“The U.S. leverage ratio doesn’t capture off-balance-sheet risks,” said Bair, now chairman of the Systemic Risk Council, a private regulatory watchdog. “Once U.S. banks start publishing the new Basel-mandated ratios, more off-balance-sheet assets will become obvious.”
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Bair said she favors raising the simple capital ratio as high as 8 percent. Hoenig, the FDIC vice chairman, has called for 10 percent. U.S. regulators are still debating how to implement the rules. Because Basel isn’t an international treaty, each country needs to adopt its own version.
Still, the European Union is balking at implementing the capital rule based on total assets. It’s considering delaying when EU banks have to begin reporting the ratio using the methodology and hasn’t decided whether to make it binding.
The first Basel rules were agreed to in 1988 in an effort to converge global banking regulations. Fourteen years later, U.S. and international rule-setters signed what is known as the Norwalk Agreement, named after the Connecticut town where the U.S. accounting board is based, pledging to work together to “make their existing financial reporting standards fully compatible as soon as is practicable.”
Behind the initial push were Sir David Tweedie, the first chairman of the International Accounting Standards Board; Harvey Pitt, who headed the U.S. Securities and Exchange Commission at the time; and Paul Volcker, the former Federal Reserve chairman instrumental in the group’s formation.
Progress on common standards slowed after Mary Schapiro became SEC chairman in 2009 and faced lobbying by companies opposed to what they said would be costly accounting changes, according to four people with knowledge of the discussions who asked not to be identified because the talks were private.
“I’ve always supported working toward convergence, and we pushed FASB and IASB hard to reach satisfactory agreements,” Schapiro, who left the SEC in December, said in an interview. “But I wasn’t keen on dropping the U.S. accounting standard and adopting the international one before those differences were significantly narrowed.”
In 2011, the U.S. accounting board came close to moving in Europe’s direction on derivatives netting. There was pushback from the largest U.S. banks, according to a person familiar with the talks. Lenders argued that gross values overstate actual positions because parties often make opposite bets rather than tear up existing contracts. The board dropped the plan.
Tweedie, a former chairman of the U.K.’s accounting board, failed to win the support of France and Germany for convergence, according to the people familiar with those discussions. While European banks have long favored the U.S. approach to netting derivatives, they haven’t pushed for change because it wouldn’t have an impact on income statements or capital requirements, which are based on risk-weighting of assets, according to Andrew Spooner, a London-based partner at Deloitte LLP.
“When it’s about the size of the balance sheet only, and not a profit-loss issue, it’s not as crucial for firms,” Spooner said.
Fannie and Freddie
New disclosure requirements for U.S. and European banks on how they net derivatives that take effect this year will make comparisons easier, Spooner said. The biggest U.S. banks already are reporting more details in the footnotes of quarterly financial statements, making it possible to calculate their derivatives assets under international standards.
There isn’t as much uniformity in disclosures of off- balance-sheet assets. JPMorgan’s securitizations of home loans backed by Fannie Mae and Freddie Mac were estimated by using the figure for mortgages the bank services and the average ratio of servicing to off-balance-sheet assets at other lenders.
U.S. rule-setters have done more than their international counterparts to force banks to consolidate securitization vehicles. Still, there was little debate about whether lenders should include loans sold to Fannie Mae and Freddie Mac.
Before the financial crisis, the government-backed firms didn’t include mortgage bonds created from those loans on their balance sheets either. After collapsing under the weight of losses and being taken over by the government, both Fannie Mae and Freddie Mac started consolidating the securities. They also tried to recover losses from banks that sold them badly underwritten home loans.
Lenders have said improved control mechanisms for loans they originate and transfer to Fannie Mae and Freddie Mac for packaging into mortgage bonds obviate the need to consolidate or set aside reserves for future repurchases. That optimism isn’t shared by Esther Mills, president of Accounting Policy Plus, a New York-based consulting firm.
“There was clearly a failure by certain institutions to appropriately assess the liabilities before the crisis,” said Mills, a former Morgan Stanley and Merrill Lynch & Co. accounting executive. “Are there enough liabilities going forward for the billions of mortgages being transferred?”
In the first nine months of last year, San Francisco-based Wells Fargo transferred $398 billion of mortgages to residential-mortgage securitizations guaranteed by Fannie Mae and Freddie Mac.
The bank recorded a $209 million liability for “probable repurchase losses,” according to its latest quarterly filing. It has faced more than $12 billion of buyback demands from the government-backed firms for crisis loans.
“There are probably some dangerous things left off the balance sheet still, and we’ll only find out what in the next crisis,” said David Sherman, an accounting professor at Northeastern University in Boston. “But how many times do we have to go through this to figure it all out?”
After failing to agree on common standards for derivatives netting and consolidation of securitizations, rule-setters are now heading in different directions as they debate how to account for loan-loss reserves.
The U.S. accounting board proposed after the financial crisis that banks mark all loans and debt securities to market values, not just those held short-term. The board abandoned the plan after lobbying by banks, which would have had to recognize losses, according to a person familiar with the deliberations.
A new U.S. proposal that would require banks to record expected losses over the lifetime of a loan has met with similar opposition. The plan would force lenders to set aside higher reserves upfront, leading to lower profits than European peers, Sherman estimates.
Under current accounting rules on both sides of the Atlantic, only incurred losses need to be reported. The international board is considering a change that would require banks to reserve for losses expected over a 12-month period.
While both the U.S. and international proposals probably would result in higher loan-loss reserves, they might not prevent lenders from being too late recognizing losses, as they were in the past, according to Jamie Mayer, a bank-accounting analyst at Grant Thornton LLP in Chicago.
“If their risk models don’t show any problems, and they didn’t before 2008, it’s unclear how solely changing the accounting would solve concerns,” Mayer said in an interview.
In a January survey of 70 banks around the world conducted by auditing firm Deloitte, 88 percent of respondents said they don’t expect convergence on accounting rules most relevant to lenders, including derivatives, balance-sheet consolidation and how to reserve for loan losses.
Leslie Seidman, chairman of the U.S. accounting board, and Hans Hoogervorst, head of the international panel, both said at a conference in New York last month that they hadn’t given up.
“I still hope for one standard,” Hoogervorst said. “But at times it’s easy to be discouraged.”