- Dodd-Frank measure would impose 15 percent limit on exposure
- New rule would leave industry about $100 billion over the cap
Wall Street giants such as JPMorgan Chase & Co., Goldman Sachs Group Inc. and Citigroup Inc. would face new limits on credit exposure to other large financial firms under a Federal Reserve plan aimed at ensuring banks won’t take others with them if they fail.
The proposal, which would limit such exposures to 15 percent of a lender’s Tier 1 capital, represents a second effort after the Fed abandoned a 2011 proposal that called for a 10 percent cap. Even so, the central bank estimates the largest institutions would have to dial back their exposures by almost $100 billion to get below the 15 percent mark.
“The credit limit sets a bright line on total credit exposures between one large bank holding company and another large bank or major counterparty,” Fed Chair Janet Yellen said in a statement before the proposal was approved Friday. The measure targets the problem of big-bank connectedness that magnified the 2008 financial crisis, she said.
The earlier version was shelved after the Fed received strong criticism from the banking industry, and the revision more closely matches an international agreement on a 15 percent cap for the biggest institutions. The strictest limits affect only the U.S. banks deemed systemically important and foreign banks with more than $500 billion in assets in the U.S. Two lower tiers of banks would face lesser limits, with lenders between $50 billion and $250 billion facing the 25 percent cap outlined in the 2010 Dodd-Frank Act.
Congress called for the safeguards in the landmark regulatory law after financial firms that fell during the 2008 credit crisis threatened to pull their trading partners toward collapse. In the most infamous instance, Wall Street banks with exposure to Lehman Brothers Holdings Inc. got taxpayer-funded aid to help them weather its’ demise.
In the years since the Fed’s initial proposal, other rules, restrictions and supervision efforts have been introduced to limit concentration of risk, including such demands as stress-testing and the drafting of living wills meant to show how big banks can fail without wrecking the wider financial system. And the Basel Committee on Banking Supervision, which sets international rules, agreed in 2014 to an exposure limit of 15 percent for the major institutions.
Because bankers were shaken by the Fed’s 2011 effort, they’re carefully looking at this latest one, especially at how the proposal treats derivatives, sovereign debt, short-term credit and clearinghouse relationships, according to Adam Gilbert, a former New York Fed official who is now PricewaterhouseCoopers LLP’s global regulatory leader. The rule could be a problem for big banks if “meaningful adjustments” weren’t made, he said before the release.
A few of the things the industry hoped for were granted in this proposal, such as exempting exposures to certain clearinghouses and high-quality sovereign debt. Though smaller banks would get a wide definition of capital under the rule, the biggest firms have to gauge their cap against Tier 1 -- a measure of a bank’s core capital, including his stock -- which is a stricter standard than the 2011 proposal.
The Fed will accept public comment on the proposal through June 3. The rules would be implemented a year after final approval for the largest firms, with smaller banks allowed a longer period.
Last year, the Treasury’s Office of Financial Research issued a report that examined some measures of how interconnected the big banks are, finding JPMorgan at the top of the list, followed closely by Citigroup and Bank of America Corp.
“While regulatory reform and better risk management practices have reduced interconnections among the largest financial firms by roughly half from pre-crisis days, it is important to put safeguards in place to help prevent a return to those prior practices,” said Daniel Tarullo, the Fed governor in charge of regulation.
JPMorgan, Citigroup and Morgan Stanley argued that the earlier proposal overstated risk and would hold back the economy. Goldman Sachs more specifically warned that it could destroy 300,000 jobs. The Bank of Japan said a similar rule affecting foreign firms could hurt liquidity of high-quality sovereign debt.