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Fed finalizes rule to guard against contagion between banks


According to Market Intelligence, February 2023


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Fed finalizes rule to guard against contagion between banks

The U.S. Federal Reserve finalized a rule aimed at preventing large banks from becoming too exposed to each other, giving them more time to comply with the rule but declining to budge on its strictest standard.

A key portion of the single-counterparty credit limit rule looks to protect against contagion of credit risk between the largest banks, so that the failure of one would have less impact on the others. The financial crisis showed that the risks those interconnections pose "can threaten the stability of the financial system," Fed Chairman Jerome Powell said at a Board of Governors meeting June 14. The board approved the rule unanimously.

They decided to keep one of the strictest parts of the rule, despite concerns from some in the industry that the Fed had not fully proved the provision's usefulness and requests from liberal-leaning groups to make it tougher. That provision will ensure that the eight U.S. global systemically important banks, or G-SIBs, such as JPMorgan Chase & Co. and Wells Fargo & Co., limit their aggregate net credit exposure to other systemically important institutions to 15% of the bank's Tier 1 capital.

Fed officials proposed the rule in 2016 after significantly reworking it from an earlier plan. It is part of the package of rules the Fed has to implement under the Dodd-Frank banking supervision law.

U.S. G-SIBs will face the 15% limit for their exposure to each other and to any nonbank company the Fed supervises. They also are prohibited from aggregate net credit exposure to other counterparties that exceeds 25% of their Tier 1 capital. The U.S. intermediate holding companies of foreign-owned banks will face the same set of standards if they have at least $500 billion in assets.

U.S. bank holding companies with at least $250 billion in assets that are not deemed systemically important will only face the 25% requirement guarding against their exposure to single counterparties. Smaller foreign-owned banks would see similar requirements.

The Fed's narrowing of the proposal is due to the Dodd-Frank revision package that President Donald Trump signed into law in May, as it generally eases requirements for banks below the $250 billion threshold. Companies between $50 billion and $100 billion in assets, for example, are no longer subject to enhanced prudential standards.

Under the new law, the Fed has flexibility to decide which companies between $100 billion and $250 billion will face those enhanced prudential standards, including the single-counterparty credit limit rule. Fed staff said in a memo that they are working on a proposal that would determine which enhanced standards they would keep for the companies that the Fed deems important enough to face more supervision.

G-SIBs will have to comply with the requirements by Jan. 1, 2020. Other companies will have until July 1, 2020, to comply with the rule.