Fed finalizes rule limiting banks' exposure to single trading partner

WASHINGTON — The Federal Reserve Board on Thursday released its final rule limiting the amount of exposure large banks can maintain with a single trading counterparty, raising applicability thresholds but otherwise hewing close to the 2016 proposal.

The rule, which the board approved unanimously at an open meeting, will prohibit all U.S. banks above $250 billion in assets from having more than a quarter of Tier 1 capital in credit exposures to a single counterparty — either a bank or nonbank.

The rule also prevents global systemically important banks, or G-SIBs, from having credit exposures of more than 15% of Tier 1 capital tied to another systemically important institution.

Federal Reserve Board Chair Jerome Powell praised the final rule, saying it shows the agency’s commitment to strong but sensible regulation.

“The financial crisis showed that financial interconnections between our largest and most complex institutions … can threaten the stability of the financial system,” Powell said. “This final rule is another step in sustaining an effective and efficient regulatory regime that keeps our financial system strong and protects our economy while imposing no more burden than is necessary to get the job done.”

Foreign banking organizations with more than $250 billion in assets would also be barred from having more than 25% of Tier 1 capital exposed to a single counterparty, unless they are already subject to a similar rule in their home jurisdiction. In that case, the banking organization can obtain a waiver from the Fed. Foreign G-SIBs would similarly be subject to the 15% Tier 1 limit, and would similarly be able to obtain a waiver from the Fed if they are subject to a similar rule in their home country.

For foreign banking organizations with U.S.-based intermediate holding companies, those IHCs with assets over $50 billion would be forbidden from having a single-counterparty exposure greater than 25% of total capital, whereas IHCs with between $250 billion and $500 billion would be subject to the 25% of Tier 1 capital limit. International holding companies with more than $500 billion would be subject to the G-SIB requirements.

Fed Vice Chairman for Supervision Randal Quarles said the rule is a “useful complement” to other post-crisis innovations, including enhanced liquidity and capital requirements.

“The final rule adds to these protections by setting out clear limits on credit exposures among the largest banking firms,” Quarles said. “I am pleased by the final rule’s efficient approach to setting limits that are appropriately adjusted for firms of lesser systemic importance.”

Fed Gov. Lael Brainard called the regulation “overdue” and said it would “ensure that distress at one of these large, complex institutions does not ricochet around the global financial system.”

The Dodd-Frank Act requires the Fed to include single-counterparty credit limits as a mandatory aspect of its Section 165 enhanced prudential standards for Systemically Important Financial Institutions.

The agency first issued a Single Counterparty Credit rule in 2011, and in that iteration of the rule, proposed a two-tiered structure. The first tier forbade banks with more than $50 billion in assets from extending more than 25% of Tier 1 capital to a single counterparty, while banks with more than $500 billion in assets faced an additional constraint of not being able to extend credit in excess of 10% of overall capital to one another.

The Fed re-proposed the rule in March 2016, making significant changes. Instead of a two-tiered structure, the Fed proposed a three-tiered structure: banks with between $50 and 250 billion in assets would face a 25% cap of total capital (as opposed to Tier 1 capital), while banks with between $250 and 500 billion would face a 25% cap based on Tier 1 capital. Banks — both foreign and domestic — with more than $500 billion, however, would have been subject to a cap of 15% of Tier 1 capital.

While the final rule resembles the 2016 proposal, it did include a notable increase in the applicability threshold from $50 billion to $250 billion. That reflects the recent passage of a bill that redefined SIFIs — which are subject to the Fed's enhanced supervisory regime — as banks with at least $250 billion in asset, rather than the earlier $50 billion threshold. The bill allows the Fed to apply enhanced prudential standards to banks between $100 billion and $250 billion in assets.

A Fed official said the agency has not yet determined how or to what degree to apply the single-counterparty rule to banks between $100 and $250 billion in assets, and that determination will be resolved at a future date.

Quarles had hinted that the Fed might do some additional tailoring in the final, saying in a speech in January that the agency in general ought to distinguish between G-SIBs and large banks with less global footprints.

“I believe it is time to take concrete steps toward calibrating liquidity requirements differently for large, non-G-SIBs than for G-SIBs,” Quarles said in a speech in January. “We should also explore opportunities to apply additional tailoring for these firms in other areas, such as single-counterparty credit limits and resolution planning requirements.”

The Treasury Department’s June 2017 report recommending changes to financial regulation called for the Fed to limit the rule to apply only “to only the largest banks.” The report also criticized the implementation costs of the rule and suggested that the rule should be revised in the event that Congress raises the applicability threshold for SIFI banks — something Congress did last month with the passage of the Senate regulatory relief bill.