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PNC is not doing anything specifically for Basel that it would not have done as part of its prudent risk management efforts, but those efforts dovetail with the requirements of the new Accord, said Shaheen Dil, senior vice president and director of portfolio and operational risk analysis for PNC. She is an RMA board member who represents PNC in RMA's Capital Working Group. The Group has been working closely with U.S. regulators for two years to demonstrate how best-practice institutions in North America use their internal risk-measurement systems to assign economic capital.

She joined William S. Treacy, manager of supervisory issues and special studies of the Federal Reserve Board in Washington, at a recent RMA audioconference to discuss her concerns about the new Accord and how her institution is preparing to meet the new requirements. Her remarks follow.

We are evaluating all of our risk management processes and enhancing those that we believe require enhancements. We're also following the Basel reform process and all the discussion papers very closely so that we will be totally familiar with the new Basel requirements.

In addition to participating in RMA's Capital Working Group, PNC has also written one comment letter to the Basel Committee directly, and we are in the process of drafting another one on the more recent working papers.

We were the first bank to host the Basel joint pilot conducted by the Fed and the OCC. PNC hosted 12 Fed and OCC examiners for a period of 2-1/2 to 3 weeks. Every day for six to seven hours a day, they evaluated PNC's risk management activities on credit, operational risk, market risk, and every risk management activity in light of the Basel requirements. It was an excellent educational experience. We learned a lot about our own risk management activities and what we still need to do to become fully qualified for the advanced processes in Basel.

PNC commends the Basel Committee for it's work towards a more fair and consistent conceptual risk capital framework. Ultimately, linking capital requirements to genuine riskiness in the portfolios of the banking system will help reduce risk in the financial system. The Basel Committee has been very responsive to many of the comments that PNC, trade groups, and other banks have made on the initial consultative paper. The recently issued working papers reflect a great deal of progress made by the Basel Committee relative to both the 1988 Basel Accord and also the earlier published versions of the New Basel Capital Accord.

Five Areas Needing More Work by Basel
We continue to believe, however, that a lot of work remains to be done prior to the 2005 implementation. Specifically, there are five different areas of concern I'd like to address today:

The internal ratings-based or advanced IRB approach on credit risk.
The regulatory treatment of operational risk that was recently released.
Market discipline or disclosure requirements.
Consistency of application of the supervisory review process.
Timing of the implementation of the New Basel Capital Accord.

IRB on Credit Risk
The data requirements are not only onerous but in some cases a bit ambiguous. Further clarification of what is required in terms of the data on probability of default and loss given default would be useful to our data collection effort. Currently, the Basel proposal requires five years worth of data on probability of default and seven years on loss given default.

Most banks in the United States and elsewhere in the world, I suspect, do not have this data on their internal books alone. I'm happy to say that PNC doesn't have sufficient loss experience to have that depth of data. So we would need to use some combination of internal data and external industry-based data to fulfill those requirements. Some further clarification of these standards would be very helpful.

Another unanswered concern about the IRB approach is that the difference between the capital allocated under the standardized approach versus the foundation and the advanced approach needs further clarification. As far as we can tell at PNC, the standardized approach is, indeed, very close to the current 1988 Capital Accord. The foundation approach, however, seems to require much higher levels of capital. And then the advanced approach, if one were to implement it and be qualified for it, would give significant capital relief.

But to qualify for the advanced approach, one would have to go through the foundation approach, and there is, it appears to me, some level of inconsistency making the foundation level capital requirements much higher than the standardized approach.

Another concern involves the independence of risk-rating review. For example, the Basel Committee is currently requiring 100% verification by an independent loan review, quality assurance or audit group. In most practicing loan review, quality assurance, or audit groups, some sampling level, say 60% or 70% of the portfolio, maybe even 80% of the portfolio, would normally be sufficient. The Basel Committee may need to review this.

Then there is the role of models. The Basel Committee has not really said anything about which models are permissible and which are not. There are a plethora of models available today, such as KMV, Moody's, S&P, and LPC. It might be helpful if the Committee would list models that might be acceptable to use for establishing and/or benchmarking probabilities of default.

Finally, the risk weighting question is so fundamental in using the advanced internal ratings-based approach that we need to establish clear-cut, consistent risk-rating guidelines between the US supervisory authorities and what the Basel Committee is requiring for qualification for advanced approaches. For instance, the OCC's revised risk-rating guidelines, released in April 2001, mention the Basel reform process, but they do not give us risk-rating guidelines that are consistent with what Basel requires.

Consequently, PNC, as an OCC-regulated bank, is going to have to maintain a risk-rating system that conforms to the OCC guidelines. And, at this point, it's going to be difficult to comply with both the OCC guidelines and also be consistent with what the Basel Committee appears to be requiring.

For example, the OCC guidelines are still calling for a single expected loss rating, which is what the old OCC risk-rating guidelines called for. The Basel Committee, on the other hand, very clearly stipulates that banks must have risk ratings that distinguish clearly between the probability of default, loss given default, and expected loss. There must be more coordination between the Basel Committee, the Fed, and the OCC so that banks' requirements are consistent across all regulatory agencies.

Education

PNC is not doing anything specifically for Basel that it would not have done as part of its prudent risk management efforts, but those efforts dovetail with the requirements of the new Accord, said Shaheen Dil, senior vice president and director of portfolio and operational risk analysis for PNC. She is an RMA board member who represents PNC in RMA's Capital Working Group. The Group has been working closely with U.S. regulators for two years to demonstrate how best-practice institutions in North America use their internal risk-measurement systems to assign economic capital.

She joined William S. Treacy, manager of supervisory issues and special studies of the Federal Reserve Board in Washington, at a recent RMA audioconference to discuss her concerns about the new Accord and how her institution is preparing to meet the new requirements. Her remarks follow.

We are evaluating all of our risk management processes and enhancing those that we believe require enhancements. We're also following the Basel reform process and all the discussion papers very closely so that we will be totally familiar with the new Basel requirements.

In addition to participating in RMA's Capital Working Group, PNC has also written one comment letter to the Basel Committee directly, and we are in the process of drafting another one on the more recent working papers.

We were the first bank to host the Basel joint pilot conducted by the Fed and the OCC. PNC hosted 12 Fed and OCC examiners for a period of 2-1/2 to 3 weeks. Every day for six to seven hours a day, they evaluated PNC's risk management activities on credit, operational risk, market risk, and every risk management activity in light of the Basel requirements. It was an excellent educational experience. We learned a lot about our own risk management activities and what we still need to do to become fully qualified for the advanced processes in Basel.

PNC commends the Basel Committee for it's work towards a more fair and consistent conceptual risk capital framework. Ultimately, linking capital requirements to genuine riskiness in the portfolios of the banking system will help reduce risk in the financial system. The Basel Committee has been very responsive to many of the comments that PNC, trade groups, and other banks have made on the initial consultative paper. The recently issued working papers reflect a great deal of progress made by the Basel Committee relative to both the 1988 Basel Accord and also the earlier published versions of the New Basel Capital Accord.

Five Areas Needing More Work by Basel
We continue to believe, however, that a lot of work remains to be done prior to the 2005 implementation. Specifically, there are five different areas of concern I'd like to address today:

The internal ratings-based or advanced IRB approach on credit risk.
The regulatory treatment of operational risk that was recently released.
Market discipline or disclosure requirements.
Consistency of application of the supervisory review process.
Timing of the implementation of the New Basel Capital Accord.

IRB on Credit Risk
The data requirements are not only onerous but in some cases a bit ambiguous. Further clarification of what is required in terms of the data on probability of default and loss given default would be useful to our data collection effort. Currently, the Basel proposal requires five years worth of data on probability of default and seven years on loss given default.

Most banks in the United States and elsewhere in the world, I suspect, do not have this data on their internal books alone. I'm happy to say that PNC doesn't have sufficient loss experience to have that depth of data. So we would need to use some combination of internal data and external industry-based data to fulfill those requirements. Some further clarification of these standards would be very helpful.

Another unanswered concern about the IRB approach is that the difference between the capital allocated under the standardized approach versus the foundation and the advanced approach needs further clarification. As far as we can tell at PNC, the standardized approach is, indeed, very close to the current 1988 Capital Accord. The foundation approach, however, seems to require much higher levels of capital. And then the advanced approach, if one were to implement it and be qualified for it, would give significant capital relief.

But to qualify for the advanced approach, one would have to go through the foundation approach, and there is, it appears to me, some level of inconsistency making the foundation level capital requirements much higher than the standardized approach.

Another concern involves the independence of risk-rating review. For example, the Basel Committee is currently requiring 100% verification by an independent loan review, quality assurance or audit group. In most practicing loan review, quality assurance, or audit groups, some sampling level, say 60% or 70% of the portfolio, maybe even 80% of the portfolio, would normally be sufficient. The Basel Committee may need to review this.

Then there is the role of models. The Basel Committee has not really said anything about which models are permissible and which are not. There are a plethora of models available today, such as KMV, Moody's, S&P, and LPC. It might be helpful if the Committee would list models that might be acceptable to use for establishing and/or benchmarking probabilities of default.

Finally, the risk weighting question is so fundamental in using the advanced internal ratings-based approach that we need to establish clear-cut, consistent risk-rating guidelines between the US supervisory authorities and what the Basel Committee is requiring for qualification for advanced approaches. For instance, the OCC's revised risk-rating guidelines, released in April 2001, mention the Basel reform process, but they do not give us risk-rating guidelines that are consistent with what Basel requires.

Consequently, PNC, as an OCC-regulated bank, is going to have to maintain a risk-rating system that conforms to the OCC guidelines. And, at this point, it's going to be difficult to comply with both the OCC guidelines and also be consistent with what the Basel Committee appears to be requiring.

For example, the OCC guidelines are still calling for a single expected loss rating, which is what the old OCC risk-rating guidelines called for. The Basel Committee, on the other hand, very clearly stipulates that banks must have risk ratings that distinguish clearly between the probability of default, loss given default, and expected loss. There must be more coordination between the Basel Committee, the Fed, and the OCC so that banks' requirements are consistent across all regulatory agencies.

Skills

PNC is not doing anything specifically for Basel that it would not have done as part of its prudent risk management efforts, but those efforts dovetail with the requirements of the new Accord, said Shaheen Dil, senior vice president and director of portfolio and operational risk analysis for PNC. She is an RMA board member who represents PNC in RMA's Capital Working Group. The Group has been working closely with U.S. regulators for two years to demonstrate how best-practice institutions in North America use their internal risk-measurement systems to assign economic capital.

She joined William S. Treacy, manager of supervisory issues and special studies of the Federal Reserve Board in Washington, at a recent RMA audioconference to discuss her concerns about the new Accord and how her institution is preparing to meet the new requirements. Her remarks follow.

We are evaluating all of our risk management processes and enhancing those that we believe require enhancements. We're also following the Basel reform process and all the discussion papers very closely so that we will be totally familiar with the new Basel requirements.

In addition to participating in RMA's Capital Working Group, PNC has also written one comment letter to the Basel Committee directly, and we are in the process of drafting another one on the more recent working papers.

We were the first bank to host the Basel joint pilot conducted by the Fed and the OCC. PNC hosted 12 Fed and OCC examiners for a period of 2-1/2 to 3 weeks. Every day for six to seven hours a day, they evaluated PNC's risk management activities on credit, operational risk, market risk, and every risk management activity in light of the Basel requirements. It was an excellent educational experience. We learned a lot about our own risk management activities and what we still need to do to become fully qualified for the advanced processes in Basel.

PNC commends the Basel Committee for it's work towards a more fair and consistent conceptual risk capital framework. Ultimately, linking capital requirements to genuine riskiness in the portfolios of the banking system will help reduce risk in the financial system. The Basel Committee has been very responsive to many of the comments that PNC, trade groups, and other banks have made on the initial consultative paper. The recently issued working papers reflect a great deal of progress made by the Basel Committee relative to both the 1988 Basel Accord and also the earlier published versions of the New Basel Capital Accord.

Five Areas Needing More Work by Basel
We continue to believe, however, that a lot of work remains to be done prior to the 2005 implementation. Specifically, there are five different areas of concern I'd like to address today:

The internal ratings-based or advanced IRB approach on credit risk.
The regulatory treatment of operational risk that was recently released.
Market discipline or disclosure requirements.
Consistency of application of the supervisory review process.
Timing of the implementation of the New Basel Capital Accord.

IRB on Credit Risk
The data requirements are not only onerous but in some cases a bit ambiguous. Further clarification of what is required in terms of the data on probability of default and loss given default would be useful to our data collection effort. Currently, the Basel proposal requires five years worth of data on probability of default and seven years on loss given default.

Most banks in the United States and elsewhere in the world, I suspect, do not have this data on their internal books alone. I'm happy to say that PNC doesn't have sufficient loss experience to have that depth of data. So we would need to use some combination of internal data and external industry-based data to fulfill those requirements. Some further clarification of these standards would be very helpful.

Another unanswered concern about the IRB approach is that the difference between the capital allocated under the standardized approach versus the foundation and the advanced approach needs further clarification. As far as we can tell at PNC, the standardized approach is, indeed, very close to the current 1988 Capital Accord. The foundation approach, however, seems to require much higher levels of capital. And then the advanced approach, if one were to implement it and be qualified for it, would give significant capital relief.

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