NEW HAVEN, Connecticut The Federal Reserve's top regulation official on Wednesday called for broad new liquidity and capital rules for the U.S. operations of large foreign banks, that would align them with those for American banks and protect the still vulnerable financial system.
Fed Governor Daniel Tarullo outlined a three-pronged approach that includes forcing the largest U.S. divisions of foreign banks to establish a "top-tier U.S. intermediate holding company," or IHC, over all subsidiaries.
The plan, which the powerful Federal Reserve Board is now refining, would also apply to the IHCs the same capital rules applicable to U.S. banks, and make liquidity standards "broadly consistent" with domestic rules, he said.
Tarullo's landmark proposal suggests that, four years after the worst of the financial crisis, regulators remain wary of the risks posed by big banks that do business globally, and are prepared to set national rules as a precaution.
Tarullo characterized his plan as "a middle course" that would, effectively, let U.S. regulators stop relying on foreign oversight of banks doing big business in the United States.
"By imposing a more standardized regulatory structure on the U.S. operations of foreign banks, we can ensure that enhanced prudential standards are applied consistently across foreign banks and in comparable ways between U.S. banking organizations and foreign banking organizations," Tarullo told a Yale School of Management forum.
"As with domestic firms subject to enhanced prudential standards, the Federal Reserve would work to ensure that the new regime is minimally disruptive, through transition periods and other means," he said.
Details of the new rules are now under discussion at the Fed, Tarullo said, adding he expects the Fed's board to issue a more detailed notice of proposed rulemaking in coming weeks.
Earlier this month, the Fed said it would delay the so-called Basel III capital standards beyond a January 1, 2013, deadline. That caused ripples globally, prompting some to worry that banks' intensive lobbying efforts succeeded in watering down and delaying post-crisis reforms.
PROBLEMS FOR EUROPEAN BANKS?
In late 2008 - in response to the financial crisis that began in the United States but spread globally - the Fed extended hundreds of billions of dollars in emergency loans to support the U.S. units of European banks that were shaken by the deep turmoil. That stoked anger at banks, leading in part to the 2010 Dodd-Frank financial reform legislation.
Tarullo's proposal could crimp international funding schemes at European banks such as Barclays Plc and Deutsche Bank, and compel them to beef up capital in the United States.
It could also amplify criticisms that regulators globally are not cooperating to set universal standards, complicating funding-market rules at a time the world economy is still struggling to recover from recession.
The additional capital and liquidity buffers "may incrementally increase cost and reduce flexibility of internationally active banks that manage their capital and liquidity on a centralized basis," Tarullo acknowledged.
"However, managing liquidity and capital on a local basis can have benefits not just for financial stability generally, but also for firms themselves," he said.
Banks have relied increasingly on shorter-term funding and riskier trading over the last decade, Tarullo added, arguing that U.S. regulators cannot be "completely reassured" by the capital levels of foreign banks.
The U.S. central bank will continue to cooperate with foreign counterparts in overseeing banking, Tarullo said. But "that supervisory tool cannot provide complete protection against risks engendered by U.S. operations as extensive as those of many large U.S. institutions," he added.
Tarullo has been busy on bank regulation. Last month, he surprised Wall Street by suggesting that Congress should cap the size of banks based on their share of U.S. gross domestic product.