Risk & Compliance

Fed Proposes Limits on Banks’ Credit Exposure

The new effort to reduce systemic risk in the industry is a less restrictive version of a 2011 rule that met with strong criticism from banks.
Katie Kuehner-HebertMarch 7, 2016

The U.S. Federal Reserve is making another attempt to reduce systemic risk in the banking industry by limiting the credit exposure that institutions have to each other and their counterparties.

Under a proposed rule released Friday, the eight U.S. banks considered “globally systemically important” by regulators would be restricted to a credit exposure of no more than 15% of the bank’s high-quality Tier 1 capital to another GSIB.

The Fed in 2011 proposed a 10% cap that was shelved amid criticism from the industry that it was too effective. The 15% cap would also apply to foreign banks with more than $500 billion in assets in the U.S.

All banks with more than $50 billion in assets will be restricted to a maximum exposure to any one counterparty equal to 25% of their total capital base, plus certain additions.

“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,” Fed Chair Janet Yellen said in a news release.

As part of the 2010 Dodd-Frank financial reforms, Congress required the Fed to impose limits on big banks’ exposure to a single counterparty. But as MicroCap Magazine reports, the rule “has spent years on the back burner,” with regulators focusing largely on other high-profile regulations tied to capital, liquidity and other curbs on risk-taking.

“The [banking] industry has warned that overly strict counterparty credit limits would mean less bank activity in derivatives markets, and therefore less competition and higher prices,” MicroCap said.

Yellen said Friday that the new rule is “another important step to enhance the resiliency and stability of our financial system.”

“In the financial crisis, we learned that the largest and most complex banks and financial institutions lent or promised to pay large amounts to other institutions that were also very large and complex,” she noted. “These credit extensions and promises did not eliminate risk, and in many cases they magnified it.”

Adam Gilbert, a former New York Fed official who is now PwC’s global regulatory leader, told Bloomberg that bankers are carefully scrutinizing the latest Fed proposal.

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