A Proposed Fundamental Shift in US Foreign Bank Supervision

The Board of Governors of the Federal Reserve System (“Board”) has devoted some time to considering how to address the potential threat to the financial stability of the United States posed by a foreign bank with banking operations in the United States (“foreign banking organization” or “FBO”). Proposed rules (the “Proposal”) issued on December 14, 2012 conclude that the best, or at least most practical, solution is to require an FBO with a significant US presence to “ring-fence” in the United States capital and liquidity deemed sufficient to support its subsidiary bank and nonbanking operations in the United States. If the Board adopts this ring-fencing approach to financial stability in its final regulation, one cannot help but wonder if other nations will follow suit with their own ring-fencing regimes.

The Proposal, if adopted, would require a systemically-important FBO — that is, one with at least US$50 billion in global consolidated assets — to corral its US bank, broker/dealer and other nonbank financial subsidiaries under a US intermediate holding company (“IHC”) if the combined assets of those subsidiaries equal at least US$10 billion. If the IHC’s assets total US$50 billion or more, the IHC would be required to maintain risk-based capital and liquid assets at levels required for a systemically-important US bank holding company. Dividends and any other capital distributions from the IHC would be limited to those pre approved by the Board. Counterparty credit limits, stress testing, risk management requirements and other enhanced prudential standards would be applied to the IHC as well. Failure to meet the required standards would result in Board-imposed early remediation ranging from dividend restrictions to required asset sales and, ultimately, resolution of the IHC by US banking supervisors.

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