Big foreign banks operating in the United States will have to keep far more money in their reserves to reduce risks to the financial system, pulling them in line with their American competitors, the Federal Reserve said Tuesday.
The board voted 5 to 0 to adopt the stricter regulations meant to limit the risks posed by foreign firms, which have been lending aggressively in the U.S. but setting aside far less to cover losses.
“The traditional framework for supervising and regulating major financial institutions and assessing risks contained material weaknesses,” said Fed Chair Janet Yellen, presiding at her first public meeting of the central bank’s board. “The final rule would help address these sources of vulnerability.”
Foreign banks have fought hard against the rule since it was first proposed in 2012, warning that it would result in higher costs for the millions of U.S. businesses that rely on their services. Banks based overseas issue about 25 percent of all commercial loans in the nation.
Regulators relaxed some elements of the final rule. Instead of banks with $10 billion in assets being required to establish so-called holding companies as originally proposed, regulators raised the threshold to at least $50 billion in assets. The Fed gave those banks more transition time by extending the compliance deadline a year to July 1, 2016.
The central bank also decided not to apply a host of tougher capital requirements, including risk-based surcharges — an added layer of money set aside to absorb losses. But it was not enough to satisfy some members of the banking industry.
“We continue to have a fundamental disagreement with the Fed about the appropriateness and necessity of applying an extra layer of U.S. bank capital requirements,” said Sally Miller, chief executive of the Institute of International Bankers.
While the head of the trade group praised the delay in implementation, she said that “the potential adverse impact of the capital requirements on the U.S. capital markets, as well as other unintended consequences, call for further assessment and consideration.”
Fed Governor Daniel Tarullo argued that gains derived from global capital flows are endangered when financial activity contracts rapidly in periods of high stress, as it did during the financial crisis. The funding vulnerabilities that foreign banks exhibited during the crisis, he said, “underscores the imperative of sound prudential policies.”
Karen Shaw Petrou, managing partner of Federal Financial Analytics, noted that the Fed’s rules were adopted with only minor revisions, demonstrating the central bank’s commitment to a stringent regulation.
“The board gave foreign banks time to comply with tough new rules, but not much else,” she said. “Yellen made it clear that any foreign bank that tries to evade the rules through its branch operations here will be harshly handled.”
Deborah Bailey, managing director of the banking and securities regulatory practice at accounting firm Deloitte, said the Fed took a measured approach to the final rule. While the central bank eased up on some requirements, it held firm on imposing leverage ratios, which measure the proportion of capital to total assets, on foreign firms.
Supporters of tougher rules have argued 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 U.S. are based outside the country.
The Fed rule applies to 107 foreign firms that have at least $50 billion in total assets around the world. These banks will have to establish a 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, will face even stricter standards in the U.S. 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 holding company that would abide by the capital rules that now apply to American banks.
Policymakers grew alarmed during the financial crisis about the risks that 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 put an end to that exemption and called on the Fed to write tougher rules for all banks doing business in the United States. The central bank released proposed rules for U.S.-based banks two years ago.
Ylan Q. Mui contributed to this report.