Merrill Lynch, including a Tokyo-
based head of Asia Credit. Holds a B.A. in economics from Duke 
University and an MBA in Finance from the Wharton School of the 
University of Pennsylvania. We welcome you, Mr. Alix, to the 
committee.
    With the introduction of all the first panel, we will 
proceed to opening statements. We are going to start with Mr. 
Elliott and proceed through to Mr. Alix.
    So at this time, I will recognize you, Mr. Elliott, for an 
opening statement.

 STATEMENT OF STEVEN G. ELLIOTT, SENIOR VICE CHAIRMAN, MELLON 
                     FINANCIAL CORPORATION

    Mr. Elliott. Thank you, Mr. Chairman. My name is Steve 
Elliott, and I am senior vice chairman of Mellon Financial 
Corporation, a leading global provider of financial services 
that has been serving its customers for more than 130 years. 
Headquartered in Pittsburgh, we are a specialized financial 
institution, providing institutional asset management, mutual 
funds, private wealth management, asset servicing, human 
resources and investor solutions and treasury payment services. 
Mellon has approximately $3.6 trillion in assets in our 
management, administration or custody, including more than $675 
billion under management.
    It is a pleasure to testify today before the subcommittee 
on the potential impact of Basel II on Mellon Financial 
Corporation and, more broadly, on the ability of U.S. banks to 
serve their customers and investors. It was an honor also to 
appear last June before this panel on this topic.
    I am grateful for Congress' continued interest in the Basel 
Accord. Your focus on this sometimes overwhelming technical 
rule has ensured attention by regulators at home and abroad on 
what the changes to the international risk-based capital rules 
mean on the most important level: The ability of individual and 
corporate customers to get what they need at a competitive 
price from a vibrant U.S. financial services industry.
    As a specialized financial institution serving pension 
plans and the securities industry, Mellon has a special concern 
with a particular aspect of the Basel II proposal: The new 
regulatory capital charge for operational risk. We think much 
in the proposed new international capital standards and low 
regulations plan to implement them are quite good. Indeed, the 
current risk-based capital standards need wholesale rewrite. 
However, the overall need for new capital standards should not 
distract from the critical importance of getting the details 
right.
    The operational risk charge could well have a dramatic and 
adverse competitive impact on specialized banks. Trillion 
dollar diversified banks can offer a broader range of services 
to their customers; however, that is often done at a cost: The 
inability to focus clearly on individual clients who want a 
high degree of expertise and service in areas like asset 
management and payment processing.
    Mellon is grateful to you, Chairman Bachus, and the 
leadership of this subcommittee, along with that of the 
Financial Services Committee under Chairman Oxley and Ranking 
Member Frank, for your continued attention to the many problems 
with the operational risk charge, particularly its potential 
adverse competitive impact.
    You have rightly pressed the Federal Reserve to analyze the 
Accord's competitive impact. We understand the board is 
currently studying the operational risk-based capital charges 
competitive impact. Mellon is of course happy to cooperate in 
any way that would help in bringing about the right result.
    The board has completed a study on the rule's impact on 
mergers and acquisitions--a key question to ensure that the 
Nation's banking system does not become too consolidated. I 
would argue that there is a direct correlation between capital 
and business activity, that if there wasn't, it would be hard 
to understand why all of the U.S. and international banking 
agencies have devoted so many years of hard work to the Basel 
II rewrite. This is far from a technical exercise but rather 
one of profound implications.
    Today, I would like to emphasize the need for the Basel 
rules and, especially the U.S. version, to rely upon effective 
prudential regulation and enforcement to address operational 
risk. An arbitrary regulatory capital charge for operational 
risk, like the one now proposed, will have an adverse market 
consequences that will ultimately undermine our customer 
service.
    The risk posed by the operational risk capital charge, even 
in the advanced version proposed in the U.S. We continue to 
believe that the ongoing improvements to operational risk 
management will be undermined by the proposed capital charge, 
creating perverse incentives for increased operational risk, 
not the decrease that regulators desire and on which Congress 
should insist.
    And the importance of other changes to the U.S. version of 
Basel II to ensure that our banks remain competitive and 
focused on key market needs. This means a review of the complex 
credit risk standards for specialized banks. A hard look at the 
proposed retention of a leverage standard and the criteria for 
determining who is a well-capitalized bank is also vital, since 
these standards only govern U. S. banks and could have an 
adverse competitive impact if retained.
    Mellon respects the desire of the Federal regulatory 
agencies in Basel and the U.S. to advance operational risk 
management. That is why the Financial Guardian Group, to which 
Mellon belongs, has answered the U.S. regulators' request for a 
detailed and enforceable safety-and-soundness standard with a 
comprehensive proposal. I have attached that proposal to this 
statement for your consideration.
    The U.S. regulators also have asked us for a safety-and-
soundness approach, called Pillar 2 in the Basel framework, to 
be paired with an improved disclosure, Pillar 3, to back up 
regulatory enforcement with market discipline. We took that 
request very seriously and provided a detailed proposal which I 
have also attached to my statement. The Federal Reserve Board 
thanked us for our submission but does not appear to be 
pursuing it as an option. However, we are still hopeful that a 
compromise can be reached.
    Thank you, and I will be pleased to answer any of your 
questions.
    [The prepared statement of Steven G. Elliott can be found 
on page 69 in the appendix.]
    Chairman Bachus. Thank you.
    Mr. Gilbert?

  STATEMENT OF ADAM GILBERT, MANAGING DIRECTOR, GLOBAL CREDIT 
             RISK MANAGEMENT, JPMORGAN CHASE & CO.

    Mr. Gilbert. Good morning, Chairman Bachus, Congressman 
Sanders and members of the subcommittee. My name is Adam 
Gilbert, managing director in the Credit Portfolio Group at 
JPMorgan Chase & Co. JPMorgan Chase is a U.S.-based 
internationally active bank operating in more than 50 
countries. We are currently in the process of merging with Bank 
One, the Nation's sixth-largest bank holding company. Thank you 
for inviting me here to discuss the proposed revisions to the 
1988 Basel Capital Accord, more commonly referred to as Basel 
II.
    We commend the committee's continued interest in Basel, 
which has been beneficial to the process and appreciate the 
unique opportunity to have a constructive dialogue concerning 
what we expect will be an improved framework for regulatory 
capital requirements. We also commend the Basel Committee, the 
US regulators and U.S. financial institutions for the openness 
of the process and their role in developing the proposals.
    Although there are a number of areas requiring further 
consideration, the proposals to date do a far better job of 
measuring risk than the rules they are intended to replace. 
Please allow me to begin with a summary of our views and 
conclude with areas we suggest warrant further review.
    We strongly support the direction of Basel II. The three 
pillars of minimum capital requirements, Pillar 1, supervisory 
review of capital adequacy, Pillar 2, and market discipline, 
Pillar 3, provide a solid framework in which to address safety 
and soundness issues in an environment of continuous innovation 
in the financial markets.
    The committee's objectives with respect to Pillar 1 capital 
requirements, that is improving the way regulatory capital 
requirements reflect the underlying risks and incorporating 
advances in credit and operational risk measurement techniques, 
will address deficiencies related to the current regime and 
have the potential to promote stronger practices at 
internationally active banks. Today's capital rules treat all 
borrowers the same regardless of credit quality and do not 
address operational risk explicitly. Basel II will correct 
this.
    Ultimately, a bank's risk profile is best measured using 
its full range of internal models. As an important step in that 
direction, we welcome the advanced internal ratings approach, 
which will permit banks to incorporate their own estimates of 
default and loss recovery rates into a formula calibrated by 
supervisors. We also welcome the advanced measurement approach 
for operational risk which directly leverages banks' risk 
measurement techniques.
    There has been considerable debate about the 
appropriateness of a Pillar 1 capital charge for operational 
risk. We are highly supportive of a Pillar 1 approach rather 
than a Pillar 2 approach, as some have suggested. A Pillar 2 
approach would require banks to gather essentially the same 
information as if they had a Pillar 1 charge, yet there likely 
would be a loss of transparency and consistency in the 
methodology applied across the global industry.
    For about a year now, we have had an internal operational 
risk capital charge in place which we believe is consistent 
with the AMA standards. We have this charge because we are 
fully cognizant that inadequate or failed systems, processes or 
people can result in losses to our firm. The information and 
control processes associated with our capital framework have 
already provided significant value to our business and risk 
managers.
    The science around operational risk measurement will 
continue to evolve, no doubt, but we believe that an explicit 
Pillar 1 charge and associated standards will be beneficial in 
this regard and will promote further discipline in banks' 
operations.
    In a few days, the Basel Committee will release a revised 
version of its capital accord, reflecting comments from across 
the financial services industry. The new version of Basel II 
will incorporate positive changes related to the calibration of 
the overall capital requirement, the measurement of credit risk 
for wholesale and consumer businesses as well as guidance on 
the practical application of the AMA.
    We appreciate the fact that the Basel Committee has 
committed to continue work on several important areas that we 
believe necessitate further enhancements. These areas include 
the treatment of counterparty credit risk, hedges of credit 
risk and short-term exposures. There are several other issues 
which merit clarification and modification, but these are 
largely technical in nature. Additional information can be 
found in our recent comment letters or I would be happy to 
discuss these in greater detail during the Q&A.
    To be sure, there is a lot for both banks and supervisors 
to do to prepare for the implementation of Basel II. A primary 
example is the qualifying process for the advanced approaches, 
which will be very burdensome unless there is close cooperation 
among supervisors. Home countries' supervisors must play the 
lead role to ensure that the process for qualifying is 
addressed at the consolidated level and that banks do not have 
to go through separate approval processes in every country in 
which they have a presence.
    We understand that some local requirements might be 
different for subsidiaries and possibly branches, but we expect 
the home supervisor to help bridge the gaps when necessary. We 
are confident the U.S. supervisors will do just that.
    Chairman, I would like to thank you and the committee for 
the opportunity to speak on these issues. This concludes my 
remarks today, and I would be happy to answer any questions you 
might have.
    [The prepared statement of Adam M. Gilbert can be found on 
page 78 in the appendix.]
    Chairman Bachus. Thank you, Mr. Gilbert. And before I 
recognize Mr. Dewhirst, I did want to say that, without 
objection, your entire written statements will be made a part 
of the record.
    At this time, Mr. Dewhirst, you are recognized for an 
opening statement.

   STATEMENT OF JOSEPH DEWHIRST, TREASURER, BANK OF AMERICA 
                          CORPORATION

    Mr. Dewhirst. Chairman Bachus, members of the Subcommittee, 
on behalf of Bank of America, I would like to thank you for 
this opportunity to provide our comments regarding the Basel II 
framework. I am Joseph Dewhirst, and I am the corporate 
treasurer of Bank of America.
    Let me begin by summarizing Bank of America's position on 
Basel II. First, the overriding concern of bank regulators is 
the safety and soundness of the banking industry, and, of 
course, we share this concern. Capital is a buffer against 
loss, and it seems sensible to us that bank management and bank 
regulators assess the adequacy of bank capital by looking at 
risk of loss.
    Bank regulators worldwide used Basel I to formalize the 
view that capital allocation should be risk-based. This capital 
accord was, in our view, a major step forward in rationalizing 
the assessment of the capital adequacy of banks. But Basel I 
was, nevertheless, only an initial step.
    As the industry has developed more sophisticated methods 
for measuring risk, often dependent on computing power that has 
become available only during the last decade, there has been a 
growing need for more advanced regulatory capital requirements, 
and Basel II is that more advanced approach. So we strongly 
support the Basel initiative to better align regulatory capital 
requirements with underlying economic risks.
    Next, let me give a brief assessment of the progress made. 
Our general view is very positive. Significant progress has 
been made, and we commend the agency's leadership in this 
process. While time-consuming and sometimes contentious, the 
consultative dialogue maintained with the industry has improved 
the transparency of the process and the quality of the results.
    There are, nevertheless, several technical issues that 
still cause us concern, and we summarized some of these issues 
in a technical appendix; but we have every confidence that 
these issues will be resolved before the final implementation 
date.
    Some have raised questions about operational risk. Bank of 
America strongly supports the Pillar 1 capital requirements for 
operational risk, because it aligns the regulatory capital 
requirements with industry best practice. Recent history 
provides ample evidence that operational risk can be 
significant, and it deserves the same rigor of analysis that is 
employed for credit and market risk.
    Bank of America has already implemented explicit capital 
charges for operational risk within its own internal systems. 
We believe these models are almost fully compliant with the AMA 
requirements, and it would be disingenuous for us to take any 
position other than supporting the Pillar 1 approach.
    Let me turn next to the competitive environment. We believe 
that changes in capital requirements will not materially alter 
the competitive landscape. In particular, well-managed banks 
will not see significant change. To the extent that change does 
occur, it will follow from more prudent management of risk and 
more rational allocation of capital.
    Bank of America believes that good risk management provides 
a competitive advantage, irrespective of the regulatory capital 
framework. Therefore, we have invested significant time and 
resources to develop industry leading risk management processes 
and economic capital models.
    Correspondingly, Bank of America already manages its 
business activities on the basis of risk-based capital. We 
believe that these tools enable us to make better risk and 
return decisions. Since we already manage based on methods 
broadly consistent with Basel II, our behavior is not likely to 
change in any material way.
    Concerns have been raised regarding the prospects for 
industry consolidation as a result of Basel II. Of course, 
there are economies of scale in risk management. So at the 
margin, by encouraging good risk management, Basel II may 
encourage consolidation. But it will be insignificant compared 
to other drivers of consolidation, such as the economies of 
scale around product development, systems and staffing as well 
as the benefits of diversification across business and 
geography.
    As indicated, we have a number of technical concerns. Under 
Pillar I, work remains to be done on a calibration of capital 
for mortgages and other retail assets. The current approach 
assumes that there is inherently more risk in these assets than 
seems justified. Under Pillar 2, we have concerns about 
implementation of rules to create a level playing field 
internationally. And under Pillar 3, we think that the 
disclosure requirements of the standard are still excessive.
    As I said, we provide details regarding these and other 
concerns in the attached appendix, and I would be happy to 
answer questions.
    In closing, let me again assure you that we strongly 
support the objectives of Basel II, and we have been pleased 
both with the process and progress to date. While we 
acknowledge and recognize outstanding issues, we believe these 
issues can be resolved satisfactorily. Finally, we believe that 
Basel II will encourage better management of risk and more 
rational allocation of capital within the banking industry. 
Thank you.
    [The prepared statement of Joseph Dewhirst can be found on 
page 60 in the appendix.]
    Chairman Bachus. Thank you, Mr. Dewhirst.
    Ms. Marinangel?

 STATEMENT OF KATHLEEN MARINANGEL, CHAIRMAN, PRESIDENT & CEO, 
 MCHENRY SAVINGS BANK, ON BEHALF OF AMERICA'S COMMUNITY BANKERS

    Ms. Marinangel. Mr. Chairman, Ranking Member Sanders, and 
members of the subcommittee, my name is Kathy Marinangel. I am 
chairman, president and chief executive officer of McHenry 
Savings Bank, a $210 million institution in McHenry, Illinois. 
I appear today on behalf of America's Community Bankers, where 
I serve as a member of the board. Thank you for this 
opportunity to testify on the impact that the Basel II Accord 
will have on community banks.
    I believe that the development and implementation of the 
Basel II Accord will present one of the most significant 
threats to community banks today, unless it is balanced by a 
carefully revised Basel I Accord.
    Since the adoption of the Basel I in 1988, the ability of 
all financial institutions to measure risk more accurately has 
improved exponentially. Community banks desire to adopt a more 
risk-based sensitive model, such as Basel II. Unfortunately, 
the complexity and cost of implementation of the Basel II 
models will preclude most community banks from taking advantage 
of the positive benefits.
    I think the resultant disparity that will be created 
between banks is totally wrong. Under the current proposal, my 
institution would remain subject to Basel I. If it were 
economically feasible, my bank would prefer to opt in to Basel 
II. In fact ACB believes that any financial institution that 
has the resources should be able to opt in to Basel II.
    While there are a number or risks involved in determining 
risk-based capital, an important one is interest rate risk, 
which Basel I has generally failed to address for most 
community banks. After barely surviving the high interest rate 
cycle of the late 1970s and early 1980s, McHenry Savings Bank 
adopted a strategic plan that included a goal to diversify 
assets in such a way that the bank would never again rely on 
one type of asset in its loan portfolio so that we could better 
manage interest rate risk.
    An important factor in this strategy was the ability to 
reprice as many assets as often as possible. We believe that 
flexibility and repricing is a key to survival in times of 
fluctuating interest rates. For several years, McHenry Savings 
Bank has repriced 80 percent of its assets annually.
    Shortly after completing the restructuring of our 
portfolio, in 1988, Basel I was implemented. Unfortunately, the 
simplicity of the formula did not enable a determination of the 
true risk of assets. Little or no consideration was given to 
collateral value or loan to value of these assets. Thus, Basel 
I has forced us to give up an asset mix that would reprice 
frequently, something that we would want now in a rising rate 
interest rate cycle. New options under Basel I are essential.
    ACB supports the efforts of U.S. and global bank 
supervisors to more closely link minimum capital requirements 
with an institution's true risk profile. This approach could 
improve the safety and soundness of the banking industry and 
allow institutions to deploy capital more efficiently. However, 
a bifurcated system will open the door to competitive 
inequities.
    Two banks, a larger Basel II bank and a small Basel I 
community bank, like mine, could review the same mortgage loan 
application that presents the same level of credit risk. 
However, the larger bank would have to hold significantly less 
capital than the small bank if it makes that loan, even though 
the loan would be no more or no less risky than if a community 
bank made that loan, assuming the large bank adopts Basel II.
    Capital requirements should be a function of risks taken, 
and if two banks make similar loans, they should have a very 
similar required capital charge. ACB is concerned that unless 
Basel I is revised, smaller institutions will become takeover 
targets for institutions that can deploy capital more 
efficiently under Basel II. As community banks disappear, the 
customers will lose the kind of personalized service and local 
decision making they want.
    If Basel II is implemented for a portion of the banking 
industry, changes must be made at the same time to Basel I to 
maintain similar capital requirements for similar risk. For 
example, I have developed a formula in appendix A that includes 
more baskets and a breakdown of particular assets into multiple 
baskets when taking into consideration collateral values, loan-
to-value ratios and other factors.
    Whatever refinements are made, community banks must retain 
the option to leverage their capital regardless of the 
complexity of the calculations. Community banks must be given 
the opportunity to compete against the international banking 
giants who, by the way, have branches in my town and many other 
towns across America.
    We thank Chairman Bachus and the rest of the subcommittee 
members for holding this hearing. As I mentioned at the outset, 
there is no more important issue to community banks today than 
the proper implementation of Basel II and the sensible revision 
of Basel I. Thank you.
    [The prepared statement of Kathleen Marinangel can be found 
on page 90 in the appendix.]
    Chairman Bachus. Thank you, Ms. Marinangel.
    Ms. Jansky, I welcome your testimony.

 STATEMENT OF SANDRA JANSKY, EXECUTIVE VICE PRESIDENT & CHIEF 
              CREDIT OFFICER, SUNTRUST BANKS, INC.

    Ms. Jansky. Mr. Chairman and members of the committee, I am 
very pleased to have the opportunity to discuss SunTrust's view 
of the proposed capital accord. I am Sandra Jansky, executive 
vice president and chief credit officer for the company.
    SunTrust is the seventh largest domestic bank in the United 
States. We have 1,201 offices located in 11 states, with 27,000 
employees.
    In my comments today, I will address our reasons for 
choosing to become an opt-in bank, that is voluntary 
compliance--I understand that has a different meaning in 
Washington--but is a volunteer bank, and also discuss the 
issues that we believe continue to be problematic.
    Our financial institution believes that it is imperative 
for us to comply with the provisions of Basel II. As a 
conservative risk taker, we believe we have been required to 
hold excessive regulatory capital without true consideration 
for the composition of the risk in our institution. If there is 
an opportunity to better align regulatory capital with economic 
capital, we want to be able to qualify for such treatment.
    We believe we have to move forward quickly to meet these 
requirements under the accord due to our current size. By the 
end of September 30 of this year, we will have approximately 
$145 billion in assets. Due to the complexity and the vast 
requirements recommended under the accord, it is impractical 
for our institution to delay compliance with the proposal. We 
believe delays would further add to the cost of implementation 
and cost of compliance.
    We also believe that we would be at a competitive 
disadvantage compared to the core banks if they are able to 
operate with lower capital levels than our institution. We have 
considered voluntary compliance because it has made our effort 
to try to work towards a better alignment more important to the 
institution. As an opt-in bank, we have issues in meeting the 
accord requirements, primarily because we are not at the table 
with the core banks and the regulators when key issues are 
explored and recommendations are made on a wide variety of 
issues.
    Core banks have the advantage of more focused regulatory 
assistance as they pursue the advanced internal ratings-based 
status. Volunteer banks need additional guidance and assistance 
from the regulators that frankly is not currently available.
    I have outlined in our testimony some of the benefits that 
SunTrust has seen from beginning the implementation of the 
Basel II Accord, primarily our risk rating system. As much as 
we like certain aspects of the accord, we do believe the overly 
prescriptive requirements as well as the level of complexity 
will continue to challenge us as we move towards advanced 
internal ratings-based status.
    We continue to remain concerned about the special treatment 
provisions required for certain specialized lending areas, such 
as commercial real estate. While some change has been announced 
to the original proposal, we believe that the higher capital 
requirements for certain asset types without regard to the 
specific risk management practices of a particular institution 
or the performance of those assets over time is problematic.
    We are also concerned about the correlation requirements 
for residential real estate and home equity lines and loans 
versus credit card products that we understand are in the 
accord. The proposed treatment will impact the cost of credit 
availability to certain product lines that have grown 
tremendously over the last 10 years. The correlation 
requirements proposed could result in higher capital to secured 
equity products than unsecured credit card products. Our actual 
experience in these products over a significant period of time 
indicates the losses have been significantly below those 
minimum requirements.
    Of all the changes required for advanced status under Basel 
II, the most significant for us is the quantification of 
operational risk. The Federal Reserve has taken the position 
that the advance measurement approach is the only acceptable 
approach to calculating operational risk regulatory capital and 
is therefore required if a bank wants to use the advanced 
internal ratings-based approach to credit capital. We believe 
this might place certain banks in the American banking industry 
at a competitive disadvantage.
    If SunTrust can satisfy the requirements for the advanced 
internal ratings-based approach for credit risk and we fail to 
meet some of the unspecified requirements for the advanced 
measurement approach for operational risk, we will be forced to 
continue with the current accord. A similar bank in another 
country would have the ability to use the AIRB approach for 
credit risk and the basic or standardized approach for 
operational risk.
    Finally, we have outlined some issues with the disclosure 
requirements in my testimony. Primarily, we believe they will 
add additional pages of information, highly technical, that 
will be of little value to a vast majority of the readers.
    SunTrust believes the new accord is a very positive step in 
the right direction. We would like to see the regulators 
establish a working group of the opt-in banks to further 
enhance our ability to meet the requirements under the accord. 
We also would request that the U.S. regulators consider 
allowing banks to qualify for the advanced internal ratings-
based capital approach for credit risk, while considering the 
standardized or basic approach for an interim period of time. 
We also believe the asset correlations, as I mentioned earlier, 
need to be addressed.
    Thank you, Mr. Chairman.
    [The prepared statement of Sandra W. Jansky can be found on 
page 81 in the appendix.]
    Chairman Bachus. Thank you, Ms. Jansky.
    Mr. Alix?

  STATEMENT OF MICHAEL ALIX, SENIOR MANAGING DIRECTOR, GLOBAL 
HEAD OF CREDIT RISK MANAGEMENT, BEAR STEARNS, ON BEHALF OF THE 
                SECURITIES INDUSTRY ASSOCIATION

    Mr. Alix. Thank you, Mr. Chairman and members of the 
subcommittee. I am Michael Alix, senior managing director of 
Bear Stearns and Company and global head of Credit Risk 
Management. I am also chairman of the Securities Industry 
Association's Risk Management Committee. I appreciate the 
opportunity to testify on behalf of a group of those members of 
SIA, including Bear Stearns, which are likely to be applicants 
under the Security and Exchange Commission's new regulatory 
regime for global consolidated supervision, otherwise known as 
CSE.
    My testimony today comes from the somewhat new perspective 
of an investment bank viewing Basel II through the prism of the 
CSE framework. I wish to make the following points. First, in 
order for U.S. investment banks to compete on a level playing 
field in Europe, we need to know now If the EU deems the SEC 
program for consolidated supervision equivalent.
    Second, regulators must coordinate and cooperate with 
counterparts around the globe to ensure smooth implementation 
of Basel II to avoid excessive costs and duplication of effort 
that could impose undue burden on firms.
    Finally, in order to ensure competitive equality, both 
banking and securities regulators must address certain 
remaining technical issues with the risk-based capital 
calculations required under Basel II.
    Let me say a few words about how we got to this point. 
Major U.S. investment banks are likely to be subject to the 
Basel Accord, including its risk-based capital standards under 
the SEC's recently released consolidated supervision program. 
One key driver of CSE is the requirement by the European Union 
that firms operating in Europe are subject to comprehensive 
consolidated supervision. That is why we care about Basel.
    The day-to-day experience with Basel I and the leading role 
of their banking regulators was a key reason why commercial 
banks were involved closely in the development of Basel II. The 
major investment banks and securities supervisors were, by 
comparison, late to the table with respect to key policy 
discussions with the framers of Basel II.
    Initially, investment banks observed that the apparent 
Basel II capital requirements for some of their key businesses 
were out of line with perceived risk and actual loss 
experience. I can report that firms have made significant 
progress in the last year, clarifying how the calculations 
should be made and conveying important technical flaws in the 
accord through direct, constructive discussions with Basel 
Committee members.
    Detailed technical discussions with officials of the 
Federal Reserve and the SEC enabled four large investment banks 
to refine their calculations and complete a quantitative impact 
study that informed our comments on the Federal Reserve Board's 
advanced notice of proposed rulemaking.
    The recent formation of a task force by the Basel Committee 
and global securities regulators to follow up on many of our 
concerns provides important evidence that the Basel Committee 
takes seriously the unique perspective of the investment banks.
    Now, for the remaining steps. First, and most importantly, 
it is essential that we obtain an EU determination that the CSE 
is equivalent. Originally, the guidance was to be announced by 
the end of April this year with the first set of equivalence 
judgments by June. These time tables have slipped, and we ask 
that you and your colleagues on the full committee monitor this 
situation carefully. It is our judgment that there should be no 
doubt that CSE is equivalent.
    Second, it is essential that all regulators coordinate and 
cooperate with their counterparts around the globe on 
implementing Basel II. Doing so will permit regulators to 
leverage their resources, help ensure that no entity is subject 
to duplicative or inconsistent requirements, and help ensure 
that supervisory responsibility is lodged with the regulator 
best situated to exercise such responsibility.
    Flexibility in the application of the Basel standards under 
CSE will be very important. U.S. securities firms have not been 
subject to Basel standards on a firm-wide basis and thus have 
not been obligated to build a global Basel I infrastructure. 
Since banks will have until as late as 2008 to implement the 
more advanced Basel II approaches, flexibility is necessary for 
CSE applicants to avoid the undue expense and burden of 
requiring implementation of a standard destined to be 
superseded in the near future. In other words, if you decided 
to build a new baseball stadium in the District in, say, two 
years, you should not have to pay to renovate RFK right now.
    The collaborative process must continue for international 
capital standards to more fairly reflect the risks inherent in 
the investment banking business, without imposing large and 
unnecessary costs. Perhaps most significant among many still 
open items is whether the SEC and other global regulators will 
recognize the reality that much of our risk taking relates to 
trading, rather than banking, activities that meet both the 
spirit and the letter of the Basel Committee's definition of a 
trading book.
    Banks and securities firms operate and report under 
substantially different accounting frameworks. Banks generally 
carry risk assets at cost, accrue earnings, and establish 
formula reserves. In contrast, securities firms mark to market 
and treat virtually all business lines as part of a trading 
book. If in the application of Basel II to investment banks 
regulators require investment banks to compute capital 
requirements for trading activities as though they are part of 
a banking book, investment banks would be taking a double hit 
in the computation of their requirements.
    We very much appreciate the subcommittee's interest in the 
adoption and implementation of Basel II. We look forward to 
working with Congress, the administration and the regulators on 
finalizing and implementing a new capital accord. Thank you 
very much.
    [The prepared statement of Michael J. Alix can be found on 
page 46 in the appendix.]
    Chairman Bachus. Thank you, Mr. Alix.
    At this time, I recognize Mrs. Biggert for any questions 
that you have for five minutes.
    Mrs. Biggert. Thank you very much, Mr. Chairman. This is a 
question I think that probably all of you could answer, because 
there seems to be a difference of opinion in what type of bank 
or institution you have. And that is what effect does the 
regulatory capital have on your pricing and lending decisions? 
And does the regulatory capital play a more important role in 
the management of a community bank than it does for a large 
financial institution?
    I think I will start with Ms. Marinangel.
    Ms. Marinangel. The second part of the question was does 
the----
    Mrs. Biggert. Does regulatory capital play a more important 
role in the management of a community bank than it does for a 
large financial institution?
    Ms. Marinangel. I think the roles are similar. Currently, 
we are all under the same regulations, and the mix of the 
portfolio you have to live by the risk-based capital levels is 
the same to maintain a well-capitalized bank.
    Recently, for example, I have had to sell some very well-
collateralized commercial loans off to some of my competitors. 
We have kind of coordinated in that. But to maintain the well-
capitalized level, my opinion is that maintaining mortgage 
loans on your balance sheet, which are 50 percent weighted, now 
will cause--even though it is a good credit risk, will cause 
interest rate risk problems as interest rates rise. And, 
therefore, I feel that the formula has caused problems for a 
rising rates scenario, and I am sure it is similar for both 
community banks and the larger banks.
    Mrs. Biggert. Well, it is my understanding that at least in 
the areas of small business and mortgage lending, that the 
advanced approach of Basel II will likely result in significant 
reductions in the required capital. And if this assumption is 
correct, do you think that Basel II will make it more difficult 
for small banks to compete?
    Ms. Marinangel. Absolutely. I think that deploying capital 
more efficiently and leveraging capital which will result from 
the Basel II banks being able to opt in will cause community 
banks to not be able to compete as effectively. The pricing of 
the products, as you stated, when you utilize your capital more 
efficiently, you can price some products at a lower price for 
the consumer and make it up in other areas. And the larger 
banks, some of them, offer credit cards and other products that 
the community banks can't necessarily offer at an efficient 
level. Therefore, it will make it extremely difficult for us to 
compete if we are not able to opt in to Basel II or have a 
revised I.
    Mrs. Biggert. Okay. And I believe that the banking 
regulators have recently announced they will consider revising 
Basel I?
    Ms. Marinangel. Yes. They have mentioned that they would 
take it under consideration, and there would be two approaches. 
Some community banks may not want to adopt the more advanced 
Basel I, so they could be left as is or my example that was 
attached shows more buckets are fairly easily administered, but 
there could be also a more risk-sensitive approach that is not 
as complex as the Basel II. And where additional risk for 
complex and sophisticated products could be added in, could be 
a Basel 1.5 and less complex.
    Mrs. Biggert. I think you have the alternative proposal in 
your testimony. Have you shared this with the banking 
regulators?
    Ms. Marinangel. Yes. I have sent thousands of letters over 
the years, but most recently in November, when the comment 
letter was due, I sent 1,000 letters out to those banks that 
had less than 11 percent risk-based capital as well as all the 
regulators. And I find that, for example, a mortgage loan, even 
if it has a 20 percent or 90 percent loan-to-value ratio, is in 
the same bucket, which makes no sense, and banks are not given 
credit for the differences in loan to values, durations or 
collateral. As another example, for the last 10 years in 
McHenry Savings Bank, my commercial real estate loans have had 
zero losses in 10 years. My overall loss has been less than 
one-tenth of 1 percent on my whole portfolio because I am a 
heavily collateralized lender, and I am not getting any credit 
for my asset risk in that regard.
    Mrs. Biggert. Thank you. I have just a short time left, so 
if anyone else would like to comment on this? No statements? 
Okay.
    Yes, yes, Mr. Dewhirst?
    Mr. Dewhirst. In general, I would say that regulatory 
capital has no role or a de minimis role in pricing. The 
principles that are the basis for regulatory capital, the risk-
based capital principles, do drive our pricing decisions, and 
that has been true for a long time. But we don't focus on the 
regulatory capital side of things in looking at those 
decisions.
    As Basel II is implemented, what will happen is the methods 
of regulatory capital will become more in line with the pricing 
disciplines that we are using already.
    Now, to the general question of mortgages, I would tend to 
agree with the comments that risk in mortgage assets is 
overstated in Basel I. I would just make the observation that 
Basel II is moving in the right direction in reducing those 
risks, so to the extent that it is a more rational assessment 
of the risk in those assets, that should help. The problems 
that were mentioned about excessive risk weights for mortgages 
are problems in Basel I that we would all hope to correct.
    I don't really have a strong answer for whether regulatory 
capital plays a more important role in the management of a 
community bank. I know that we hold more capital at Bank of 
America than is required by the regulators by a long shot. So 
regulatory capital is not a constraining factor.
    Mrs. Biggert. Thank you. Thank you very much. My time has 
expired. Yield back.
    Chairman Bachus. Thank you, Ms. Biggert.
    Mr. Frank?
    Mr. Frank. Thank you, Mr. Chairman. I haven't had a chance 
to read the testimony, so I am upset at myself. I have a 
fundamental question, maybe I am missing something. Sometimes I 
find out when I ask fundamental questions I may not be the only 
one who is missing something. And that is I am trying to 
understand how it is that a capital charge is supposed to 
alleviate, diminish, compensate for operational risk. I 
understand a capital charge with regard to lending, and I know 
you are not, on the whole, all advocates of it, but I want to 
understand--I mean is it--there are a couple of possibilities.
    One is that a capital charge somehow will give you an 
incentive to avoid the dangers, I don't think anybody is really 
arguing that. Is it that the amount of capital you have to put 
aside, is that supposed to be able to take care of any losses 
in operational risk so that we don't have to go to the fund? 
What is the relationship? From their standpoint, as you 
understand it, how will requiring you to put up this amount of 
capital help us avoid the problems that would result from the 
operational risks becoming real problems? Yes?
    Mr. Gilbert. Thank you, Congressman. One can never say that 
will help you avoid all problems. No capital charge could do 
that at a reasonable cost. I think the best way to think about 
an operational risk capital charge is in the context of an 
entire risk management framework. It is not an end in and of 
itself.
    Mr. Frank. What contribution does it make to this? I mean I 
can't look at the whole thing. I need to know what is better 
because we have a capital charge for operational risk than if 
we didn't?
    Mr. Gilbert. Right. Because it makes the risk that we run 
in our operations much more transparent, so the measurement 
processes, the control processes that feed into the capital 
make it much more transparent.
    Mr. Frank. You don't have to have a capital charge to make 
the risks transparent? Transparent to whom, I guess would be 
the first question.
    Mr. Gilbert. Well, it certainly makes it more transparent 
to our internal businesses and risk managers. It provides them 
incentives to control those risks----
    Mr. Frank. How does it provide them an incentive to control 
the risks that they don't otherwise have? I mean would a 
capital charge go down if they----
    Mr. Gilbert. Yes. In a risk-sensitive regime, if they have 
stronger controlled mechanisms that are experienced----
    Mr. Frank. And you mean the people running the operation 
don't have an incentive to reduce those anyway? I am really 
skeptical that a capital charge in terms of transparency 
internally. I mean, first of all, doing a lot of capital 
charges through management supervision would seem to do this, 
but your argument is that the capital charge increases the 
internal incentive to avoid the dangers and also makes people 
more aware of what they are? It would seem to me there are 
better ways to do that, and I would hope that they would be 
doing that without this.
    Mr. Gilbert. They largely do, but the capital charge 
internally puts a highlight, a stamp on that, if you will, and 
helps make transparent what it costs to the organization of 
not----
    Mr. Frank. Let me ask others what they think about either 
that particular justification or some others?
    Yes, sir?
    Mr. Elliott. At Mellon, we take an entirely different 
viewpoint here. Where we have tried to focus our resources----
    Mr. Frank. No, no. I am asking you--Okay, well, go ahead 
finish this if it is directly responsive.
    Mr. Elliott. I think it will be, sir.
    Mr. Frank. Okay.
    Mr. Elliott. Where we have tried to focus our resources 
around the operational risk side of things is not on a capital 
charge, which really is in many ways a black box, especially to 
people on the inside. But it is really to focus in terms of the 
basic fundamentals of risk management, starting all the way at 
our board of directors----
    Mr. Frank. I understand, sir. Let me ask you this: Would a 
capital charge give you any greater incentive, do you believe, 
to deal with risk?
    Mr. Elliott. Not in our view, no.
    Mr. Frank. Yes. I mean I would think you would have--I mean 
what are the operational risks? Are you talking about theft, 
about fire, about----
    Mr. Elliott. The more relevant ones, typically, on the part 
of financial services that we deal with, which is more the 
processing and asset management businesses, are errors in 
pricing, there are errors like in not doing a corporate action, 
recognizing a merger or an acquisition type of transaction, and 
they are typically very modest in proportion if you----
    Mr. Frank. Okay. But, again, I don't see--it does seem to 
me you have every incentive to avoid those anyway, so I don't 
see what a capital charge--what about transparency? Would a 
capital charge increase transparency in your operation?
    Mr. Elliott. No, sir, not the way we look at it. We would 
see it in terms of basically having those strong internal risk 
management systems is where your first line of defense----
    Mr. Frank. Let me ask if any of the others have any--yes, 
Mr. Dewhirst?
    Mr. Dewhirst. You asked if there is an incentive created by 
a capital charge. I think that the question or your skepticism 
would apply equally if you asked the same question but changed 
operating risk to credit risk or market risk. There are 
incentives for good managers to manage credit risk. There are 
incentives for good managers to manage market risk. The thing 
is that people aren't perfect, markets aren't perfect, events 
happen, things go bump in the night.
    Mr. Frank. How does having a capital charge help then?
    Mr. Dewhirst. Capital is there to protect the bank and the 
bank shareholders and the----
    Mr. Frank. Okay, but it is not an incentive. It is----
    Mr. Dewhirst. The capital is there to protect against 
economic loss.
    Mr. Frank. Right.
    Mr. Dewhirst. If the system is one that gives you a lower 
capital charge to the extent that you are better able to 
control your risk, whether it is credit or operating or 
whatever, then you have an incentive to control that.
    Mr. Frank. You think the analogy between credit risk and 
operational risk follows very closely?
    Mr. Dewhirst. Sure. In the examples mentioned earlier, many 
of the operating risks mentioned were kind of minor and 
routine, like fraud. And my opinion is they are not so much for 
those routine losses as for the bigger ones.
    Mr. Frank. Like what?
    Mr. Dewhirst. Market timing, like late trading. If a 
company doesn't have the right kind of controls in place over 
its operations to make sure that people don't do those things, 
they can lose a lot of money, and capital is there to make sure 
that that----
    Mr. Frank. Okay. Let me ask you this, though--and I would 
appreciate a little extra time if I could--of course what you 
are saying is if you have those controls in place, you will 
then get a reduction in the capital charge?
    Mr. Dewhirst. I would hope that eventually that is where 
the system goes.
    Mr. Frank. Oh, that is very attenuated. It is not 
currently--you wouldn't get any today? Because it can't be an 
incentive if you don't get it. Is that not built in today?
    Mr. Dewhirst. Certainly, on the capital side, the direction 
we would move----
    Mr. Frank. No, I am not talking about on the operational 
risk side. You are saying----
    Mr. Dewhirst. There has been an evolution in the regulation 
that starts with formulas like 20 percent risk weights for 
securities and has evolved towards an actual assessment of 
losses on credit risk. On the operating risk side, to the 
extent that you have an advanced approach, what I would expect 
to see happen is that your own data and models that project how 
much you could lose would tend to support a particular capital 
level, and as the regulators get more confidence in your loss 
history and your projections of future losses, your own history 
of good risk management ought to lead you to lower capital----
    Chairman Bachus. Mr. Frank----
    Mr. Frank. I have one last question, which is I thought we 
were talking about unexpected losses, and how does that fit 
into----
    Chairman Bachus. Let me do this: Let me recognize Mr. 
Murphy and then I will come back.
    Mr. Frank. All right. I apologize.
    Chairman Bachus. Mr. Murphy?
    Mr. Murphy. Thank you, Mr. Chairman. I only have a time for 
a quick question here, although there is nothing quick when we 
are talking about the Basel Accord.
    But a question for Mr. Elliott. I know the Fed has done a 
preliminary study on the effect of Basel II on mergers and 
acquisition activity within the whole banking industry. It 
concluded that any potential drop in capital accompanying the 
accord would have little impact on merger activity. However, 
they did admit that because of relevant data, and I quote here, 
``The results are statistically insignificant, and in cases 
where results are statistically significant, quantitative 
magnitudes are small.'' What is your opinion of the study and 
statements like that?
    Mr. Elliott. My perspective on that is that it is like any 
study, it is a little bit backward looking, it is not forward 
looking. And when you look in terms of the potential 
consolidation of the financial services industry, obviously the 
winners are going to be the ones that have the large capital 
resources to basically provide acquisition opportunities. And 
if you don't have strong capital, you are not going to 
participate in the consolidation of the financial services 
industry.
    So my view would be it is an interesting study but more 
backward looking, and any evaluation has to be more forward 
looking in nature.
    Mr. Murphy. Are there elements here in the accord which 
would help or hinder--and I guess I will open this up to all 
the panelists--help or hinder the flexibility of allowing 
institutions to move forward in best ways with regard to 
mergers and acquisitions. I mean the idea being that we don't 
want it to just be a couple of big players end up acquiring 
everything but allow the marketplace to work here. Are there 
elements that you think help or hinder overall?
    Mr. Elliott. Potentially it helps the larger financial 
organizations to the extent they free up capital from some of 
the other aspects of the Basel II Accord. You do have to take 
into consideration, however, that basically the marketplace is 
going to be the real determinant around the amount of capital 
you need in a consolidating type environment. Others may have a 
different view.
    Mr. Murphy. Any other panelists have a comment on that?
    Ms. Marinangel. I do. I think that when the larger banks 
that would be able to adopt Basel II would be able to deploy 
their capital, I believe that they would be able to buy a 
competing smaller institution and then convert those assets 
into a more efficient use by having less capital required. And 
so I think that that will encourage mergers and acquisitions to 
occur, because they will be able to deploy the capital of the 
acquired bank.
    Mr. Murphy. Is that a positive or negative?
    Ms. Marinangel. Well, I think that perhaps for those 
community banks that want to be sold, it is a positive. But I 
think it is a negative long term because I believe that 
community banks serve functions in the communities that the 
large banks sometimes can't address. So I think it would be a 
negative. There are a lot of de novos that are opening to 
service the needs of communities as community banks.
    Mr. Murphy. Thank you.
    Mr. Gilbert, you had a comment?
    Mr. Gilbert. Just to take a different view, I just believe 
that regulatory capital will have no role in bank decisions 
about whether to merge or acquire another bank. As Mr. Dewhirst 
said, we make our decisions on all sorts of factors, largely 
driven by our economic signals, economics of the marketplace. 
Regulatory capital is not on the radar screen as a drive of 
decision making in that regard.
    Mr. Murphy. So we have some differences of opinion here? 
Well, that helps clarify this point.
    [Laughter.]
    Mr. Murphy. Thank you, Mr. Chairman. I remain obfuscated by 
the----
    Mr. Dewhirst. I guess I would say or ask you in any article 
you have ever read about a bank merger, did anybody ever talk 
about regulatory capital as a driver? It is never on the table.
    Ms. Marinangel. It could be, though, in the future because 
of Basel II.
    Mr. Murphy. Thank you, Mr. Chairman.
    Chairman Bachus. Thank you, Mr. Murphy.
    Ms. Maloney?
    Mrs. Maloney. First of all, I would like to welcome one of 
my constituents, Michael Alix, and thank you for your testimony 
today.
    I would like to ask you about your--you mentioned in your 
testimony the trading book. Can you elaborate on this issue and 
discuss how it may impact your firm and similar firms under 
Basel II?
    Mr. Alix. I would be delighted to, thank you. The trading 
book is a concept in the Basel Accord which allows positions 
and businesses to have their regulatory capital calculated 
using a market risk model. And the idea behind the trading book 
is that assets that are in the trading book are marked to 
market, held for sale and actively managed as market risks. 
That describes virtually all of the activities of the major 
investment banks. There are some exceptions, but virtually all 
of the inventory positions and activities in the investment 
banks would be encompassed in a trading book.
    However, it also includes activities which in commercial 
banks are in a banking book, and a banking book is more of a 
held-to-maturity traditional lending concept. And what we fear 
from our discussions with regulators, both in the U.S. and 
around the world, is that the activities that we have 
effectively managed for years and years as market risks could 
be recharacterized as banking risks.
    That includes, for instance, mortgages purchased with the 
intent to securitize, loans purchased with the intent to sell. 
Those activities are recharacterized as banking book 
activities. It has two harmful effects. Number one is it causes 
us to have to build infrastructure to collect data and make 
calculations on those activities that we wouldn't otherwise do 
for our own purposes. We would not think it would be relevant 
information.
    And the other thing it does is to create a disparity in the 
actual capital charge between the banking book and the trading 
book such that investment banks, which have already recognized 
the expected loss in the activity through the mark-to-market 
process, would then be asked to take a capital charge on top of 
that. The reserves, which banks would hold against those 
activities, and which are, in some measure, expected losses, 
would continue to be allowed as capital under the Basel Accord. 
So that disparity would cause us a concern.
    Mrs. Maloney. Thank you. Getting back to the point that Mr. 
Frank was making, and I would like to ask all the panelists to 
comment if they would, why would it not be more advantageous to 
all United States financial sector institutions to move 
operational risk to Pillar 2 and disclosure under Pillar 3? And 
wouldn't that solve the competitive problems better and protect 
better against risk, with the regulators and supervisors 
looking at it. Would anybody like to comment on that?
    Mr. Elliott. Well, that is precisely our proposal, and we 
think one of the things that you have outlined is basically 
getting to the heart of the matter. Each individual 
organization is different here, and it is very difficult to 
take something that is really unproven, basically mathematical 
formulas, and try to level set it as it relates to a capital 
charge. We think the aspect of regulators understanding an 
organization and its activities well goes a long way to 
answering the operational risk aspect. Disclosures, we think, 
just continue to add to the transparency that has been 
discussed. So we would be very much of a like mind with 
yourself.
    Mrs. Maloney. I would like all the panelists to answer if 
they would. What would your position be on moving operational 
risk to Pillar 2 and disclosure under Pillar 3?
    Mr. Gilbert. Thank you. As I mentioned in my testimony, I 
think if you had a Pillar 2 approach to operational risk, you 
can imagine your supervisor coming to you and saying, ``Okay, 
we are here to discuss how you handle operational risk and 
whether you adequately address it in your risk measurement and 
capital systems. So please now show us the data that you have 
collected that helps us understand how you have adequately 
addressed this particular issue.''
    That is the same exercise, essentially, that you would go 
through to have a Pillar 1 capital charge. In fact, if you did 
that across the board, subject to standards that are broadly 
agreed in the industry as part of Pillar 1, you would have a 
much more consistent framework than a bilateral discussion that 
would not only go on here but across the world for banks that 
we actively compete with across a wide range of businesses. So 
we just think it improves the transparency to make that a 
Pillar 1 charge.
    In terms of the point about unproven, I think we and other 
banks have been doing operational risk internal capital for 
some time. We think it is working quite effectively, and so we 
would challenge the idea that it is unproven.
    Mrs. Maloney. Sir?
    Mr. Dewhirst. My comments are very similar. First, on the 
consistency and transparency point, I think it is evident that 
you would have more consistency and better transparency with 
models that are publicly discussed and used----
    Mrs. Maloney. But why would it be more transparency? Why 
would it be more transparent?
    Mr. Dewhirst. Imagine the situation, as Mr. Gilbert 
suggested, where each regulator at each bank has a somewhat 
idiosyncratic approach to assessing the risks at that bank. The 
constituents who care about risk management at that bank, 
shareholders for example, would not know exactly what 
idiosyncratic standard those regulators were----
    Mrs. Maloney. But if you had it under Pillar 2 and Pillar 
3, which Pillar 3 is just disclosure, wouldn't it be totally 
disclosed? If it is under Pillar 3, it would be totally 
disclosed. Why wouldn't it be transparent if it is required to 
be disclosed?
    Mr. Dewhirst. Disclosure is an area where it is difficult 
to achieve a standard which is high enough that everybody 
learns what they--in other words, you have disclosures in a lot 
of other areas that still create confusion, and I think that--
--
    Mrs. Maloney. What if we had a standard for disclosure?
    Mr. Dewhirst. If you have a standard for disclosure that 
really explains how risk is being done in a consistent way 
across the system, you would have to have a methodology that 
was consistent as well.
    Let me just add one other comment on the maturity of the 
process. The comment that operating risk management is so new 
that we can't do it I think is contradicted by the fact that 
the insurance industry has been looking at these kinds of risks 
and analyzing them in a very statistical way and projecting 
losses for many, many decades. And what we are really talking 
about is just an extension of many of those same techniques.
    Mrs. Maloney. I would feel that it would be better to move 
the operational risk to Pillar 2, the abstract nature of 
operational risk. I believe a capital charge would not have any 
significance towards operational risk, and I would not want to 
see a capital charge for operational risk. I would rather have 
it be disclosed or have regulators discuss it as they do 
currently.
    Ms. Jansky. I believe that we need to consider the fact 
that it would take some time to develop for a lot of 
institutions, perhaps not all of those that are at the table 
today, but for a number of us to go back and develop all of the 
information that is necessary and to develop that over long 
periods of time to really build the models that support 
operational risk at our institutional level. Our big concern is 
it is going to take quite a bit of time, so we would support 
moving to Pillar 2.
    Mr. Alix. I think our firm and the firms I am speaking on 
behalf of in theory agree with the idea of a Pillar 1 
requirement and in theory agree that there ought to be capital 
set aside for failures of people, processes and systems. Those 
failures are inevitably going to happen, and there ought to be, 
as we do a better job in the Basel II Accord, a much better 
process of measuring and isolating the unique market and 
credits risks, which for the most part create a reduction in 
capital requirements. To have an isolation of capital for 
operational risks would be, in theory, a good thing.
    In practice, it is very difficult, and while some 
institutions have made some significant progress, we, in 
looking at some of the methodologies that are out there, are 
somewhat skeptical of their applicability to our firms. And so 
we would like to ensure that if we continue along the path of 
having a Pillar 1 capital charge for operational risk, that it 
be sensitive to the unique operational risks that our firms 
wear and not try to apply a one-size-fits-all approach.
    Mrs. Maloney. My time has expired--unless you had a point 
to make.
    Mr. Gilbert. I just wanted to make one additional comment 
if I could. Basel II is a package that includes judgments to 
credit and operational risk charge. If we were to remove the 
operational risk component from Pillar 1 without knowing in 
great detail, my sense is that the supervisors would feel 
compelled to recalibrate the rest of the remaining Pillar 1 and 
capital framework, and that is market risk and credit risk in 
particular.
    And I think that the law of unintended consequences would 
take over, because you would force them to kind of recalibrate 
in a way that would move the credit risk charge in particular 
away from the underlying dimensions of risk, and that would be 
unfortunate, because what we are trying to do in Basel II, in 
the first instance, is link those risks more closely.
    Mrs. Maloney. Could I do a brief follow-up question on this 
just to try to clarify it from the statement and Mr. Gilbert 
and Mr. Dewhirst? Basically, are you saying that because we 
have several financial regulators, that we would not be able to 
achieve consistency or transparency through supervision? Is 
that your point? Could you clarify a little more?
    Mr. Gilbert and Mr. Dewhirst, from your comments.
    Mr. Gilbert. It is not just that we have several regulators 
in the United States. We have regulators all across the world, 
and so absent some very clear standards which are the core of 
Pillar 1, because Pillar 1 isn't just a formula in which you 
calculate a capital requirement but rather it comes with 
operational standards that the supervisors expect the banks to 
adhere to.
    Without the consistency that is associated with those 
standards as well as the calculation itself, what you end up 
having through Pillar 2 is really a whole series of bilateral 
discussions across--in our case, across 50 countries that 
becomes unworkable and in inevitably will be inconsistent and 
not transparent. And, therefore, we would be concerned about 
something like that in the Pillar 2 framework, and the Pillar 1 
framework makes that much more explicit.
    Mrs. Maloney. Thank you.
    Mr. Dewhirst. And I would just add that even if you imagine 
a world where there were one regulator, you have different 
examiners in charge of exams at various institutions, and there 
is variability among the set of standards that they apply, 
which is inevitable because they are people.
    To the extent that you have a uniform approach that they 
are attempting to adhere to, you minimize that, and 
specifically you see a regulator issue a set of guidelines for 
how they examine a particular risk. If you don't have 
uniformity, then you risk a lack of consistency.
    Mrs. Maloney. Thank you for that clarification, and thank 
you for the time, Mr. Chairman.
    Chairman Bachus. Thank you.
    Ms. Jansky, in your testimony, you mentioned the arbitrary 
minimum capital standards that have been set for commercial 
real estate lending.
    Ms. Jansky. Yes, sir.
    Chairman Bachus. Why do you think that our U.S. regulators 
agreed to these arbitrary capital lending minimums?
    Ms. Jansky. I could only guess about that, sir, but I would 
say that I think that a great deal of work apparently had been 
done, and they were looking back in time and looking at asset 
correlations and asset performance over the last two or three 
cycles. My concern with that is there are a lot of other 
factors that have to be taken into consideration. There were 
lots of reasons for the different cycles that we went through.
    There has been lots of change since those, particularly the 
last commercial real estate cycle, as it relates to both the 
introduction of FDICA but also it relates to the elimination of 
the tax incentives that existed back in the 1988 era when we 
had so much oversupply of product that was built, not because 
of demand in the marketplace but frankly because of tax 
incentives.
    We have asked a lot of questions. We have asked for 
empirical evidence, we have asked to see support, and we 
frankly have just yet to see anything that we find that leads 
us to that same conclusion.
    Chairman Bachus. Do you think they could be more concerned 
about maybe risk management in Europe as opposed to here?
    Ms. Jansky. I can't answer that question, sir, I don't 
know.
    Chairman Bachus. Okay. But you have pretty clearly 
testified that you believe it will have a negative effect on 
commercial real estate lending in the United States?
    Ms. Jansky. I believe it can have a negative impact in 
certain products as we begin to rationalize and begin to work 
towards an efficient utilization of capital, those products 
that require higher capital, if you cannot get the right price 
in the market or the price tends to be higher than perhaps non-
financial institutions providing that product, I do think we 
will see it become an issue for certain markets. Yes, sir, I 
do.
    Chairman Bachus. And if the capital charges for certain 
acquisitions and development and construction loans remain as 
drafted, will SouthTrust--or SunTrust----
    Ms. Jansky. I don't think SouthTrust is worried about it.
    Chairman Bachus. New Wachovia, right?
    [Laughter.]
    Will SunTrust and other institutions, you think, be--I will 
just say SunTrust--be forced to make fewer loans?
    Ms. Jansky. I wouldn't say today, because I really think it 
is too early to say that, that we would be forced to make fewer 
loans, but I would say that that line of business, as all of 
our lines of business, as we assess the capital required to run 
our total operation as we get more efficient there, we will 
look at the capital allocation for that line of business, and 
it may force them to reconsider what their targets are in the 
market.
    Chairman Bachus. Okay. I will ask this question of all 
witnesses. There have been significant innovations in 
commercial real estate risk assessment that have been employed 
in the last 10 years, and I think, Ms. Jansky, you mentioned 
that. Do you believe that acquisition development and 
construction lending has gotten more or less risky over the 
past 10 years?
    First of all, I will ask--just start with you, Mr. Elliott. 
Do you think it is more risky or less risky?
    Mr. Elliott. The perspective that we have is that we, in 
essence, are not in that line of business, so mine would be a 
little bit more as an outside observer. I think an outside 
observer's perspective would be that I think people understand 
the risks a lot more, they have monitored the risks a lot 
better than what they would have historically, and people have 
built their loan portfolios in a much more diverse manner so 
that to the extent they do have any issues inside the 
portfolio, they are able to handle them from a financial 
perspective.
    Chairman Bachus. Does Mellon do residential lending?
    Mr. Elliott. Very selectively for high networth 
individuals, yes.
    Chairman Bachus. Okay. Do you think that that has become 
less or more risky?
    Mr. Elliott. I think it has become less risky because the 
way that we do it. We have very low loan-to-value type ratios 
associated with it, and we typically have other collateral 
associated with those loans in addition to the property.
    Chairman Bachus. But you all just aren't in that market 
that much.
    Mr. Elliott. We are not a significant player, no.
    Chairman Bachus. How about, Mr. Gilbert, JPMorgan Chase and 
I guess Bank One now?
    Mr. Gilbert. Yes. Thank you. My new partners at Bank One I 
think are more engaged in the real estate lending business than 
we have been at JPMorgan Chase, but I think I would agree with 
Mr. Elliott on the comments about the relative riskiness. But, 
of course, the thing to keep in mind is that relative risk in 
this type of activity is also a function of the State of the 
economy, and we have generally had a benign economic 
environment, certainly for in the nineties. We had some 
problems early, of course, in this decade, but you can see that 
it is a lot--that the economic environment on the whole is a 
lot better than, say, the previous decade.
    And I think if you take a long historical view, I think, as 
the Fed has published in its study on real estate, you find 
that this is not a riskless activity by any means, but you can 
make relative risk statements about various points in time, but 
I think what is most prudent to do is take the longest possible 
historical view.
    Chairman Bachus. Okay.
    Mr. Dewhirst?
    Mr. Dewhirst. My answer is colored mainly by my experience 
in New England and history at Fleet there. New England went 
through a very traumatic period in the real estate market in 
the nineties. I think that taught people some lessons about 
mismanagement and underwriting, and so I would say that market 
has become much less risky over time. And I would also echo Mr. 
Gilbert's comments that the business cycle seems to be becoming 
less volatile, and that helps credit risk in general, including 
both commercial and residential real estate.
    Chairman Bachus. Ms. Marinangel?
    Ms. Marinangel. I agree that the acquisition development 
and construction lending have become less risky. Being in the 
Midwest, that is generally a stronger economy, and because of 
the interest rate cycles as well, I believe that it has become 
less risky. Hopefully, it will stay that way, but when you have 
good business environment, generally it is less risky.
    Chairman Bachus. All right.
    And Ms. Jansky, you have already testified that it has 
become less risky, I believe, both residential and commercial, 
in your opinion?
    Ms. Jansky. Yes, sir. I would just comment that I believe 
that we have had a lot that is happened over the last 10 years 
and the advancement of risk management practices in our 
industry. I also believe there is a great deal more 
transparency in the commercial real estate market. I also 
believe that real estate developers have had a much more 
consistent approach to market and have been somewhat more 
conservative than I observed over the last 25 years in the 
business.
    Having said that, I am not sitting here today and saying 
that there won't ever be additional real estate problems 
because there will, but I believe that the industry has done a 
very, very good job, and I believe a lot of regulation in 
certain areas, but at the time we would have been careful but 
now it looks to me like we are very prudent and it has helped 
us to make sure that we are managing that risk. And I think the 
industry as a whole is managing it much better.
    We also have to remember that we have had some very high 
vacancy factors across the country in different markets. We 
have had lots and lots of new starts that have been pulled from 
the market, but we have been in an incredibly low interest rate 
environment. So you have to balance all of that as you look at 
the relative risk. But we feel very comfortable with it, and we 
just want to see a lot more documentation and more of a forward 
thinking about the risks associated with commercial real 
estate.
    Chairman Bachus. Mr. Alix, Bear Stearns is not really in 
that market.
    Mr. Alix. I would suggest that we are but in a very 
different way than the other panelists. One of the things that 
hasn't been mentioned I think as a positive in commercial real 
estate lending has been the enormous development of a robust 
capital market for securitized commercial real estate loans.
    And our firm, as well as others in the industry, have a 
very active business in originating and purchasing loans from 
other originators, packaging those loans in large and diverse 
packages--diverse by geography, diverse by property type, et 
cetera--and selling pieces of those securitizations to 
institutional investors.
    That has diversified the ultimate holders of the risk and 
has ensured that if there were a problem, another problem in 
commercial real estate lending, the pain would be distributed a 
little bit differently than it was the last time around. So I 
think that is a very positive development.
    I also believe that this is an area where our argument for 
trading book treatment is crucial, because these are loans that 
if we applied banking book, which the other witnesses argue is 
extremely conservative, if we apply banking book capital 
charges to our commercial real estate loans held for 
securitization, it would have a very detrimental effect on the 
regulatory capital charge.
    Chairman Bachus. All right. Thank you. You know, I will say 
we are going to hold a hearing tomorrow on non-prime lending, 
and I am sure we will touch on securitization in that lending 
is somewhat threatened by some liability questions, as you 
know.
    I will say this--I am going to yield to Mr. Frank for as 
much time as he may consume. Before I do that, I do want to 
say--I want to offer one cautionary note that I have as far as 
the residential real estate lending market, and that is we have 
been in a historic period, I would say, for the past several 
years of low interest rates where people that weren't able to 
afford mortgages before because of low interest rates were--
many of those residential mortgages are adjustable rate 
mortgages.
    And I am not sure that if we have rising interest rates out 
of a very low interest rate, residential mortgages and 
adjustable rate mortgages as opposed to fixed rate mortgages, I 
am not sure what kind of stress that will put on the market. I 
am not sure that we--I am sure you all factored some of that 
in. Anybody want to comment on that? Is that a concern?
    Mr. Alix. I would suggest, as a firm that has a significant 
mortgage capital markets business, that prudent risk management 
would compel us to do sensitivity analysis and stress analysis 
for the sort of scenario that you are describing. And one 
observation would be that the market seems to have absorbed the 
increase in volatility and interest rates in the mortgage 
markets quite well, but time will tell as to whether the 
ultimate home value and delinquency rates are affected by a 
materially higher interest rate environment.
    Chairman Bachus. All right.
    Mr. Dewhirst?
    Mr. Dewhirst. Well, certainly, it is a concern, and it is 
one that we have looked at for many years. When you get burned 
once in a particular area, you tend to focus on that for the 
rest of your life. The one caveat I would put around the growth 
in the ARMs market is that many of the most popular ARM loans 
have a fixed period that is quite long in the front. So I just 
bought a house myself in Charlotte, preparing to move down 
there, and it is not only an ARM but there is 10 years of fixed 
rate in front of it.
    So I think there is a possibility that in just looking at 
aggregate ARM numbers, we can exaggerate the exposure. Many of 
the people that have 5-, 7-, 10-year ARMs will have moved or 
refinanced by the time that those fixed rate periods end.
    Chairman Bachus. That is a good point. I am not sure I was 
considering that.
    Mr. Frank?
    Mr. Frank. I want to return to the question of incentive, 
et cetera, and I would say I agree with Mr. Dewhirst. I have 
advanced the argument that you can't do the operational risk 
capital charge because we don't know how to measure it, but it 
does seem to me that acknowledging that they have made 
significant progress in measuring it cuts the other way as 
well. That is, I understand the importance of some uniformity 
and standards and the problems of inconsistent application.
    I don't understand what a capital charge adds to that. That 
is, why can't you do all those things you were talking about, 
promulgating uniform standards, et cetera, under a management 
approach? What does promulgating a number, a capital charge, 
add to that administrative procedure, because I agree with 
everything else you have talked about.
    The second point I would have is this: You said that the 
incentive works this way, which is logically straightforward as 
you say it. Once there is a capital charge, you would get an 
incentive to improve your procedures because that way your 
capital charge could be lowered. But the people who would 
decide to lower the capital charge are the people who are 
checking. I don't understand why you would still have the same 
group of people monitoring your procedures.
    Now, without a capital charge, they are monitoring your 
procedures and passing on their adequacy. With a capital 
charge, they are monitoring your procedures and passing on 
their adequacy so they can reduce the capital charge. I 
literally don't understand how a capital charge adds to the 
transparency, the rationality. All those things could be done, 
it seems to me, by administrative regulation and requirement 
without a capital charge.
    So, particularly, for Mr. Gilbert, I guess, and Mr. 
Dewhirst. I would be interested in your responses.
    Mr. Dewhirst. Let me make two--well, a comment and ask a 
question, sort of turn it around and maybe I can get clarity on 
what your concerns are.
    Banks already hold capital. There is implicitly a capital 
charge for operating risk. If large losses occur because of 
operating risk losses, the shareholder pays.
    Mr. Frank. Mr. Dewhirst, I understand that, but that is not 
answering my question.
    Mr. Dewhirst. Well, then let me try to understand it by 
asking this.
    Mr. Frank. Go ahead.
    Mr. Dewhirst. We insist on a certain approach to credit 
risk. We say there ought to be a methodology for deciding how 
much risk there is in the assets we have, what the possibility 
is of unexpected losses occurring in those assets, and we ought 
to have capital that is scaled to that. What is different about 
operating risk?
    Mr. Frank. Well, I think there are some differences in 
terms of what you are dealing with. Loan losses are expected, 
but I do want to go back to your question. I have to say this: 
When you don't want to answer my question but want to ask me 
one in return, it suggests to me you haven't thought of the 
answer yet. I will take it in writing later.
    But you were saying that a capital charge deals with the 
following problems. First of all, it deals with the problem of 
inconsistent regulators. Was I correct in hearing you that way, 
that you said that one of the problems that leads you to be for 
capital charge is the difference and inconsistency among 
regulators; is that correct?
    Mr. Dewhirst. A capital charge under the advanced approach. 
We could do that.
    Mr. Frank. Yes. Right. And that is a way to get around--to 
diminish the problem of inconsistent regulators. It would 
increase transparency. You would have one set of standards. My 
question to you is why can't you accomplish all of that by 
regulation and by promulgations without a capital charge and 
don't in fact even if you have a capital charge, you still need 
to get them together and do that.
    I think that what you are saying is, well, only if there is 
a capital charge--the capital charge in and of itself doesn't 
do any of that. The capital charge does not homogenize or 
regularize or get uniform. You still have the individual basis. 
Why is the capital charge necessary to achieve all those other 
things which I think we ought to achieve?
    Mr. Dewhirst. You may be able to achieve consistency and 
transparency without the capital charge.
    Mr. Frank. No, that is not my question. My question is what 
does the capital charge add to it?
    Mr. Dewhirst. I understand. What it adds is what capital 
adds for every other risk, which is a cushion against loss.
    Mr. Frank. Okay. Then that is a different question, I 
understand that. And that is what I was asking my question, but 
that is a different justification than the one you gave. That 
is fine.
    Mr. Dewhirst. It was----
    Mr. Frank. Excuse me, I am going to finish. I have to be 
honest with you, even if you weren't moving out of my district, 
I would still interrupt you. You are moving to Charlotte, so I 
don't mean to--I do that with people.
    Mr. Dewhirst. Not before the next election.
    Mr. Frank. Weak opposition this time. It is not a problem.
    [Laughter.]
    But here is the point. Here is the point: If you had said 
that originally, we wouldn't be having this discussion. I 
understand that argument that a capital charge is there to 
provide money to make up for the risk, but in addition to that, 
and I really think you have to deconstruct all these arguments, 
there is an argument that a capital charge incentivizes you, et 
cetera.
    In other words, one argument for capital charge is that it 
diminishes the likelihood that there will be risk which the 
capital will be used to fill up, and the argument that you need 
a capital charge to deal with losses, I understand. I would 
have dealt with that earlier if we had gotten to it earlier. 
The argument that a capital charge improves the quality of 
regulations somehow increases transparency and deals with the 
problem of inconsistent regulation, I am unpersuaded.
    Mr. Dewhirst. Let me make a distinction. Again, it is based 
on my analogy to the credit risk capital framework. Under Basel 
I, all commercial loans were 100 percent risk weight. Not all 
commercial loans have the same amount of risk. The capital 
charge did not do anything for transparency or did not do much 
for transparency. It did a lot for consistency but not a lot 
for transparency. It certainly didn't tell the shareholder or 
the debt holder in a particular bank whether the loans were 
extremely risky or not.
    The advanced approach goes to a very different standard 
where the capital assigned is going to be proportional to the 
risk assessed, based on estimates of probability of default, 
loss if default occurs, exposure and so on. Under that system, 
there would be an incentive--the capital charge would create an 
incentive for better risk management, because to the extent 
that you could reduce probability of default or loss given 
defaults, you would have a lower capital charge. Now, if we 
can----
    Mr. Frank. But you have a lower capital charge only if the 
regulator examined your procedures and felt that you had 
achieved increased efficiency and therefore you were entitled 
to a lower capital charge.
    Mr. Dewhirst. Yes.
    Mr. Frank. And my question to you is why can't we have the 
regulator do that without the capital charge? In other words, 
in each case--excuse me, I want to finish this--in each case, 
we are relying on the regulator's analysis of what you have 
done and the regulator having analyzed what you have done says, 
``Oh, you did a pretty good job.'' Well, why can't we give the 
regulator the power to enforce that? Why does he need the 
ability to reduce the capital charge to have the ability to do 
that?
    Mr. Dewhirst. If you again go to the credit example, with 
100 percent risk weights for all commercial loans, the 
regulator comes in----
    Mr. Frank. Well, you are going back and forth with the 
credit example. The credit example is sometimes relevant and 
sometimes isn't. If you can't answer it in terms of the 
operational risk, then I am skeptical.
    Mr. Dewhirst. The analogy to operating risk would be 
exactly----
    Mr. Frank. Well, explain to me then why does the regulator 
need a capital charge to be able to look at those procedures, 
evaluate them and pass judgment on them?
    Mr. Dewhirst. They don't, but then what happens?
    Mr. Frank. Okay.
    Mr. Dewhirst. In order for there to be an incentive--I mean 
there could be banks that are extremely well capitalized, very 
well capitalized, marginally well capitalized that a regulator 
would come in and--I mean a regulator just wants to have a 
certain level of capital so they can ensure the safety and 
soundness.
    Mr. Frank. I didn't say that. That is the loss to me. That 
is a separate argument, and I would like to return to the one 
we are talking about. It is very important to sort them out.
    Mr. Dewhirst. I am sorry, say that again.
    Mr. Frank. That is the loss provision, to make up for 
losses, but that is a separate one from the--I mean I did 
notice you said it didn't add to transparency. I mean I am 
trying to understand what it is over and above capital to make 
up for losses that makes it important to have a capital charge. 
I don't understand how it adds to transparency, how it adds to 
the incentive, how it--I mean you still haven't gotten to me on 
that.
    Mr. Dewhirst. Under the current system, I would say 
transparency is minimal because--and I am going to the lending 
approach because what is happening now is the regulators are 
trying to make the operating risk approach more like the 
lending approach. But under the current lending approach, 100 
percent risk weight for all commercial loans, it is very hard 
for anybody to know what is going on, because it is 100 percent 
for every kind of loan. You don't get detail.
    If the system went to the advanced approach and capital 
were allocated by risk, then you would know both from the 
process and probably from the disclosures that banks that had 
more capital for credit risk had more risk.
    Now, if you did the same thing under the operating risk 
framework, you could have two different approaches. One 
approach would just be all banks or all financial institutions 
have a certain level of risk. One of the early Pillar 2 
approaches said operating risks in proportion to revenue.
    Mr. Frank. That is a strawman, nobody said that. But it is 
a strawman, it doesn't help us to throw it in here.
    Mr. Dewhirst. But it is very similar to----
    Mr. Frank. No, it isn't. What we are talking about is--we 
have agreed that there needs to be--and I am going to end this 
now because we are not getting anywhere--we need--yes, we want 
to have a system whereby the regulators look at things 
individually and at the same time you want both individuality 
and uniformity. You want regulators looking institution by 
institution, but you want regulators with each institution to 
have a somewhat similar approach. I agree with that. I just 
don't understand how at the end--beginning or ending with a 
capital charge in any way makes that likelier or easier to 
accomplish.
    That is all, Mr. Chairman. We are going to end where we 
began.
    Chairman Bachus. Thank you. I am going to go ahead now and 
ask a question, and then Ms. Maloney will wrap up, but at least 
you have some----
    Mr. Frank. I am going to lunch, Mr. Chairman. I am going to 
go have lunch.
    Chairman Bachus. We are all going to lunch pretty quick 
here, including some students over here.
    I have one question. It is actually for Mr. Alix, it is 
something you raised in your testimony. This spring we heard 
testimony from the U.S. and European government officials 
regarding the consolidated supervision issue. You talked about 
your concerns there. Last week, the International Subcommittee 
heard testimony from the U.S. financial sector regarding this 
issue as well. The securities industry in particular has now 
asked the committee I think for two weeks in a row to keep a 
close eye on the implementation of the commission's 
consolidated supervision directive.
    So my question is this: What should members of this 
committee do in monitoring this situation?
    Mr. Alix. Well, first, I would say, as I said in the 
testimony, that we believe it should be unambiguous. There is 
no doubt that the SEC's form of supervision, which is embodied 
in the consolidated supervised entities rule, is first rate, 
world class, equivalent to the best supervisory programs around 
the world for financial institutions. And I think that the best 
thing that the people in this room and elsewhere in this city 
can do is to push the European representatives to abide by 
their deadlines in making that determination.
    And if that determination is made, for instance, in the 
next few weeks, I think that will enable U.S. investment banks 
to get on with the business of making their applications and 
getting the exams done and putting themselves in a position 
without undue cost or burden to meet the requirements that the 
SEC has put forward. If there is a delay, that could be very 
damaging, both from the perspective of having to do more in 
less time as well as from the perspective of having the 
commission distracted by that particular issue still being 
open.
    So we want it to be unequivocal, clear and final as soon as 
possible, and anything you can do to make that concern known to 
the appropriate people would be appreciated.
    Chairman Bachus. What if the European Commission and I 
guess the parliament can't conclude or finalize their work and 
make the necessary determinations in a timely manner? What 
could the Financial Services Committee do about this 
internally?
    Mr. Alix. Well, first of all, I don't think the equivalence 
judgment is a matter for the European parliament. I think that 
has been delegated to each firm's respective regulator of their 
principal activities in Europe. And so that is a matter for the 
regulatory agencies in Europe. To be honest, I think it is not 
something that we contemplate.
    As I said, it is so obvious to us that it is something that 
we believe ought to be done right away. Were that not to 
happen, I think that would be sufficiently serious that it 
would inspire very high level across-Atlantic conversations 
about the implications, and I think that for our firms the 
prospect of having our operations ring fenced in Europe and not 
being able to enjoy the benefit of global franchises would make 
it very difficult to compete in some of our core businesses in 
Europe. And I think that would be very detrimental.
    So, as I said, I would like not to contemplate a 
significantly longer delay or a decline of equivalence status, 
but if that were to happen, we would be very, very concerned.
    Chairman Bachus. I would ask all of you if your firms or 
your corporations have researched whether the regulators in the 
various countries have the legal authority to share supervisory 
information or oversight responsibilities, possibly join 
together in enforcement actions across borders?
    Mr. Gilbert. I am not sure we have researched it as such. I 
think in those matters we tend to rely on the supervisors to 
discuss among themselves their ability to share information and 
pursue actions. We, of course, need to abide by the local rules 
that apply to the sharing of information, even within our own 
firm, so there are a lot of rules and requirements out there 
that can vary from country to country. But in terms of the 
ability of the supervisor to share information----
    Chairman Bachus. And really legal authority.
    Mr. Gilbert. Right. We tend to have not looked per se at 
that issue but, again, rely on the bank supervisors themselves 
to determine that.
    Mr. Alix. If I might add, I would agree that it is a 
question better placed with the regulatory authorities here who 
have done the legal research, but it is my understanding that 
the SEC in the case of the investment banks has negotiated 
agreements with the relevant regulatory authorities about the 
protection of private information that they exchange in the 
course of their supervisory activities.
    I think it is kind of interesting because we actually 
support cooperation among regulators to avoid, for instance, 
being asked the same question or being asked for the same 
information by 10 different regulators around the world. We 
would encourage them, where appropriate, to consult with each 
other and share information where it is directly relevant to 
carrying out their activities.
    Chairman Bachus. All right. This concludes our hearing, and 
members will have five legislative days to submit opening 
statements. And the chair notes that some members may have 
additional questions for the panel, which they may wish to 
submit in writing. Without objection, the hearing record will 
be held open for 30 days for members to submit written 
questions of those witnesses and to place their responses in 
the record.
    With that, this hearing is adjourned.
    [Whereupon, at 12:15 p.m., the subcommittee was adjourned.]


                            A P P E N D I X



                             June 22, 2004


[GRAPHIC] [TIFF OMITTED] T6292.001

[GRAPHIC] [TIFF OMITTED] T6292.002

[GRAPHIC] [TIFF OMITTED] T6292.003

[GRAPHIC] [TIFF OMITTED] T6292.004

[GRAPHIC] [TIFF OMITTED] T6292.005

[GRAPHIC] [TIFF OMITTED] T6292.006

[GRAPHIC] [TIFF OMITTED] T6292.007

[GRAPHIC] [TIFF OMITTED] T6292.008

[GRAPHIC] [TIFF OMITTED] T6292.009

[GRAPHIC] [TIFF OMITTED] T6292.010

[GRAPHIC] [TIFF OMITTED] T6292.011

[GRAPHIC] [TIFF OMITTED] T6292.012

[GRAPHIC] [TIFF OMITTED] T6292.013

[GRAPHIC] [TIFF OMITTED] T6292.014

[GRAPHIC] [TIFF OMITTED] T6292.015

[GRAPHIC] [TIFF OMITTED] T6292.016

[GRAPHIC] [TIFF OMITTED] T6292.017

[GRAPHIC] [TIFF OMITTED] T6292.018

[GRAPHIC] [TIFF OMITTED] T6292.019

[GRAPHIC] [TIFF OMITTED] T6292.020

[GRAPHIC] [TIFF OMITTED] T6292.021

[GRAPHIC] [TIFF OMITTED] T6292.022

[GRAPHIC] [TIFF OMITTED] T6292.023

[GRAPHIC] [TIFF OMITTED] T6292.024

[GRAPHIC] [TIFF OMITTED] T6292.025

[GRAPHIC] [TIFF OMITTED] T6292.026

[GRAPHIC] [TIFF OMITTED] T6292.027

[GRAPHIC] [TIFF OMITTED] T6292.028

[GRAPHIC] [TIFF OMITTED] T6292.029

[GRAPHIC] [TIFF OMITTED] T6292.030

[GRAPHIC] [TIFF OMITTED] T6292.031

[GRAPHIC] [TIFF OMITTED] T6292.032

[GRAPHIC] [TIFF OMITTED] T6292.033

[GRAPHIC] [TIFF OMITTED] T6292.034

[GRAPHIC] [TIFF OMITTED] T6292.035

[GRAPHIC] [TIFF OMITTED] T6292.036

[GRAPHIC] [TIFF OMITTED] T6292.037

[GRAPHIC] [TIFF OMITTED] T6292.038

[GRAPHIC] [TIFF OMITTED] T6292.039

[GRAPHIC] [TIFF OMITTED] T6292.040

[GRAPHIC] [TIFF OMITTED] T6292.041

[GRAPHIC] [TIFF OMITTED] T6292.042

[GRAPHIC] [TIFF OMITTED] T6292.043

[GRAPHIC] [TIFF OMITTED] T6292.044

[GRAPHIC] [TIFF OMITTED] T6292.045

[GRAPHIC] [TIFF OMITTED] T6292.046

[GRAPHIC] [TIFF OMITTED] T6292.047

[GRAPHIC] [TIFF OMITTED] T6292.048

[GRAPHIC] [TIFF OMITTED] T6292.049

[GRAPHIC] [TIFF OMITTED] T6292.050

[GRAPHIC] [TIFF OMITTED] T6292.051

[GRAPHIC] [TIFF OMITTED] T6292.052

[GRAPHIC] [TIFF OMITTED] T6292.053

[GRAPHIC] [TIFF OMITTED] T6292.054

[GRAPHIC] [TIFF OMITTED] T6292.055

[GRAPHIC] [TIFF OMITTED] T6292.056

