Tags: Fed | foreign | bank | capital

Fed Sets Foreign-Bank Capital Rules as World Finance Fragments

Tuesday, 18 February 2014 03:46 PM

The Federal Reserve is set to vote on 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.

A final Fed rule announced today would raise the threshold at which banks have to comply with that standard to $50 billion of assets in the U.S. from $10 billion proposed in 2012. The central bank, which will vote on the rule at a meeting in Washington, 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 banks’ borrowing costs and hurt their profitability. The firms say it will also raise borrowing rates for governments and consumers.

“The Fed doesn’t trust other countries’ regulators because the crisis showed nobody was watching the capital levels of the biggest banks,” said Andrew Stimpson, a London-based analyst with Keefe, Bruyette & Woods. “This rule will force foreign banks to do more local bond sales, which will cost more than what the parent company would borrow at.”

The new standards would 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 had objected to both elements.

Firms Affected

The new rules set for approval today 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, a Fed official estimated.

Banks will have until January 2018 to comply with local leverage requirements. Leverage standards are minimum capital-to-assets ratios calculated without taking risk of holdings into account.

The U.K. has adopted U.S.-like rules, forcing subsidiarization of local operations. The European Union, which has criticized the U.S. plans, has threatened 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 trying to prevent a repeat of the 2008 crisis when it provided $538 billion of emergency loans to U.S. units of European banks.

Lowering Returns

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 based in other countries and doing business in the U.S. The smallest firms have to do as little as set up a U.S. risk committee. Bigger institutions face multiple hurdles, including having an umbrella structure that must comply with domestic capital and liquidity standards. The largest banks also will be subject to Fed stress tests.

Numerous Units

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 today that gains from global capital flows are reversed in periods of financial stress.

‘Disproportionate’ Assistance

“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 a prepared statement.

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.

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. business, restructuring some of its businesses and retaining earnings since then, according to 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.

Barclays Affected

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.

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The Federal Reserve is set to vote on 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.
Tuesday, 18 February 2014 03:46 PM
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