FDIC's McKernan criticizes Basel's final plan, expresses concern for long-term debt

FDIC board member Jonathan McKernan has raised concerns about a proposal to implement Basel endgame standards, stating that it could lead to overcapitalization of banks, potentially lock in regional banks' existing structures, or incentivize consolidation.

Speaking at an event held by law firm Mayer Brown in New York City, McKernan emphasized the importance of giving reasons for proposals and being accountable for them. He hopes that commenters will point out any gaps and suggest solutions.

One of the key issues McKernan addressed is the profit-and-loss attribution test, a framework used by banks to evaluate alignment between their risk management and front office models. The quantitative thresholds defining this framework significantly impact market risk capital requirements. However, there is little information in the public domain regarding how the Basel Committee determined these threshold levels.

McKernan also raised concerns about the proposal for banks to hold long-term debt. Under the proposed regulation, regional banks and certain foreign banking organizations would need to issue debt from both the top-tier parent company and the bank subsidiary, while U.S. G-SIBs only need to issue it from the parent company. This divergent approach may result in regional banks having less flexibility than U.S. G-SIBs to pre-position resources throughout the banking organization, potentially leading to decreased flexibility and greater challenges in crafting resolution plans.

The Basel Committee itself acknowledged that its approach to operational-risk capital could lead to overcapitalization, but omitted a proposed solution from the final standards without explanation. McKernan argues that this could lead to increased prescriptive regulation and the shifting of responsible risk-taking out of the banking system.

McKernan believes that bank failures, even large ones, are an inevitable result of a dynamic and innovative economy. Instead of solely trying to preemptively avert bank failures, he suggests that the FDIC should focus on ensuring the orderly resolution of troubled banks.

In his speech, McKernan did not mention any information about purchasing licensing rights in the context of the discussion. He encouraged commenters to evaluate the risk of the proposal and share their views on how to fix any gaps, including the possibility of developing a U.S. implementation that deviates from the Basel standards in some respects. The Federal Deposit Insurance Corp (FDIC) has proposed implementing the Basel endgame standards, but the rationale behind this proposal is unclear.

The Basel Committee has not provided details on the decision-making basis for defining quantitative thresholds in the traffic light system for market risk capital requirements. Such decisions are typically based on confidential internal assessments and ongoing consultations with member authorities to ensure regulatory consistency and financial stability.

In conclusion, FDIC board member Jonathan McKernan has expressed concerns about the proposed Basel endgame standards, highlighting potential issues such as overcapitalization, decreased flexibility for regional banks, and the shifting of risk-taking out of the banking system. He encourages commenters to evaluate the proposal and suggest solutions to any identified gaps.