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AmericasJanuary 28 2013

US tightens leash on foreign banks

The desire of the US Federal Reserve to create more uniform supervision of foreign bank subsidiaries is understandable, but its proposals risk cutting across international efforts at regulatory coordination.
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What's happening?

The US Dodd-Frank Act of 2010 instructed regulators to bring the supervision of foreign banking organisations (FBOs) in the US more into line with that of domestic banking institutions. In December 2012, the resulting proposed rulemaking was published, with a consultation period extending to March 2013. The new rules would come into force in July 2015, with a one-year transition period for any banks that fall under the rules for the first time thereafter.

What are the main provisions?

The new regulation applies to large FBOs, defined as those whose total global assets exceed $50bn. Any large FBO that has assets of more than $10bn in the US, excluding branches and agencies, must bring all subsidiary companies under a single intermediate holding company (IHC). This will be subject to the same US interpretation of Basel III capital and leverage ratios as domestic bank holding companies, and annual stress-testing of capital. The IHC will need its own risk committee. It is expected that 25 to 30 foreign banks will need to form these IHCs, if they have not done so already.

Any large FBO that has assets of more than $50bn in the US will additionally be subject to Basel III liquidity requirements as interpreted by US supervisors, and will have to maintain a separate liquidity buffer for its branch and agency network. It will also be subject to semi-annual stress-testing of capital and monthly testing of liquidity.

It is understandable that the authorities should be concerned about the very broad range of structures currently employed by foreign banks in the US, says Susan Krause Bell, a managing director at financial and regulatory advisory firm Promontory in the US.

“Complying with the governance requirements of this proposal is unlikely to be too onerous. A bank’s existing global risk committee could simply sit as the US risk committee, provided it holds separate meetings with separate minutes to discuss the US IHC,” says Ms Krause Bell, who was previously a senior manager at the US Office of the Comptroller of the Currency.

It’s not fair?

The new capital and liquidity requirements will have a far greater impact, especially for banks with large securities operations in the US. The Federal Reserve has promised to take account of the strength of home country supervision, and group capital and liquidity requirements, to avoid banks facing the regulatory equivalent of double taxation.

“The Fed insists that this will level the regulatory landscape and that it will not undermine foreign bank competition in the US. FBOs are welcome, but they must be regulated in the same manner as domestic players,” says Charles Horn, regulatory partner at law firm Morrison & Foerster.

But until FBOs see how the proposals are implemented, there will be compliance concerns about separate US liquidity buffers and where US domestic requirements diverge from Basel III. The US requires a higher pure leverage ratio of 4% (compared with 3% for Basel), although this excludes certain off-balance-sheet assets that Basel includes. Moreover, Dodd-Frank forbids reliance on credit rating agencies to risk-weight assets, and the Collins Amendment sets a floor on risk-weighted assets – both rules that are idiosyncratic to the US.

What will the banks do?

US tightens leash on foreign banks

“Some of the largest FBOs had restructured their US operations in part to reduce the level of regulatory capital required. Those with large US businesses will now need to rethink that approach and conduct a hard cost-benefit analysis of the regulatory and resource needs of each business line,” says Mr Horn.

Deleveraging will clearly be part of the response, but banks may also look at optimising structures to move assets into their branch and agency networks, which are not subject to the capital requirements.

“The Fed has said that there is not much scope for arbitrage as many securities activities are not likely to be eligible for inclusion in the branch networks, which will still have capital equivalence requirements that have a similar effect to capital ratios. The largest FBOs will also have liquidity requirements on their branches. Even so, the Fed will need to monitor this and tweak the regulatory framework if necessary,” says Ms Krause Bell.

Could we live without it?

The Fed’s proposal came just days after a joint declaration by the US Federal Deposit Insurance Corporation and the Bank of England on “resolving globally active, systemically important financial institutions”. Yet the two approaches appear conflicting.

“There has not been public reaction from other national regulators, but the most likely response will be to question whether the FBO regulation is consistent with efforts to harmonise international regulation, especially on the resolution of cross-border banking groups,” says Ms Krause Bell.

The introduction to the Fed proposal openly refers to legislation in other jurisdictions that could limit a parent’s ability to support its US operations, such as the UK’s ring-fencing plans. The Fed argues that “resolution regimes and powers remain nationally based”, which leaves host countries at risk. In other words, we could live without the new FBO regulation if international agreements on resolution are reached, but the Fed is not holding its breath. 

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