The Federal Reserve moved to subject two dozen foreign banks with at least $50 billion of global assets to stricter U.S. capital rules as it attempts to lower risks to the financial system.
The Fed proposed that most of the banks also be forced to comply with more-stringent liquidity rules and pass stress tests analyzing how they would fare in a severe economic downturn. The board voted yesterday to seek public comment on the plan for 90 days. It would take effect in July 2015.
Deutsche Bank AG, based in Frankfurt, and London-based Barclays Plc would be among the institutions that would have to keep more easy-to-sell assets in the U.S. and face restrictions on distributing capital to parent companies. 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 lenders.
“This is a huge paradigm shift in U.S. regulation of foreign banks operating here,” said Kim Olson, a principal at Deloitte & Touche LLP in New York and a former bank supervisor. “This means captive capital and liquidity in the local unit that U.S. regulators can go after during failure.”
Lenders with more than $50 billion of global assets and more than $10 billion in the U.S. will be required to house their U.S. businesses, including securities trading, within regulated holding companies. The $10 billion threshold excludes the domestic assets that are connected to a U.S. branch of a bank. About 25 institutions would fall under this requirement, Fed staff said.
Those so-called intermediate holding companies would have to abide by capital rules that already apply to their U.S. counterparts. The new treatment may force foreign banks to inject capital into their U.S. units and limit their ability to move funds across borders.
The proposal is “overly broad and could prompt foreign banks to pull back from the U.S. market, hurting our economy and financial markets,” Sally Miller, chief executive officer of the Institute of International Bankers, said in a statement. It would be more appropriate “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.”
Foreign companies 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. The 2010 Dodd-Frank financial overhaul removed that exemption. Non-U.S. lenders including Deutsche Bank and Barclays then altered their legal structures to remain outside the scope of local capital rules.
The foreign banks with assets exceeding $50 billion in the U.S., 23 of the roughly 25 companies, would face the toughest standards under the Fed’s proposal. They would have to keep in their U.S. units enough cash, Treasuries or other easy-to-sell assets to meet liabilities coming due in 30 days. Those units would face Fed stress tests annually like their U.S. peers and could be prevented from paying dividends to their parent company if they fail the test.
“Will foreign banks retreat from the United States?” asked Charles Horn, a Washington-based attorney at Morrison & Foerster LLP who advises financial companies on regulations and transactions. “I suspect that the large foreign banks are too committed to the United States to do that. Others that may be more on the margins may take a harder look at these rules and do an appropriate cost-benefit analysis.”
Switzerland, whose banking system is five times the size of the nation’s economy, proposed in 2010 to give priority to the domestic units of its two largest lenders if they fail, indicating that overseas businesses might be left on their own.
In the U.K., where banks’ assets are also five times the nation’s gross domestic product, regulators have said they plan to require lenders based in Britain to insulate domestic consumer-banking businesses from investment-banking and foreign operations.
Most of the largest foreign institutions have small commercial-banking units in the U.S., where their operations are largely centered on securities trading.
Through the 1990s, most foreign banks borrowed from their parent companies to lend in the U.S. and had excess cash reserves to meet local requirements. The trend reversed early last decade, when foreign firms started borrowing in the U.S. to lend overseas. Their trading in the U.S. surged to 50 percent of assets in 2011 from 13 percent in 1995, Fed Governor Daniel Tarullo said last month.
“The financial crisis exposed flaws in the pre-crisis structure for supervising and regulating both large U.S. banking organizations and the U.S. operations of large foreign banking organizations,” Fed Chairman Ben S. Bernanke said in a statement. The proposal is a step toward “strengthening our regulatory framework to address the risks that large, interconnected financial institutions pose to U.S. financial stability.”
When Lehman Brothers Holdings Inc. collapsed in 2008, European creditors alleged that $8 billion of cash had been transferred to the firm’s New York headquarters days before the bankruptcy. When Iceland’s banks failed that same year, the government agreed to pay local customers while leaving British and Dutch depositors trying to recoup more than $5 billion.
To reduce links between banks, the Fed’s plan would also set limits on credit exposures between foreign financial institutions similar to those already proposed on U.S. lenders. U.S. intermediate holding companies of foreign banks wouldn’t be allowed to have aggregate net credit exposure to another company that exceeds 25 percent of the holding company’s regulatory capital. The caps would be even lower on credit exposures between companies with more than $500 billion in assets.
U.S. banks, including Goldman Sachs Group Inc., balked earlier this year at a Fed proposal that would limit financial firms with at least $500 billion in assets from having credit risk to any other exceeding 10 percent of regulatory capital plus excess loan-loss reserves. The Fed has gone back to study that proposal and said it won’t set a specific limit on the credit exposures of the largest foreign banks until it decides how to treat domestic bank holding companies.