Fed's Tarullo Foreshadows New Regulatory Regime for Foreign Banks

WASHINGTON — Federal Reserve Board Gov. Daniel Tarullo on Wednesday offered an early peek at significant policy changes U.S. regulators are considering for the supervision of large foreign banking organizations.

Tarullo said the central bank will release a proposal in the next few weeks that would require foreign banks operating here to comply with the same regulatory requirements as U.S. bank holding companies.

"By imposing a more standardized regulatory structure on the U.S. operations of foreign banks, we can ensure that enhanced prudential standards are applied consistently across foreign banks and in comparable ways between U.S. banking organizations and foreign banking organizations," Tarullo said in a speech at Yale University's Law School.

U.S. regulators, he added, would provide transition periods to ensure that the new set of rules would be "minimally disruptive."

Regulators have been working behind the scenes to draft new rules required under the Dodd-Frank Act to improve their supervision of foreign banking organizations and address the risks such firms took in the lead-up to the crisis, especially with regard to their reliance on short-term funding.

"We need to adjust the regulatory requirements for foreign banks in response to changes in the nature of their activities in the United States, the risks attendant to those changes, and instructions from Congress in new statutory provisions," Tarullo said.

Such reforms, he said, should address reducing the challenges in resolving institutions that operate across borders and limiting the possibility of "ex-post ring-fencing when losses mount or runs develop during a crisis."

Tarullo outlined three changes to how foreign banking organization should be regulated in the future. He suggested that the largest U.S. operations of foreign banks should establish a first-tier intermediate company that encompasses all its U.S. bank and nonbank subsidiaries. Those firms, he said, would then face the same capital requirements that U.S. bank holding companies must adhere to.

"These rules have been reshaped to counteract the risks to the U.S. financial system revealed by the crisis and should be implemented consistently across all firms that engage in similar activities," Tarullo said.

Other requirements called for under Dodd-Frank like annual stress testing, risk management regulations and single counterparty credit limits, should also apply, he said.

Lastly, there should be liquidity standards for such firms that are consistent with the requirements that bank holding companies will have to adopt once the Basel Committee on Banking Supervision reaches a final agreement.

"Standards are needed to increase the liquidity resiliency of these operations during times of stress and to reduce the threat of destabilizing runs as dollar funding channels dry up and short-term debt cannot be rolled over," Tarullo said.

Still, Tarullo expressed caution that such regulatory changes should also take into account the benefits that such firms have to the U.S. economy and the important policies of "national treatment and comparable competitive opportunity."

"We should chart a middle course, not moving to a fully territorial model of foreign bank regulation, but instead making targeted adjustments to address the risks I have identified," he said.

The Fed governor acknowledged that the suggested set of reforms are "more territorial" than the current approach, such as requiring additional capital and liquidity buffers, but they don't represent "a complete departure from prior practice."