Fed Proposal Addresses Key Cause of Financial Distress Between Banks

The Federal Reserve has proposed a rule aimed at improving financial stability among larger bank holding companies by limiting excessive credit exposures by a bank to a single counterparty. During the financial crisis, excessive credit exposures between financial institutions resulted in the spread of financial distress and undermined financial stability.

The proposal would apply single-counterparty limits to banks with total consolidation assets of $50 billion or more, according to the Fed. The stringency of the limits would increase the larger the systemic footprint of the institution to which they apply.

The proposed rule implements part of the Dodd-Frank Wall Street Reform Act of 2010 and builds on earlier proposals made by the Fed in 2011 and 2012. Some modifications were made to the earlier proposals based on comments received.

“We are determined to do as much as we can to reduce or eliminate the threat that trouble at one big bank will bring down other big banks,” said Fed Chair Janet L. Yellen.

“We are determined to do as much as we can to reduce or eliminate the threat that trouble at one big bank will bring down other big banks.”

Federal Reserve Chair Janet Yellen

Under the proposed rule:

• Globally systemically important banks would be limited to credit exposure of 15 percent or less of the bank’s tier 1 capital to another systemically important financial firm and up to 25 percent of the bank’s tier 1 capital to another counterparty.
• For banks with total consolidated assets of $250 billion or more, the credit exposure limit would be no more than 25 percent of the bank’s tier 1 capital to a counterparty.
• For banks with $50 billion or more in total consolidated assets, credit exposure would be limited to no more than 25 percent of the bank’s total regulatory capital to another counterparty.
• The proposed rule would not apply to banks with less than $50 billion in total consolidated assets, including community banks

According to the Fed, the new proposal is seeking to promote global consistency by generally following the Basel Committee on Banking Supervision’s international large exposures framework released in 2014.

“This regulation would complement overall capital requirements, which are generally based on the size and nature of a bank's assets, but do not address the concentration of risk in specific borrowers or counterparties,” Fed Governor Daniel K. Tarullo said.

The Fed has released a white paper explaining the analytical and quantitative reasoning for the proposed rule's tighter 15 percent limit for credit exposures between systemically important financial institutions and why such institutions are likely to come under stress at the same time.

Comments on the proposed rule are invited until June 3, 2016.

Click here to view the notice published in the Federal Register.

Click here to view the Fed’s white paper on the new rule.

Click here to read Chair Janet Yellen’s opening statement and click here to read Fed Governor Daniel Tarullo’s opening statement.