The Marriner S. Eccles Federal Reserve building stands in Washington, D.C., U.S.(. Photographer: Andrew Harrer/Bloomberg)

Fed Caps How Much Giant Banks Can Be Each Other's Customers

(Bloomberg) -- The Federal Reserve is imposing limits on big banks’ credit exposure to one another with a new rule, though their interactions have already declined and the rule has been eased so much that all of Wall Street is already generally in compliance.

The single-counterparty credit limit -- required by the 2010 Dodd-Frank Act as a way to keep a future crisis from spreading -- was approved by the Fed board in a 3-0 vote on Thursday. The long-awaited measure reflects changes from a 2016 proposal that would have required banks to dial back exposures by as much as $100 billion, and it’s even less stringent than the Fed’s first try in 2011. Relaxed demands, coupled with banks’ moves to central clearing of derivatives, has reduced the excess exposure closer to zero, though Fed officials declined to estimate how much.

The Fed narrowed the rule to primarily affect banks with more than $250 billion in assets instead of those with more than $50 billion, which would have encompassed some smaller regional banks. The regulator also has tweaked its measurement methods to reduce the exposure math for affected firms.

The rule is meant to prevent a repeat to the fallout from the 2008 collapse of Lehman Brothers Holdings Inc., when the financial connections among Wall Street firms threatened to take down the entire banking system.

Reducing Burden

“This final rule is another step in sustaining an effective and efficient regulatory regime that keeps our financial system strong and protects our economy while imposing no more burden than is necessary to get the job done,” Fed Chair Jerome Powell said in a statement.

The planned constraints had already been weakened over the years, and the final limits are in line with efforts from President Donald Trump’s appointed regulators -- including Powell and Fed Vice Chairman for Supervision Randal Quarles -- to ease the burdens of bank regulations.

The Fed is capping a global bank’s credit exposure to any of its peers at 15 percent of tier 1 capital -- matching the 2016 proposal. Other large banks that aren’t among the most complex and systemically important face a 25 percent limit. But the calculations of credit exposure have been simplified, and the banks’ newly assessed exposures are generally well under the limit, with the Fed estimating that “the draft final rule is unlikely to have a material impact” on the affected firms. Specifically, the rule would let banks use internal models to tally “securities financing transactions” -- a major part of their exposure.

The rule, based on international agreements and a provision of Dodd-Frank, could be changed to add limits for banks between $100 billion and $250 billion in assets, the agency said. And the institutions under the regulation will likely face a new filing requirement to show their ongoing exposures, with the Fed now working to set up that system.

Foreign Banks

Big foreign banks in the U.S. are also required to meet the credit limits, but the final rule adds an ability for them to comply by assuring the Fed that their home regulators already hold them to a similar standard.

Virtually all derivatives contracts in the U.S. banking system are concentrated among the largest firms, and other big banks are their main trading partners. Those connections were highlighted by the 2008 crisis, when the U.S. government had to step in to keep investor panic from spreading through the financial system.

This final rule represents significantly less pressure than the first proposal in 2011, which would have limited the biggest banks to a much tighter 10 percent exposure.

Wall Street lobbyists have argued, though, that regulators have overstated risks already dealt with over the years by changes in how the banks do business, the implementation of other rules and supervisory efforts such as the Fed’s annual stress tests.

“The financial system more broadly has adjusted in the period since the crisis to reduce potential contagion by shrinking harmful transmission channels among banks,” Quarles said in a statement. “Central clearing of derivatives is an example of such a reduction in interconnectedness.”

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