Lawmakers quizzed bank regulators Tuesday about whether the industry has done enough to protect itself from spreading losses on mortgage investments.
Federal banking regulators, testifying at a Senate Banking Committee hearing, acknowledged that banks have been hit hard by mortgage-related losses, but said the institutions have enough on hand to withstand the downturn.
Key senators also questioned the wisdom and sufficiency of a new international agreement that gives banks more flexibility in how much money they keep on reserve.
Banks will start adopting the so-called Basel II standards as soon as April 1. Regulators should start tinkering with them now to make them more stringent, lawmakers said.
Wall Street has been increasingly concerned about the rising estimate of damage from the mortgage market mess, with the most pessimistic forecasts putting total losses as high as $600 billion.
“The problems in the mortgage and housing markets have been highly unusual and clearly some banking organizations have failed to manage their exposures well and have suffered losses as a result,” said Donald Kohn, vice chairman of the Federal Reserve. “But in general these losses should not threaten their viability.”
Under questioning from Sen. Richard Shelby, the committee’s top Republican, Kohn acknowledged that the Federal Reserve did not anticipate hefty mortgage-market losses.
“I don’t know that we fully appreciated all these risks out there.” Kohn said. “I’m not sure anybody did.”
Thomas Gronnstal, Iowa’s chief banking regulator, speaking on behalf of state banking officials said that while state officials are readying themselves for more bank failures than has been common in recent years, “we do not expect widespread failures.”
But the committee’s chairman, Sen. Christopher Dodd, D-Conn., suggested that the recent financial market trouble should cause regulators to impose tighter standards than those required by the Basel II accord.
Lawmakers are particularly concerned about a piece of the agreement that would allow banks to calculate different risk levels among the mortgages, corporate loans and other types of credit they extend, taking into account the opinions of credit rating agencies, such as Standard & Poor’s and Moody’s Investors Service.
Several senators questioned whether Basel II places too much emphasis on the opinions of those rating agencies, which critics say grossly underestimated the risk of mortgage investments.
Large U.S. banks that operate internationally — such as Citigroup Inc., Bank of America Corp., JPMorgan Chase & Co., and Wachovia Corp. — are required to switch to the standards, but have up to 36 months to do so.
No U.S. bank has done so yet, and they are not expected to start until this fall. Critics say Basel II will allow the banks to significantly reduce the amount of capital they have to hold in reserve against their loans.
However, the Fed’s Kohn said regulators plan to make adjustments to Basel II as it is put in place. They “are committed to making it work for a safe and sound U.S. banking system,” he said.