Fed Closes a Loophole for Banks Overseas

By PETER EAVIS

The New York Times

Updated, 8:51 p.m. | Foreign banks with a major presence on Wall Street will no longer be allowed to avoid many of the tougher rules that the United States introduced after the financial crisis to prevent banking failures and bailouts.

The Federal Reserve, a leading bank regulator, approved a final rule on Tuesday that will force the American operations of foreign banks to follow many of the same rules as American banks. In doing so, the Fed closed a gaping loophole that roughly half the big firms on Wall Street were able to exploit simply because their headquarters were overseas.

Foreign banks lobbied against the rule, which was first proposed in 2012, arguing that their home country regulators already had sufficient oversight over their global operations. Critics of the rule also contended that it would interrupt the flow of capital around the world, and even prompt foreign banks to reduce their activities in the United States, damaging the American economy.

But in writing its final rule, the Fed kept many of the elements that angered foreign banks, making only a few concessions. “The requirements applicable to foreign banking organizations with a large U.S. presence are an essential part of regulatory reform in the aftermath of the financial crisis,” Daniel K. Tarullo, the Fed governor who oversees regulation, said in a statement. In response to critics of the rule, he said that strengthening banks would help ensure that capital keeps flowing during times of stress. “I would say that the most important contribution we can make to the global financial system is to ensure the stability of the U.S. financial system,” he said.

Under the rules, foreign banks with more than $50 billion of assets in America will have to form special holding companies in the United States. The Fed estimates that 15 to 20 foreign banks will have to form such holding companies. These entities will have to hold a minimum level of capital as a financial buffer to absorb potential losses. In addition, the holding companies will have to own a certain amount of easy-to-sell assets, in case they quickly need to raise cash in a period of stress. The foreign bank entities will also be subject to regular stress tests, which the Fed applies to banks to gauge whether they can weather shocks to markets and the economy. If a foreign bank fails the stress test, the Fed would, in theory, have the ability to stop it from paying dividends, even to its parent company.

The new rules have their roots in the financial crisis, when foreign Wall Street firms took out huge emergency loans from the Fed to shore up their faltering businesses. Despite needing that assistance, some foreign banks later took steps to avoid elements of the financial system overhaul that Congress passed in 2010. Deutsche Bank, for instance, changed the status of its large American operations.

Some analysts have said they believe that some foreign banks have been operating in the United States with far less capital than their American rivals. Deutsche Bank’s American operations, for instance, had negative capital ratios, an almost unheard-of practice in banking. Some analysts have estimated that Deutsche Bank will have to put several billion dollars of fresh capital into its American operations to comply with the new rules.

By operating with low levels of capital, foreign banks were in some ways able to reduce the costs of running their business, giving them a competitive advantage over their American competitors like Goldman Sachs and Morgan Stanley. Still, the foreign banks’ American operations will be allowed to hold less than the largest American Wall Street firms. Under the new rules, the foreign bank operations will have to hold capital equivalent to as much as 4 percent of their assets, when applying the so-called leverage ratio. But the largest American banks will most likely have to maintain a leverage ratio of 5 percent.

The Fed did, however, make some significant concessions in the face of complaints from the industry. The new rules come into effect in July 2016, a year later than originally envisioned, and the leverage ratio requirement does not apply until 2018. The Fed also originally proposed that banks with more than $10 billion of assets form a holding company in America, but it raised that threshold to $50 billion in the final rule.

Foreign banks can still take steps to avoid the new rules, but the Fed said on Tuesday that such maneuvers would most likely be limited. A foreign bank could, in theory, shift assets into American entities that are legally set up as branches, which are do not have to comply with many of the new rules. But a Fed official said that such branches are barred from doing almost all types of Wall Street business, which is the dominant source of revenue for several of the foreign banks affected by the new rules.

A version of this article appears in print on 02/19/2014, on page B1 of the NewYork edition with the headline: Fed Closes a Loophole for Banks Overseas.