Federal Reserve Governor Daniel Tarullo said the central bank is planning tougher capital and leverage rules for U.S. units of foreign banks, which some firms have sought to skirt.
“We need to adjust the regulatory requirements for foreign banks in response to changes in the nature of their activities in the United States, the risks attendant to those changes, and instructions from Congress,” Tarullo said today in a speech at Yale University in New Haven, Connecticut.
The Fed will force non-U.S. firms to house all of their U.S. businesses, including securities trading, within regulated holding companies, Tarullo said. Those holding companies also must abide by capital and liquidity rules that already apply to U.S. counterparts, he said. That means foreign banks’ local units would have to bolster capital in the U.S. to guard against losses regardless of their parents’ resources.
Deutsche Bank AG and London-based Barclays Plc have changed their U.S. legal status in the past two years to discard the holding-company structure. The treatment could force foreign banks to inject capital into their U.S. units and limit their ability to move funds across borders, said Luigi De Ghenghi, a partner at law firm Davis Polk & Wardwell LLP in New York.
“Fragmenting capital along regional lines will impose real costs on doing cross-border banking,” said De Ghenghi, a member of the firm’s financial-institutions group. “Global banks will risk ending up with overcapitalized units all around the world because regulators are reluctant to allow the repatriation of capital once it’s moved to their jurisdiction.”
Tarullo, who leads the Fed’s committee on bank supervision, said in response to audience questions that the regulator is entering the “homestretch” of completing the proposal that would include these new requirements.
While Tarullo didn’t indicate which banks would be covered by the new rules, he said 23 foreign lenders have at least $50 billion in assets in the U.S., the threshold established by the 2010 Dodd-Frank Act for treating U.S. firms with “special prudential measures.”
The Fed’s move fits with a worldwide trend of increasing local supervision powers, according to Barbara Matthews, managing director of BCM International Regulatory Analytics LLC, a Washington-based consulting firm. Regulators are moving in that direction because of the failure to agree on a cross-border resolution framework for globally active banks, she said.
“So when the next crisis hits, you can seize the assets of the local unit and prevent its liquidity from fleeing your jurisdiction,” Matthews said.
Tarullo also pointed in his speech to obstacles facing an international resolution framework. He said other countries were moving toward tougher rules for foreign banks functioning in their jurisdiction and referred to the 2008 crisis when the Fed came to the aid of foreign lenders operating in the U.S. as a reason why a new regulatory approach was needed.
The Fed provided $538 billion of emergency loans to the U.S. units of European banks during the financial crisis, almost as much as it did to domestic firms. That increased political pressure on lawmakers and regulators to tighten rules for all.
Foreign lenders currently can choose whether to create U.S. bank holding companies. Those units were exempt from capital standards as long as their parent firms were well-capitalized. Dodd-Frank removed that exemption. Some non-U.S. lenders then altered their legal structures to remain outside the scope of local capital rules.
Deutsche Bank, Germany’s biggest lender, estimated in 2010 that it might need to inject almost $20 billion into its U.S. unit to comply with the same rules as domestic banks, the Wall Street Journal reported last year, citing an internal company document. The division, known as Taunus Corp., dropped its status as a bank holding company in February.
Barclays, the U.K.’s second-biggest bank, said in February 2011 that it deregistered Barclays Group U.S. as a bank holding company, partly to sidestep the capital requirements.
UBS AG and Credit Suisse Group AG, Switzerland’s largest lenders, were among firms that didn’t have holding companies to start with. Most of the largest foreign institutions have small commercial-banking units in the U.S., where their operations are largely centered on securities trading.
Toronto-Dominion Bank already has a holding company in the U.S. that will have to add about $5 billion in capital to comply with Dodd-Frank, according to Brad Smith, an analyst at Stonecap Securities Inc. A requirement to consolidate all U.S. businesses into the holding structure would boost the capital need by billions of dollars, Smith said in a note today.
“This is not great news for any Canadian bank as it will likely push up the amount of capital required to run their U.S. businesses,” Smith said. “All Canadian banks that are running capital markets businesses in the U.S. will need to take a very close look at their business lines.”
Spokesmen for Frankfurt-based Deutsche Bank, Barclays and UBS and Credit Suisse, both based in Zurich, declined to comment on the potential rule changes.
Forcing foreign lenders to put U.S. assets under bank holding companies would subject them to U.S.-specific leverage requirements, in addition to global capital rules agreed to by the Basel Committee on Banking Supervision.
Basel regulations dictate how much capital banks need based on the riskiness of their assets. Lenders headquartered in the U.S. are subject to an additional leverage cap based on total assets, rather than on those weighted by risk. Leverage is a measure of a bank’s debt in relation to shareholder equity.
While it would be easier for U.S. trading units of foreign banks to comply with the risk-based standard, the simple leverage limit could force them to raise more capital, a bank executive familiar with the discussions said before Tarullo’s speech.
The Institute of International Bankers, a New York-based lobbying group that represents 100 foreign lenders operating in the U.S., has warned regulators against blanket rules that would treat all firms the same, according to Chief Executive Officer Sarah “Sally” Miller.
“Based on the risk Bank X poses to the U.S. financial system, then they could ask that one for more capital, as Dodd-Frank stipulates,” Miller said. “But across-the-board, one-size-fits-all rules like this can be very harmful, discouraging foreign banks to be here. That could hurt lending, considering that 25 percent of all commercial and industrial bank loans in the U.S. are made by foreign firms.”