Fed Completes Rule Limiting Banks’ Size

Bars Acquisitions That Result in a Firm Holding Over 10% of Financial-Sector Liabilities

By SCOTT PATTERSON and  VICTORIA MCGRANE

Updated Nov. 5, 2014 3:52 p.m. ET

The Wall Street Journal

WASHINGTON—Bank regulators took a step toward curbing the ability of large financial institutions to get bigger as Washington continues trying to lessen the risk giant firms pose to the U.S. economy and taxpayers.

The Federal Reserve on Wednesday finalized a rule, mandated by the 2010 Dodd-Frank financial law, that generally prohibits banks and other financial firms from buying or merging with rivals if the deal would result in the combined firm holding more than 10% of all liabilities in the financial system.

The so-called concentration limit doesn’t mean a financial firm exceeding the 10% threshold needs to slim down. The rule also doesn’t prohibit organic growth by a financial firm. But it would effectively limit the ability of J.P. Morgan Chase & Co., or a similarly sized bank, to merge with another large financial firm, except in certain circumstances.

As of Dec. 31, 2013, the Fed estimated total financial-sector liabilities stood at $18 trillion, which means the 10% concentration limit would cap firms at holding $1.8 trillion in financial-sector liabilities.

Several U.S. firms are already near the limit. As of the second quarter, J.P. Morgan had $1.4 trillion in liabilities, the most in the U.S., ahead of Bank of America Corp. and Citigroup Inc., each of which had $1.1 trillion in liabilities, according to research firm SNL Financial.

The move is the latest attempt by the Fed and other regulators to prevent another round of government bailouts by making it costly to be a large, risky financial institution. Fed Governor Daniel Tarullo told Congress in September the regulator plans to impose a costly capital surcharge that would require the biggest U.S. banks to maintain fatter cushions to protect against potential losses.

The requirement would force some big U.S. banks to increase capital cushions beyond their overseas rivals. That raised questions among the banks and some lawmakers about whether Washington, in its attempt to safeguard the financial system, is putting U.S. banks at a competitive disadvantage.

Under the rule finalized Wednesday, scheduled to take effect Jan. 1, a firm over the 10% liability threshold would only be able to do deals, with permission from the Fed, that result in a de minimis increase in the firm’s liabilities, defined as an increase of less than $2 billion. The rule also provides an exception—again with preapproval from the Fed board—in a crisis situation, including if the firm is buying a bank that is in default or in danger of failing.

The Fed also provided a new exception for “securitization” transactions, in which firms package together debt and other financial instruments for investment purposes. The exception, adopted in response to concerns raised by commenters on the rule, would let a firm continue to engage in securitization transactions even if its liabilities exceed the concentration limit.

Securitization deals were at the heart of the recent financial crisis, helping to feed the real-estate bubble and triggering shortfalls at banks in the U.S. and Europe. Banks scooped up residential and commercial real-estate mortgages, providing a ready buyer for debt and helping loosen credit standards, critics say.

Some big banks exposed to large chunks of securitized deals that went sour suffered billions in losses as the real-estate market collapsed in 2007 and 2008.

Write to Scott Patterson at scott.patterson@wsj.com and Victoria McGrane at victoria.mcgrane@wsj.com