Banks Lament U.S. Effort to Be Toughest Cop on Planet

This version of the story includes additional perspective on the Fed’s reasoning for its enhanced implementation of international agreements.

WASHINGTON — The banking industry is increasingly concerned that U.S. regulators' propensity for tougher rules than those envisioned in global agreements is leading to increasing entanglements between U.S. and foreign compliance regimes.

Since the crisis, the Federal Reserve Board, Federal Deposit Insurance Corp. and Office of the Comptroller of the Currency have routinely gone further than international standards — such as the capital standards outlined by the Basel Committee on Banking Supervision and more macroprudential guidelines proposed by the Financial Stability Board — implementing more rigorous versions. Fed Gov. Daniel Tarullo, who heads the central bank's supervisory committee, said during a 2014 congressional hearing that he views "the notion of Basel Committee agreements as a minimum level" of regulation.

But there are some indications that these enhancements — sometimes referred to as "gold-plating" — of the Basel and FSB standards create discrepancies for large global banks that answer to multiple national regulators. For example, in October the Office of Financial Research issued a report that said differences between the Basel III "liquidity coverage ratio" and the final LCR rule issued by the U.S. bank regulators in 2014 make liquidity health harder to gauge when comparing banks between different jurisdictions.

The Fed, for one, has advanced stronger rules than those issued by international bodies despite the U.S. central bank's desire to keep global frameworks intact, said Karen Shaw Petrou, managing partner of Federal Financial Analytics. She said other member jurisdictions that are part of the Basel and FSB process also pursue their own strategic agendas when implementing standards for their banks.

"The Fed is working very hard to keep its action within the construct of the global framework because it so fears what might happen if that fell apart," Petrou said. "But the global framework permits all the gold-plating that in fact fragments [the standards] despite all the rhetoric that everyone's working together. They're not. The substance of the rules is strategically very different."

Before the final U.S. "liquidity coverage ratio" was issued, in 2014, the U.S. agencies similarly finalized a higher leverage ratio — measuring total capital strength without risk weights for different assets — than that agreed to at the Basel Committee. The U.S. version of the LCR, which requires banks to hold enough "high-quality liquid assets" to get them through a liquidity crisis, adopted a faster phase-in period than the Basel III accords and included restrictions not included in the Basel agreements.

The Fed has continued the trend with rules it has issued without other U.S. regulators. Its capital surcharge rule for global systemically important banks, or G-SIBs, in July 2015 included an extra charge for banks that relied more heavily on short-term wholesale lending. And in October, the Fed similarly proposed a more complex version of total loss-absorbing capacity rules — and a week earlier — than the final rule agreed to by the FSB.

Others also point to the Fed's 2014 rules imposing additional capital requirements on "foreign banking organizations" operating in the U.S. as illustrating the problem with jurisdictions' not being consistent. Under the rule, foreign banks must keep at least some capital in the U.S.

Gregory Lyons, a partner at Debevoise & Plimpton, said the rule on foreign banking organizations effectively broadened the scope of the Basel accords for foreign banks that have a U.S. business, even though the Fed's rule was not tied to the Basel process. If such gold-plating is emulated around the globe, Lyons said, it can lead to "fiefdoms of capital" in which a jurisdiction can ensure that capital is trapped there instead of being deployed based on efficiency and return.

"The real danger, I think, for the banks comes in … if what ends up happening is that, on top of this new Basel framework, individual countries require their own separate capital frameworks for banks outside of those jurisdictions," Lyons said. "That can make it difficult for those banks, because of inefficient use of capital."

For its part, the Fed has repeatedly maintained that almost all of its gold-plating moves have been directed at only the largest and most systemically risky banks, a reflection of its longstanding policy of "tailoring" its rules to appropriately fit a bank's risk profile. The U.S. banking regulators have also maintained that they go above and beyond international agreements because, while regulators — particularly the Fed — are active in international forums and strive to make international agreements as stringent as possible, the final agreements are not always as strong as they feel they would need to be to offset the risks posed by the largest U.S. banks.

It is also true that the U.S., while further ahead in implementation of Basel rules than some other jurisdictions, is far from the only country that goes above and beyond those standards. The United Kingdom and Switzerland in particular have taken great strides in implementing their own financial rules that exceed the minimum Basel standards, and those regulators cite similar concerns that Basel standards are not stringent enough to meet the risks posed by their largest institutions as justification for that heightened regulation.

Some observers said distinctions between different countries' approaches are expected when it is up to a domestic regulator to implement a global standard.

Adam Gilbert, global regulatory leader of PwC's financial services advisory practice, said that, although international regulators negotiate a global framework, the buck really stops with each individual regulator writing the rules.

"It's an inherent tension in the process," Gilbert said. "You don't have an international body that has the force of law, and so you have to rely on local implementation, and that gives the members of the group their own kind of veto, if you will, on what they agree to internationally."

But other areas that international agreements have not yet fully resolved are ripe for more mismatches and future complications. In the near term, a standard set of capital floors for banks and guidelines dealing with the risk weights for assets in banks' trading books are among the last Basel III standards to be completed.

Several observers said that in the longer term banks will be watching how international regulators, specifically in Europe, implement stress testing and resolution planning rules — areas where the U.S. has already devised formal rules that other jurisdictions seem reluctant to emulate.

Meanwhile, the Basel Committee is developing standards not associated with Basel III that could have a significant impact on international banking, regardless of whether the U.S. imposes a tougher version. Susan Krause Bell, managing director of Promontory Financial Group, said the committee is considering more quantitative, prescriptive standards for managing interest rate risk and whether the global 3% leverage ratio should be higher.

Another potential step being considered by the Basel Committee this year appears to deal directly with discrepancies between member countries. The committee is weighing whether to standardize the process for approving banks' risk management measuring models. Basel III allows certain large banks — which can follow so-called "advanced approaches" to measuring risk-based capital — to develop their own risk models for assets rather than using regulators' standardized models. But with banks' internal models subject to approval by their home-country regulators, there appear to be significant discrepancies in models sanctioned by different countries and a lack of accountability for some of those discrepancies.

"It's generally agreed that some of the variation [in advanced approaches] is inappropriate and has to do with differences in supervisory implementation, and some of the variation is appropriate because it has to do with differences in credit risk and sophistication of different banks," Krause Bell said. "The outcome isn't yet clear, but I expect they will seek to standardize banks' internal models a little more without doing away with the risk sensitivity."

Lyons said that, while some discrepancies between regulators may even be welcome, the dynamic between global frameworks and home-country implementation could get more complicated as the FSB looks at even more prescriptive requirements, a set of initiatives sometimes referred to as "Basel IV."

He said it is often overlooked how the hodgepodge of global standards combined with countries issuing their own versions and regulators requiring granularity with capital regimes creates technical compliance challenges.

"Even if you put aside the policy issues, just the systems requirements … are staggering, especially since regulators expect it to be done with precision," Lyons said. "If you're a global bank now, you have to be able to track and monitor capital in all different kinds of ways in all these different jurisdictions. As these rules become finalized now, it's just becoming evident how burdensome" they are.

Krause Bell said it is unclear whether the appetite of regulators, particularly in the U.S., for onerous rules that go beyond the global standard will ever level off. She said that banks inadvertently undermine arguments that capital rules are too stringent by complying with them, and that there are always unknown risks in the banking sector. But, she added, regulators could also consider marking a finish line that the industry can say it has finally crossed at some point.

"Regulators have been successful in getting banks to reduce their short-term wholesale funding, and while resolvability of a G-SIB hasn't yet been tested, there is a lot more thought given to the structure of large banks from a resolvability point of view," Krause Bell said. "Between these and other changes — as well as the stronger capital positions at most institutions — the urgency of additional requirements may have eased. I think there will come a time when a commensurate adjustment in the pace of new regulation will be appropriate."