At its heart, our analysis is extremely simple. The Basel Committee's Quantitative Impact Study 3 (QIS-3) showed a 17 percent reduction for credit-risk capital at U.S. banks. This reduction occurred despite the participating banks' use of credit loss assumptions that were far more severe than historical experience. If more normal loss assumptions were input into the Basel II risk functions, capital requirements would be expected to be much less than the QIS-3 predicts.
Our analysis appears to confirm this. Over time and on average, the A-IRB formulas would be expected to deliver much lower capital requirements than the current standards for the same pool of exposures. While we develop a range of capital estimates as described below, we believe Chart 2 describes the qualitative features of the most likely capital outcome of Basel II. Specifically, A-IRB capital requirements are likely to be at or below the leverage standards set by U.S. Prompt Corrective Action standards for "well capitalized," and could often fall into a range currently deemed "undercapitalized" by PCA. Consequently, U.S. regulators would be forced to ignore much of the output of Basel II or weaken the PCA standards. Not as evident from Chart 2, but as described in a subsequent section, Basel II also creates the likelihood of significant cyclical swings in risk-based capital requirements for wholesale lending.