Fed rule tailors bank regulations to link requirements to risk

The final rules “maintain our objective” to “develop a regulatory framework that more closely ties regulatory requirements to underlying risk,” said Randal Quarles, Federal Reserve Board vice chair for supervision, in a press release.

The Federal Reserve Board’s action stems from the Economic Growth, Regulatory Relief, and Consumer Protection Act, which was signed into law by President Trump in 2018. The act directed federal banking agencies to promote economic growth by tailoring their regulations to reflect the character of the different institutions they supervise.

Categorizing by size and other factors

The “tailoring rules” sort large banks into categories. “Size will remain a key factor in our evaluation of a firm’s overall risk,” explained Federal Reserve Board Chair Jerome Powell in a statement prepared for the meeting at which the rules were approved. Other measures of risk are incorporated into the Federal Reserve Board’s tailoring framework as well, though.

“These measures include cross-border activity and reliance on runnable funding,” Powell said. Including those risk measures “will better capture a firm’s overall complexity and risk,” he continued.

The tailoring rules are “generally the same for domestic and foreign banks,” Powell said, noting that U.S. regulators “have a long-standing policy of treating foreign banks the same as we treat domestic banks.” That approach, he maintained, is a fair one. It also “helps U.S. banks, because banking is a global business, and a level playing field at home helps to level the playing field for U.S. banks when they compete abroad,” Powell said.

Words of caution

Not every member of the Federal Reserve Board of Governors was quite so supportive of the board’s easing of requirements. “Today’s actions go beyond what is required by law and weaken the safeguards at the core of the system before they have been tested through a full cycle,” said Federal Reserve Board Governor Lael Brainard in a statement. “At a time when the large banks are profitable and providing ample credit, I see little benefit to the banks or the system from the proposed reduction in core resilience that would justify the increased risk to financial stability in the future.”

According to Brainard, the liquidity coverage ratio of domestic banks with assets of $250 billion to $700 billion would be reduced by “15 percent or $34 billion.” The Federal Reserve Board estimates the rule change will just result in “a reduction of 2 percent of required liquid assets for all banks with assets of $100 billion or more.”

Ongoing dialogue

Although the Federal Reserve did receive public comments regarding the liquidity of U.S. branches of foreign banks, liquidity requirements for those branches are not covered by the tailoring rules the board approved last week. Brainard said the board for years had contemplated the risk posed by these branches and had discussed “proposing the application of standardized liquidity requirements to the branches and agencies of foreign banks.” The Federal Reserve Board did not address this risk in its most recent rulemaking action. Quarles said input from peer supervisors in other jurisdictions had been obtained and that a dialogue with foreign counterparts would continue.

The regulatory capital and liquidity elements of the rules were developed jointly by the Federal Reserve Board with the FDIC and the Office of the Comptroller of the Currency. The rules will become effective 60 days after they are published in the Federal Register.

Lori Tripoli is a writer based in the greater New York City area who focuses on legal and regulatory issues.