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Federal Reserve Strengthens Regulation Of Large Banks

by Glen Shapiro,, New York

28 December 2011

The United States Federal Reserve Board (FRB) has proposed steps to strengthen the regulation and supervision of large bank holding companies and systemically important nonbank financial firms.

It was explained that the proposal, which includes a wide range of measures addressing issues such as capital, liquidity, credit exposure, stress testing, risk management and early remediation requirements, is mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

The proposal generally applies to all US bank holding companies with consolidated assets of USD50bn or more, and any nonbank financial firms that may be designated by the Financial Stability Oversight Council (FSOC) as systemically important companies. It was added that the FRB will issue a proposal regarding foreign banking organizations shortly.

The FRB is proposing a number of measures, including risk-based capital and leverage requirements that would be implemented in two phases. In the first phase, the institutions would be subject to the FRB's capital plan rule, which was issued in November 2011 and which requires firms to develop annual capital plans, conduct stress tests, and maintain adequate capital, including a tier one common risk-based capital ratio greater than 5%, under both expected and stressed conditions.

In the second phase, the FRB would issue a proposal to implement a risk-based capital surcharge based on the framework and methodology developed by the Basel Committee on Banking Supervision.

In addition, liquidity requirements would also be implemented in multiple phases. Firstly, institutions would be subject to qualitative liquidity risk-management standards generally based on the interagency liquidity risk-management guidance issued in March 2010, requiring companies to conduct internal liquidity stress tests and set internal quantitative limits to manage liquidity risk.

In a second phase, the FRB would issue one or more proposals to implement quantitative liquidity requirements based on the Basel III liquidity rules. Stress tests of the companies would be conducted annually by the FRB and a summary of the results, including company-specific information, would be made public.

Single-counterparty credit limits would limit credit exposure of a covered financial firm to a single counterparty as a percentage of the firm's regulatory capital, and credit exposure between the largest financial companies would be subject to a tighter limit.

Early remediation requirements would also be put in place for all firms subject to the proposal so that financial weaknesses are addressed at an early stage. The FRB is proposing a number of triggers for remediation - such as capital levels, stress test results, and risk-management weaknesses. Required actions would vary based on the severity of the situation, but could include restrictions on growth, capital distributions and executive compensation, as well as capital raising or asset sales.

The FRB is proposing that firms would need to comply with many of the enhanced standards a year after they are finalized. The requirements related to stress testing for bank holding companies, however, would take effect shortly after the rule is finalized.

The Federal Reserve has consulted with other members of the FSOC in developing the proposal. Comments on it are requested from interested parties by March 31, 2012.

TAGS: law | banking | financial services | legislation | United States | standards | regulation | services

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