Federal Reserve governor Daniel Tarullo on Wednesday outlined stricter capital and liquidity rules for foreign banks operating in the United States, a plan that would force them to adhere to the same standards as U.S. institutions.
Policymakers grew alarmed during the financial crisis about the risks foreign banks posed as they borrowed heavily from the Fed’s discount window, the primary tool for providing cash to banks facing liquidity problems. At the time, foreign firms were exempt from U.S. requirements that banks keep a certain amount of assets in reserve to cover potential losses, provided their parent companies were well capitalized.
The Dodd-Frank financial law ended that exemption and called on the Fed to write tougher capital rules for all banks doing business in the United States. The central bank last year released proposed rules for U.S. banks but had yet to unveil its plans for their foreign counterparts until now.
Speaking at the Yale School of Management on Wednesday, Tarullo said the central bank will require foreign firms to create intermediate holding companies to house all of their U.S. subsidiaries. This would “reduce the ability of foreign banks to avoid U.S. consolidated-capital regulations” and make “supervision more consistent across foreign banks,” he said.
Tarullo, who heads the Fed’s bank supervision efforts, said the final details of the plan are under discussion at the central bank but a proposal will be issued in the coming weeks.
“These rules have been reshaped to counteract the risks to the U.S. financial system revealed by the crisis and should be implemented consistently across all firms that engage in similar activities,” Tarullo said.
The new rules would apply to 23 foreign banks with at least $50 billion in assets in the United States, the threshold that Dodd-Frank established. A majority of the largest foreign banks have small commercial banking operations here that are primarily focused on securities trading.
In anticipation of the rules, some major foreign banks have restructured their U.S. operations to skirt the higher capital requirements. Deutsche Bank, Germany’s largest lender, shed its bank holding company in February, just as London-based Barclays did a year earlier. But Tarullo seemed intent on stamping out efforts to evade tougher standards.
While Deutsche Bank spokesman Duncan King declined to comment on Tarullo’s speech, he said that “Deutsche Bank will respond to new rules and standards as they are proposed, and will comply with new regulations as they are implemented.”
Officials from Barclays declined to comment.
Tarullo acknowledged that added capital and liquidity requirements could “increase cost and reduce flexibility of internationally active banks that manage their capital and liquidity on a centralized basis.” Still, he said, “managing liquidity and capital on a local basis can have benefits not just for financial stability generally, but also for firms themselves.”
The outline for the new foreign capital rules arrives on the heels of the Fed’s decision to delay the implementation of international capital standards, known as Basel III. Regulators on both sides of the Atlantic have been bombarded with industry comments asking for modifications.
While Tarullo considers Basel an important step in improving liquidity, he said the reforms don’t address the vulnerabilities posed by international banks operating outside their home markets — which is why the Fed is taking additional action.