Fed proposes tougher capital rules for foreign banks

December 14, 2012

The Federal Reserve said Friday it would press big foreign banks operating in the United States to keep far more money in their reserves to reduce risks to the financial system, a move that could have broad effects on the banking landscape.

The plan essentially would pull foreign banks in line with their American competitors by forcing them to adhere to many of the same standards. Many foreign firms have been lending aggressively in the United States but setting aside far less to cover losses.

But lobbying groups for the foreign banks and some analysts are concerned that stricter rules would result in higher costs for the millions of U.S. businesses that rely on the services of these lenders, which issue about 25 percent of all commercial loans in the nation.

“There is no doubt this plan will cost foreign banks more money, require much more management,” said attorney Douglas Landy, head of the regulatory practice at Allen & Overy. “If banks face significantly higher costs, they are going to pass them on to customers. That’s just the way it is.”

Advocates of the proposal contend that foreign banks, if they collapsed, would pose too great a threat to the stability of the nation’s financial system and should be subject to the same supervision that American institutions face. After all, five of the largest investment firms in the United States are based outside the country.

“Treating all of the systemically significant banks similarly is the appropriate way to do all regulation,” said Dennis Kelleher, president and chief executive of Better Markets, a financial reform advocacy organization. “The rules are going to make financial crisis and taxpayer bailouts much less likely.”

The Fed proposal, which is subject to a 90-day comment period, applies to 107 foreign firms that have at least $50 billion in total assets around the world. These banks will have to establish council to examine their riskiness and submit to stress tests analyzing how they would fare in a severe economic downturn.

Of these firms, 23 large ones, some with as much as a half-trillion dollars in assets, in the United States will face even stricter standards. These companies will have to have enough money set aside to cover 14 days of operations in an emergency.

Many of these banks will have to tuck all of their U.S. subsidiaries into a so-called holding company that would abide by the capital rules that now apply to American banks.

“The biggest concern here is the holding company aspect,” said Susan Krause Bell, managing director of Promontory Financial Group and a former official at the Office of the Comptroller of the Currency. “It’s more expensive for a bank to build up infrastructure in the U.S. if they don’t have it.”

But Krause Bell said that the firms subject to the rule vary in structure. Some already have holding companies and will not feel as squeezed by the new rules. The new treatment nonetheless would force many of the banks to pour more money into their U.S. units to meet the higher reserve requirements. Currently, their capital reserve levels are set by their home countries.

“While the proposal is tailored to some extent, the Fed’s approach is nevertheless overly broad and could prompt foreign banks to pull back from the U.S. market,” said Sally Miller, president of the Institute of International Bankers.

She added that the more rational approach would be to “concentrate on the very small number of foreign banks whose U.S. operations could actually be considered to present risks to U.S. financial stability. This can and should be done on a case-by-case basis, taking into account comparable home-country standards.”

During the financial crisis, policymakers grew alarmed about the risks teetering foreign banks posed and allowed them to borrow heavily from the Fed’s discount window, the primary tool for providing cheap loans to banks facing a cash crunch.

But the foreign firms did not have to follow strict U.S. requirements to keep enough in their reserves to cover potential losses, provided their parent companies overseas were well capitalized.

The Dodd-Frank financial law ended that exemption and called on the Fed to write tougher rules for all banks doing business in the United States. The central bank last year released proposed rules for U.S.-based banks.

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