NEW YORK (The Deal) -- The Federal Reserve Tuesday afternoon approved a tough package of rules for the biggest banks operating in the U.S., a move that central bankers believe could help avoid a repeat of the crisis that shook global markets in 2008.
However, the central bank also punted or substantially delayed some of the more stringent provisions that many critics of the large financial institutions had been seeking.
The Fed, under newly approved chair Janet Yellen in her first public meeting as head of the central bank, voted unanimously to require the largest U.S. institutions with $50 billion or more in assets hold more short-term "highly liquid" assets that they believe would help a bank stabilize itself in a crisis. Banks will also need to set up a risk committee of individuals responsible for making sure executives are advised on when to cut back on investments that could pose a risk to the institutions and to the financial markets if their value suddenly dropped. The rule would apply to the largest 24 U.S.-based banks and about 100 foreign institutions operating here, with more restrictions on the largest firms that make up this group.
"The traditional framework for supervising and regulating major financial institutions and assessing risks contained material weaknesses," Yellen said. "The final rule would help address these sources of vulnerability."
However, the final rule did not set up new capital and liquidity requirements for so called non-bank systemically important financial institutions, even though a Dec. 2011 proposal suggested the Fed would issue requirements for them too. So far, regulators have designated three non-bank firms as systemically risky, including American International Group (AIG), whose collapse was instrumental in the 2008 panic. A Fed official suggested the central bank will take more time to consider capital restrictions on non-bank firms designated as a potential threat to the financial system, in particular on insurance firms, which the central bank is not an expert at regulating. In addition to AIG, regulators have designated Prudential Financial (PRU) and GE Capital, a unit of General Electric (GE), as systemically important firms.
The Fed also punted on a series of restrictions that would limit how much exposure a bank can have to a single counterparty institution, a key limitation sought by big bank critics worried about the impact of a failure of a large complex institution. It also didn't approve an approach that would allow banks to go through a so-called early remediation process where the central bank tells the institution to correct a failure or face punishment later. A Fed official said that these measures "are still under development" and that U.S. regulators are waiting on an international Basel Committee on Banking Supervision, to develop a global standard before moving forward with U.S. counterparty restrictions. Basel's action is expected in the "coming months." The proposal had sought, for example, to prohibit a bank with $500 billion or more in assets form having credit exposure of more than 10% with a counterparty bank that also has more than $500 billion in assets. Many large financial institutions had significant exposure to other big banks in 2008, when one failure would create a domino effect that expanded to other institutions.
The Fed also reduced the number of big foreign banks that would have to set up an intermediary holding company structure: Instead of an estimated 25 foreign banks, only 17 will need to set up this structure, which would help the Fed to supervise all of a foreign bank's U.S. operations.
The Fed's proposal on foreign banks, introduced in December 2012, sought to have foreign banks with $10 billion or more in U.S. assets set up the intermediary structure but the final rule only requires foreign banks with more than $50 billion in U.S. assets to implement it.
One bank regulatory attorney argued that with the new structure foreign banks would have less of an ability to avoid Fed requirements by restructuring their U.S. operations "in ways that would not necessarily reduce their risk profile in the U.S."
Fed officials said that the structure would make it easier to dismantle a large failing foreign bank with major U.S. operations, responding to many of the jurisdictional issues that regulators faced in 2008 when big global banks either were bailed out or filed for bankruptcy in various global jurisdictions. A fed official argued that during the 2008 crisis many U.S. divisions of foreign banks were "somewhat undercapitalized," adding that the new buffers will make them "more resilient." Federal Reserve Governor Daniel Tarullo noted that during the crisis many foreign banks' U.S. units experienced "funding vulnerabilities" partly because they didn't receive adequate support from their parent firms.
In addition, large foreign banks such as Deutsche Bank and Barclays Bank, will be required to hold significantly more capital in the U.S. though they won't be subject to the same tough leverage restrictions as large U.S. banks are expected to be subject to. Like U.S. banks they will be subject to stress tests, but many are expected to be permitted to rely on home country tests.
Nevertheless, responding to concerns from big foreign banks, the Fed also gave non-U.S. institutions an additional year, until July 2016 to comply with most aspects of the regulation and until 2018 to comply with the Fed's leverage caps. (Big U.S. banks must comply with the rules by Jan. 2015).
The regulations are based on the Dodd-Frank Act, legislation approved in the wake of the 2008 crisis. The rules apply to banks with $50 billion and more in assets, but there are even more stringent restrictions on ties among the biggest banks such as Goldman Sachs (GS) that have more than $500 billion in assets.