The Federal Reserve approved new standards for foreign banks that will require the biggest to hold more capital in the U.S., joining other countries in erecting walls around domestic financial systems.
Banks with $50 billion of assets in the U.S. will have to meet the standard under a revised rule approved yesterday, which raised the threshold from $10 billion proposed in 2012. The central bank left out two controversial elements of the original proposal, saying those were still being developed.
Walling off U.S. units of foreign banks, designed to protect taxpayers from having to bail them out in a crisis, may increase borrowing costs for those companies and hurt their profitability. The firms say it will also raise borrowing rates for governments and consumers.
“This implies concern by policy makers in the U.S. regarding the speed and robustness of the evolving European framework for bank resolution,” said Barbara Matthews, managing director of BCM International Regulatory Analytics LLC, a Washington-based consulting firm. “It will put pressure on the Europeans to push ahead with a strong resolution regime.”
The new standards take effect in July 2016, one year later than originally proposed after the final approval of the regulation was delayed. Part of the proposal that established limits on banks’ exposures to single parties was held back because the Fed is still working on how to define them for U.S. firms. Another planned change, which would have set an additional capital buffer above the standard requirements, also was left out. The industry objected to both elements.
The new rules will force the largest foreign firms to consolidate U.S. operations into one subsidiary and abide by the same capital and liquidity minimums as domestic peers. The change in the threshold will lower the number of firms that have to set up such holding companies to about 17 from 25, a Fed official estimated.
Banks have until January 2018 to comply with local leverage requirements. The standards are minimum capital-to-assets ratios calculated without taking risk of holdings into account. While U.S. banks have had such a requirement for decades, it was just introduced as part of global capital standards for other countries and will go into effect in 2018 as well.
“It would be very onerous for European banks to comply with leverage rules so fast when it’s completely new for them,” said Deborah Bailey, a managing director at Deloitte LLP.
The U.K. is in the process of adopting U.S.-like rules, forcing subsidiarization of local operations. The European Union, which has criticized the U.S. plans, has considered retaliation. Since the European debt crisis erupted, national regulators in the EU have prevented cross-border fund transfers among units of regional banks. The Fed is seeking to prevent a repeat of the 2008 crisis when it provided $538 billion of emergency loans to U.S. units of European banks.
The Balkanization of global finance will lower the industry’s average return on equity by as much as 3 percentage points, Morgan Stanley analyst Huw van Steenis estimated. The Americas region accounted for half of global banks’ revenue in 2012 and about 60 percent of their profit, he said. Only 60 percent of those earnings were by U.S.-based banks. Deutsche Bank AG and Barclays Plc will be hit hardest among European banks, he said in a Feb. 13 report.
The foreign-lender rules may affect about 100 institutions. The smallest have to do as little as set up a U.S. risk committee. Bigger firms face multiple hurdles, including having an umbrella structure that must comply with domestic capital and liquidity standards. The largest banks also must pass Fed stress tests.
Foreign firms currently can have dozens if not hundreds of legal entities in the U.S., many of which aren’t required to disclose financial information, making it difficult to glean from public data the exact size of their operations.
France’s Natixis and Rabobank Groep of the Netherlands may benefit from the change in the threshold for the holding company requirement, according to data compiled by Bloomberg.
Deutsche Bank, Barclays, Zurich-based Credit Suisse Group AG and other foreign firms that engage mostly in securities trading in the U.S. are the most affected by the new rules because they rely on wholesale funding in the country for their dollar needs. London-based HSBC Holdings Plc, Spain’s Banco Santander SA and other lenders that focus on retail banking in the U.S. depend on deposit funding more and already need to abide by domestic regulations on capital and liquidity.
The central bank made the 2012 proposal, championed by Fed Governor Daniel Tarullo, after Deutsche Bank and Barclays dismantled their umbrella holding-company structures, allowing them to avoid tougher standards. The Institute of International Bankers, a group that represents almost 100 foreign banks including those two, lobbied against the rule, arguing that it would restrict the movement of capital worldwide. In response to such criticism, Tarullo said that gains from global capital flows are reversed in periods of financial stress.
“The funding vulnerabilities of numerous foreign banks and the absence of adequate support from their parents made them disproportionate users of the emergency facilities established by the Federal Reserve,” Tarullo said.
In an April comment letter, the IIB said member banks might be forced to curtail business in the Treasury repo market. That could drain $330 billion, or about 10 percent of the market, leading to higher borrowing costs for the government, the group said, citing an Oliver Wyman study it commissioned.
The IIB hailed the additional time given for compliance while reiterating its opposition to the essence of the rule.
“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 to foreign-owned broker-dealer subsidiaries,” said Sally Miller, head of IIB.
Better Markets Inc., a consumer advocacy group, said the new rules are a win for U.S. taxpayers and the global financial system.
“No one should forget that it was the U.S., not the U.K., France, Germany or any other country, that bailed out and prevented the collapse of the global financial system in 2008,” said Dennis Kelleher, the group’s president.
Deutsche Bank, which would have faced a capital shortfall of as much as $20 billion in its U.S. unit in 2010, has narrowed that gap to about $2 billion after funneling some capital raised at the parent level to its U.S. operations, restructuring some of its businesses and retaining earnings since then, according to Morgan Stanley’s van Steenis. The German firm still needs to shrink its U.S. balance sheet by about $140 billion to comply with new capital minimums though some of that could be done through separating Latin America units on paper, he said.
Deutsche Bank would have to shrink its repo business to comply, KBW’s Stimpson estimates. Replacing some parent company funding with local funding for the U.S. unit could increase costs by $600 million, about 5 percent of 2015 expected earnings, according to Stimpson.
Barclays could have a capital shortfall of $10 billion, according to van Steenis. Being based in London, Barclays is hit from both sides. Because the U.K. has adopted similar rules, requiring minimum capital for local units of banks operating in that country, any equity transferred to the U.S. unit has to be kept apart from the capital of the British subsidiary. That means even if the consolidated business meets global capital requirements, the U.S. and U.K. carve-outs could force the bank to hold more capital in total.
“We’re confident that we have options that will allow us to implement the new regulations in the prescribed time frame,” the British bank said in a statement.
The Fed made clear that it wouldn’t apply bank capital rules on insurance companies and other financial firms that might be deemed systemically important. Although this was “another positive sign” that regulators will come up with industry-specific standards for insurance companies, it shouldn’t be “cause for celebration” because it’s not clear how those will turn out, said John Nadel, an analyst at Sterne Agee & Leach Inc..
“The industry will have a chance to help guide” the creation of new rules, Nadel said in a note published today. “Until proposed rules are made publicly available for evaluation and comment, we remain very much in the dark as to how some of the more significant risks will be treated.”