March 4, 2016 / 8:21 PM / in 3 years

Fed proposes new limits on big banks' exposure to each other

WASHINGTON (Reuters) - The Federal Reserve on Friday proposed new limits on how much financial exposure the biggest U.S. banks can have to one another, part of a rulemaking process that aims to protect the system from a failing-bank domino effect in the event of a future crisis.

U.S. Federal Reserve Board Chair Janet Yellen testifies at the House Financial Services Committee in Washington February 10, 2016. REUTERS/Gary Cameron

The Fed first proposed a set of such limits in 2012, and faced backlash from the biggest Wall Street firms. Executives and lobbying officials argued that tight limits would hurt the financial system. Their biggest concerns had to do with how derivatives trades were treated. reut.rs/1LYPnmV

The new set of proposed limits - which cap financial exposure as a share of capital reserves - is more lenient than the first, but still places the toughest restrictions on the biggest banks.

Banks whose health is deemed important for the global financial system would be able to lend no more than 15 percent of the value of their stock and other durable capital to another large institution. The first proposed limit was 10 percent.

It is unclear where big banks’ exposure to one another now stands relative to the newly proposed rule.

After the Fed’s 2012 proposal, Goldman Sachs Group Inc (GS.N) estimated that big banks were 18 percent more exposed to one another than that rule would have allowed. But since that time, big banks have taken steps to reduce exposure to one another by, for instance, canceling certain derivatives trades.

Under the new proposal, banks with $250 billion or more in assets would be able to lend no more than 25 percent of their top-tier capital to one other institution. Banks with assets between $50 billion and $250 billion would be able to lend up to 25 percent of stock, cash and other capital to a peer.

The Fed must write this rule as part of the Dodd-Frank financial reform law passed in 2010. The interconnectedness of large financial firms - particularly in derivatives trades - fueled the panic and chaos that erupted during the financial crisis, because there were worries that one failing institution could take down many others.

Friday’s proposal “sets a bright line on total credit exposures” between the largest, regulated financial companies, Federal Reserve Chair Janet Yellen said in prepared remarks.

Wall Street banks and members of the public now have three months to comment on the proposal.

Reporting By Patrick Rucker and Jason Lange in Washington; additional reporting by Lauren Tara LaCapra in New York; Editing by Chizu Nomiyama

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