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FDIC Hosts 6th Annual Bank Research Conference

Experts gather to discuss Basel II and other topics.

Then FDIC Center for Financial Research (CFR) and the Journal of Financial Services Research hosted the 6th Annual Bank Research Conference at Virginia Square September 13-15. More than 170 people attended the conference, including prominent academics from U.S. and foreign universities, U.S. and foreign bank supervisors, Congressional staff, consultants, bankers and a cross-section of people from the FDIC. Chairman Sheila C. Bair opened the three-day conference, which included the presentation of nearly 30 papers, three internationally recognized guest speakers and an expert panel of discussants on Basel II.

The conference sessions focused on a range of timely topics, such as issues dealing with the implementation of Basel II, the cost of bank resolutions and alternative insurance funding schemes, measuring the benefits and costs of relationship information, as well as advances in bank risk analysis. The conference agenda with links to papers and presentations can be found at: http://www.fdic.gov/bank/analytical/cfr/2006/sept/agenda.html. The three-day conference generated lively discussion among presenters, discussants and conference participants.

The conference program was jointly organized by Haluk Unal, Professor of Finance at the University of Maryland, a CFR special advisor and the managing editor of the Journal of Financial Services Research, and Paul Kupiec, Co-Director of the FDIC's Center for Financial Research (CFR). Michelle Rose and Katie Ahrens, both from the Division of Insurance and Research's Planning and Resource Management Section, handled the many complex administrative and logistical issues of conference production.

The first day focused on the U.S. implementation of Basel II, the new international standard for setting bank minimum regulatory capital requirements. While the U.S. banking agencies participated in developing Basel II, its implementation into U.S. regulations is a separate process that began with the September 2006 publication of an interagency Notice of Proposed Rule Making.

The Basel II symposium addressed issues that included: the design of Basel II and the need for capital floors and the retention of FDICIA (Federal Deposit Insurance Corporation Improvement Act) leverage ratios; the cyclicality of the Basel II minimum capital requirement; the competitive position of non-Basel II banks relative to credit card specialty banks; and the quality of the risk measurement standard set by the Basel II AIRB (Advanced Internal Ratings Based) approach.

Some papers attempted to assuage concerns raised regarding Basel II. For example, a paper by William W. Lang, Loretta J. Mester, and Todd A. Vermilyea of the Federal Reserve Bank of Philadelphia argued that Basel II capital standards will not disadvantage community and regional banks in providing credit card services. In contrast, other papers highlighted less desirable features of Basel II. A paper by Jesús Saurina and Carlos Trucharte of Banco de España showed that Basel II capital requirements will vary over the business cycle, and the magnitude of bank capital requirements will vary depending on the technique used for estimating probability of default. Similarly, a paper by the FDIC's Paul Kupiec challenged the view that the Basel II AIRB approach sets a sound risk measurement standard for a complex banking organization by documenting several critical areas in which the AIRB approach fails to allocate sufficient capital for the credit risk. While the shortcomings can be fixed, the changes would recalibrate the capital rule in the international agreement, according to Kupiec.

The Symposium included a session of leading scholars who were invited to present their views on Basel II. Robert A. Jarrow of Cornell University, Sanjiv Das of Santa Clara University and Edward Kane of Boston College evaluated Basel II from a public policy perspective. Professor Jarrow analyzed the need to include capital floors and maintain the leverage ratio when implementing Basel II. Using a very simple framework, he explained why he believes these additional safeguards must be included in any sound regulatory capital policy. Professor Das analyzed the risk measurement standard implicit in the AIRB approach and found areas in which banks could arbitrage the new rules. Professor Kane presented a contracting model that helped explain how the current Basel II formulation developed. His model predicts that, because of implicit commitments, regardless of how Basel II is ultimately implemented, it will allow some reduction in bank capital requirements.

Following a luncheon address by the Honorable Diana Taylor, Superintendent of Banks for the State of New York, which outlined the history and significant milestones in the life of Basel II, a panel of policy experts debated the merits of Basel II. The panel included Edward Ettin, Board of Governors of the Federal Reserve System (retired); Daniel Tarullo, Georgetown University; George Kaufman, Loyola University Chicago; and Katherine Wyatt, New York State Banking Department. Panelists' views covered a wide spectrum. Some panelists welcomed Basel II as a vast improvement over current regulations while others viewed it as a waste of time, talent and resources.

The second and third days of the conference were devoted to sessions on topics in banking research. The two days were highlighted by a lecture from Professor Charles Goodhart of the London School of Economics and a keynote address by Professor René Stultz of Ohio State University on banks' use of derivative instruments.

Professor Goodhart presented his pioneering work on measuring financial stability. As inflation and GDP (gross domestic product) growth have become standards for measuring economic stability, policymakers need a measure for monitoring the stability of their financial systems. Goodhart noted numerous difficulties in measuring financial stability, as it depends on many features of the financial system that are not easily measured. At present, financial stability is most often characterized by the absence of its converse–a financial crisis, which is not a practical definition for measuring a financial system's resilience to shocks. Economists are working to design a framework that reliably describes the sensitivity of financial systems to economic shocks. One of the biggest challenges is to identify common features or variables that measure the health of a financial system over time and across countries. Although much work remains in this area, Professor Goodhart is optimistic that such measures can be developed and included in policymakers' stability assessments. Success in this endeavor will enable policymakers to anticipate the deterioration of financial sector health.

Among other conference sessions, "Resolution Policy and the Cost of Bank Failures" was particularly relevant for the FDIC. Klaus Schaeck, University of Southhampton, analyzed factors that affect the cost of resolving failed banks with particular attention to cost differences across banks of different sizes. Tanju Yorulmazer, Bank of England, discussed aspects of optimal resolution policy for failed banks. Both studies provide a useful perspective for the FDIC's failure-resolution function. Haluk Unal presented a paper that determines insurance premiums under a countercyclical, risk-based deposit insurance scheme in which premiums are high in good economic times when banks can afford the premiums and lower in recessions when banks can least afford the premiums.

Other sessions analyzed banks' ability to use bank relationship information about borrowers to identify good risks even in novel markets and how they might be able to sell loans without compromising the advantages they gain from banking relationships. Banks exist in part to channel funds from depositors to borrowers and are generally believed to have the particular skill at identifying productive loans. Although this process clearly takes place, many aspects of the banking relationship are not well understood by academics. For example, do banks have a special skill or access to information that also enables them to select "better" borrowers than, say, venture capitalists can? If so, how does this skill or information advantage arise? If banking relationships are the source of this special information, then how does this influence their ability to sell off loans to free resources? These questions were discussed in detail during this session of the conference. For example, Chris James of the University of Florida examined whether banks were successful at spotting winners among the multitude of firms that sprang up during the technology boom of the late 1990s. Evidence suggests that they were. Steven Drucker of Columbia University examined how banks might sell loans even when they have access to special information gained from a banking relationship with borrowers. The paper found that banks have developed loan products that permit them to even sell these loans while still maintaining an ongoing relationship with borrowers.

The conference organizers have received many positive reviews of the conference. The Journal of Financial Services Research has solicited the conference papers for consideration for publication in a special issue. The CFR will host the 17th Annual Derivatives Securities and Risk Measurement Conference in April 13-14, 2007, at Virginia Square. Interested employees should mark their calendars.

Chairman Sheila C. Bair opens the Bank Research Conference.
Chairman Sheila C. Bair opens the Bank Research Conference.

Vice Chairman Martin J. Gruenberg and attendees listen to presenters discuss Basel II on the conference's first day.
Vice Chairman Martin J. Gruenberg and attendees listen to presenters discuss Basel II on the conference's first day.

Diana Taylor, Superintendent of Banks for the State of New York
Diana Taylor, Superintendent of Banks for the State of New York

Professors Robert Jarrow (left) and Edward Kane
Professors Robert Jarrow (left) and Edward Kane

Vice Chairman Martin J. Gruenberg and attendees listen to presenters discuss Basel II on the conference's first day.
DIR Director Art Murton

Last Updated 11/20/2005 cfr@fdic.gov