Can Fed's New Rules For Foreign Banks Promise More Immunity?

Adding to the already stringent capital regulations, 23 foreign banks operating in the United States will now abide by another rule, which may ease some of their lending activities, while tighten rules for riskier foreign financial firms. The Federal Reserve, along with the Federal Deposit Insurance Corp. (FDIC), and the Office of the Comptroller of the Currency (OCC), has proposed the new liquidity rule.

The proposal forms part of the Fed’s bigger plan to modify banking rules aligning with the banks’ risk profiles. Notably, the proposed rule would involve major banks, including UBS Group AG (NYSE:UBS) , Credit Suisse (NYSE:C) , Deutsche Bank (NYSE:DB) and HSBC.

The Rule

The Fed’s proposal put forth for public comments is likely to ease foreign banks’ subsidiaries capital and stress-testing requirements. However, subsidiaries of foreign lenders involved broadly in riskier activities, including short-term funding, would face stringent liquidity rules.

Notably, the Fed designed some plans for domestic banks last year, regulating those in various ways depending on the assessment of the risks these firms create for the financial system. Therefore, the proposed plans follow the same track.

Particularly, regulatory changes have relieved domestic banks from the post-crisis Dodd-Frank legislation. Nevertheless, some foreign banks are likely to face more complexities, while others might benefit.

Per the latest rules, depending on the size of their U.S. subsidiaries and the extent of risky nature of business operations, foreign banks have to hold liquid assets.

“Because the U.S. operations of most foreign banks tend to have a larger cross-border profile, greater capital markets activities and higher levels of short-term funding, they often present greater risk than a simpler, more traditional domestic bank,” Fed Chairman Jerome Powell said in a statement on the proposal. Notably, liquid assets are defined as assets sold easily for covering short-term cash needs.

Per the central bank’s estimations, total capital requirements for foreign banks will likely be down 0.5%. Moreover, banks will be able to record lower regulatory compliance costs. Further, these banks will be able to utilize freed-up capital to generate more revenues by boosting lending activities. However, the proposed rule, approved by a 4 to 1 vote, is likely to increase liquidity requirements of some foreign banks by 0.5% to 4%.

The regulator has categorized banks into four types per their risk profile. Foreign banks, including Deutsche Bank, Barclays (LON:BARC), Credit Suisse, Mitsubishi UFJ Financial Group Inc., Mizuho Financial Group Inc. and Toronto-Dominion Bank are in the second category, following major U.S. banks in the first tier. The second level of banks has to go through routine stress testing and stricter capital rules, along with meeting liquidity demands similar to the U.S. major banks.

The third category is expected to gain from lower capital requirements and might include HSBC, UBS Group AG and Royal Bank of Canada (NYSE:RY) . Additionally, the fourth tier includes Banco Santander (MC:SAN) SA, Societe General SA and BNP Paribas (PA:BNPP) SA which would face reduced stress-test, capital and leverage restrictions.

Notably, for the first time, the two mega foreign banks — Credit Suisse and UBS — have come under the purview of such liquidity rules.

‘Living Wills’ Modified Proposal

In another proposal, the Fed officials plan to rollback requirements for some major foreign banks and domestic banks, including JPMorgan (NYSE:JPM) , Citigroup (NYSE:C) and Bank of America (NYSE:BAC) , regarding submission of so-called ‘Living Wills’ every three years, rather than two. In addition, several other foreign banks, including Santander, BNP Paribas and Societe Generale (PA:SOGN), are anticipated to go through regulatory stress tests every two years instead of an annual one.

Lael Brainard, one Fed governor voted against new reforms as these excludes local branches. “I am disappointed the proposal today does not address this important outstanding vulnerability and therefore does not represent a balanced package,” she noted.

Notably, ‘Living Wills’ requires large banks to outline the ways to liquidate, by breaking up and selling off assets, in case the firms are on the verge of collapse. The main goal is to avoid re-run of the 2008 financial crisis, when the Lehman Brothers Inc. tumbled. These also reduce risks of further bailouts, if these banks sink in the incident of another financial crisis.

Road Ahead

The primary purpose of the liquidity rule is to make sure that banks are self-sufficient to meet their cash requirements during a financial crisis. Randal Quarles, the Fed’s vice-chair for bank supervision, stated, “The proposals seek to increase the efficiency of the firms without compromising the strong resiliency of the financial sector.”

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