Fed Likely To Tighten Regulatory Noose Around Foreign Lenders

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Deutsche Bank

Deutsche Bank (NYSE:DB) and Barclays (NYSE:BCS) thought they had escaped the ambit of the Dodd-Frank Act by changing their legal status in the U.S. (see Deutsche Bank No Longer a U.S. Bank; What Does This Mean?) But it looks like the Federal Reserve will have the last laugh in this matter. The Fed is reportedly framing guidelines which will force foreign banking groups to organize all their U.S. units under a bank holding company. [1]

Both Deutsche Bank and Barclays had deregistered their U.S. arms as bank holding companies in recent years to escape the stricter capital requirements laid out for all U.S. banks which would have forced their parent companies to pump in billions of dollar into their U.S.-based subsidiaries. The Fed’s stand will also affect the Swiss banks UBS (NYSE:UBS) and Credit Suisse (NYSE:CS) which were never formed as bank holding companies to begin with.

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The Motive

When the Dodd-Frank Act quashed the exemption accorded to U.S. subsidiaries of foreign banks regarding minimum capital levels, the foreign banks responded by removing their ‘bank holding company’ status in the country – thereby avoiding the need to comply with the local capital norms. In a bid to address this glaring loophole, the Federal Reserve is apparently considering a compulsory requirement for all U.S.-based units of foreign banks to be housed under a bank holding company. This would automatically subject the U.S. subsidiaries to all the implemented and proposed laws under the Dodd-Frank Act.

The Fed’s Stand Is Rational..

The biggest advantage of this rule the Fed is pondering on is that the overall banking industry in the U.S. will be more resilient to adverse economic conditions. After all, about a quarter of all commercial and industrial loans in the country are handed out by foreign banks. [1] And considering the fact that the Fed essentially gave out the same amount of emergency loans to foreign banks as it did to U.S. banks during the economic downturn of 2008, it hardly seems fair to let the foreign banks off the hook when strict capital requirement laws are being drafted.

But It Will Hurt The Foreign Banks

The U.S.-specific leverage requirements will mean the foreign banks will need to recapitalize their U.S. subsidiaries. Deutsche Bank, for example, estimated that it will need to pump in $20 billion in capital into its U.S. subsidiary, Taunus Corp., to meet the comply with the leverage cap. Barclays, UBS and Credit Suisse would also be required to make similar multi-billion dollar capital infusions.

This poses two serious problems for the foreign banks. While funding costs linked to the additional capital will drag down the net interest margins for the banks’ U.S. operations, it will also restrict the ability of the parent company to move funds across regions. This will hit the competitiveness of the foreign banks in the U.S., and they could even be driven to trim their presence in the country.

The impact of a reduction in interest margins on Deutsche Bank’s total value can be understood by making changes to the chart above.

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  1. U.S. Said to Weigh Tightening Rules for Foreign Lenders, Bloomberg, Nov 27 2011 [] []