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Federal Reserve Board Issues Rules for Systemically Significant Financial Institutions
Practical Law Legal Update 0-517-0092 (Approx. 5 pages)
Federal Reserve Board Issues Rules for Systemically Significant Financial Institutions
by PLC Finance
| Published on 21 Dec 2011 • USA (National/Federal) |
On December 20, 2011, the Federal Reserve Board issued proposed rules under the Dodd-Frank Act on the regulation of systemically significant financial institutions.
On December 20, 2011, the Federal Reserve Board (FRB) issued a proposed rule under the Dodd-Frank Act on the supervision and regulation of systemically significant financial institutions (SSFIs). SSFIs include both large bank holding companies (BHCs) and nonbank financial firms designated as systemically important by the Financial Stability Oversight Council. Under the proposed rule, SSFIs would be subject to a number of enhanced regulatory measures, including:
- Risk-based capital requirements and leverage limits.
- Liquidity requirements.
- Single-counterparty credit limits.
- Risk management and risk committee requirements.
- Stress tests.
- Debt-to-equity limits.
- Early remediation requirements.
The proposed rule would apply the same set of enhanced requirements to both large BHCs and nonbank companies designated as SSFIs. However, the FRB may tailor the application of these enhanced requirements to different companies on an individual or category-wide basis after taking into consideration the company's or companies':
- Capital structure.
- Level of risk.
- Complexity.
- Financial activities.
- Size.
- Other risk-related factors.
The FRB indicated that its ability to tailor these requirements will be particular important when applying them to nonbank SSFIs that are organized and operated differently from BHCs.
Risk-based Capital Requirements and Leverage Limits
The proposed rule would implement risk-based capital and leverage requirements in two phases:
- SSFIs would initially be subject to the capital plan rule issued by the FRB in November 2011, which requires large BHCs (and by extension under the proposed rule to nonbank SSFIs) to:
- annually develop and submit a capital plan to the FRB;
- conduct stress tests; and
- maintain adequate levels of capital.
(For more information on the capital plan requirements, see Legal Update, Fed Requires Annual Capital Plans From Top-tier Bank Holding Companies). - The FRB will eventually issue a rule implementing the risk-based capital surcharge based on the international framework and methodology developed under Basel III (for more information, see Basel III: an overview: Additional capital requirements for global systemically important banks (G-SIBs)).
Liquidity Requirements
The liquidity requirements under the proposed rule would also be implemented in two phases:
- SSFIs would initially be subject to qualitative liquidity risk management standards and requirements, including conducting internal liquidity stress tests and setting internal quantitative limits to manage liquidity risks that are generally based on the Interagency Policy Statement on Funding and Liquidity Risk-management Practices, previously issued by the federal banking agencies.
- The FRB will eventually issue rules implementing the quantitative liquidity requirements formulated under Basel III (for more information, see Basel III: an overview: Liquidity requirements).
Single-counterparty Credit Limits
The proposed rule would limit:
- A SSFI's credit exposure to a single counterparty to 25% of the SSFI's capital stock and surplus. This is similar to the lending limits already imposed on depository institutions (see, for example, US Banking Law: Overview: Lending Limits for National Banks).
- The credit exposure between a SSFI and a counterparty to 10% of the capital stock and surplus of the relevant SSFI where each party either:
- has $500 billion in total consolidated assets; or
- is a nonbank designated as a SSFI.
Risk Management and Risk Committee Requirements
The proposed rule requires:
- All SSFIs to implement enterprise-wide risk management practices that are overseen by a qualified chief risk officer and by a risk committee established by the company's board of directors.
- Publicly traded BHCs with $10 billion or more in consolidated assets to establish a risk committee that includes an appropriate number of independent directors and at least one risk management expert.
Stress Testing Requirements
Under the proposed rule, SSFIs would be subject to annual stress tests by the FRB using various economic and financial market scenarios. A summary of the results of these stress tests would be disclosed to the public. SSFIs would also be required to conduct one or more company-run stress tests each year and publicly disclose a summary of their results.
The stress test requirements also extend to any financial company that has more than $10 billion in total consolidated assets and is regulated by a federal financial regulatory agency.
Debt-to-Equity Limits
The proposed rule imposes a maximum debt-to-equity ratio of 15:1 for a SSFI if the FSOC has determined that both:
- The company poses a grave threat to the financial stability of the US.
- The debt-to-equity limit is necessary to mitigate the systemic risk posed by the company.
Early Remediation Requirements
The early remediation requirements are intended to enable the regulators to identify emerging or potential issues with a SSFI before they develop into larger problems. Early remediation measures could be triggered by numerous factors, including:
- The company's regulatory capital levels.
- Stress test results.
- Market indicators.
- Enterprise-wide and liquidity risk management.
Remedial measures would depend on the severity of the situation, but may include:
- Restrictions on growth, capital distributions and executive compensation.
- Required capital raising or asset sales.
Banking Organizations Not Covered Under the Rule
The following types of banking organizations are not generally covered under the proposed rule:
- Foreign banking organizations. They do, however, apply to a foreign banking organization's US bank holding company subsidiary that itself qualifies as a SSFI. The FRB plans to issue a separate proposed rule applying enhanced standards to foreign banking organizations that have both a US banking presence and global consolidated assets of $50 billion or more.
- Thrift holding companies. However, they are subject to the proposed rule's stress test requirements. The FRB plans to issue a separate proposed rule applying enhanced standards to relevant thrift holding companies.
The FRB may also extend some of the proposed rule's requirements to BHCs that do not qualify as SSFIs if the FRB has determined that these measures are necessary to promote financial stability or to protect the safety and soundness of the BHC.
Compliance Dates
Compliance with most of the proposed requirements will be required within one year after the effective date of the rule becoming final. However, the enhanced risk-based capital and leverage requirements, the single counterparty credit limits and the stress testing requirements would be subject to different compliance dates.
Comments on the proposed rule are due by March 31, 2012.
For more information on the Dodd-Frank Act requirements applicable to SSFIs, see Practice Note, Summary of the Dodd-Frank Act: Regulation of Systemically Significant Financial Institutions.