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On Tuesday, the Federal Reserve Board approved the final rules put in place for foreign banks. The tougher rules intend to make banks more regularized and supervised, in order to guarantee that the banks maintain a solid capital position and become resilient in stressful times.

The regulators are contemplating proactive measures to ensure that the world’s largest banks strengthen their capital and liquidity positions to better combat another financial meltdown.

A weak capital level is always a threat to the global economy. Needless to say, meeting new rules would act as building blocks for the still shaky global economy, with fewer bank collapses and less involvement of emergency loans for the bailout of troubled financial institutions.

New Rules

The final rule directs foreign banks with $50 billion or more in assets in America to establish an intermediary holding company in the U.S. As per the new rules, the holding company will be required to meet the same capital, risk management and liquidity standards as the U.S. banks. The proposed rules suggest that banks would need to set aside more capital as buffer in times of unexpected losses.

Moreover, regular stress tests will be conducted on the foreign-owned U.S. intermediate holding company. Failure in the tests will restrict dividend payments even to the parent company. Notably, the stress test rounds are precautionary measures amid an economic recovery to check whether the banks have enough capital to survive another financial crisis.

The new rules were chalked out following the financial crisis, when the Fed shelled out huge emergency loans to big foreign banks for pushing up their downtrodden businesses. Fed estimates that around 15 to 20 foreign banks would be required to comply with the new rule, which was proposed previously in Dec 2012, when the requirement was $10 billion in U.S. assets.

According to the new rules, the foreign bank operations will be required to maintain capital equal to 4% of their assets as compared with the largest American banks, which will be maintaining a leverage ratio of 5%.

Operating with low levels of capital gave foreign banks the opportunity of decreasing theirs costs of operations, providing them an edge over their American competitors like The Goldman Sachs Group, Inc. (GS - Analyst Report) and Morgan Stanley (MS - Analyst Report). With the aim of implementing fair rules to all operating entities, the Fed has come up with such rules which still permit the foreign banks’ American operations to hold less capital.

However, some major foreign banks with significant operations in the U.S. including Deutsche Bank AG (DB - Analyst Report) and Barclays PLC (BCS - Analyst Report) opposed the rules as implementation of such rules will bound them to transfer their costly capital from Europe.

Notably, the new rules will be effective from Jul 2016, while the leverage ratio requirement will not be applied until 2018. This is to comply with the requirements of section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Our Viewpoint

These rules might limit the flexibility of the banks with respect to investments and lending volumes. Moreover, such stringent capital rules may considerably slacken the pace of a worldwide economic recovery in the near term.

Though economic uncertainty still lingers, banks are actively responding to every legal and regulatory pressure. In fact, this has positioned the banks well to encounter impending challenges. As the sector is undergoing a radical structural change, it is expected to witness headwinds in the near to mid term. However, entering the new capital regime will significantly improve the industry’s long-term stability and security.

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