Global liquidity flows threatened by Dodd-Frank provision on foreign banks

The Dodd-Frank and US Federal Reserve proposal to regulate foreign banking organisations and ring-fence liquidity could hamper the efficient allocation of capital, according to a senior chief risk officer in Japan.

Section 165 of the Dodd-Frank Act says that in order to mitigate risks to the financial stability of the US from the failure of “large, interconnected financial institutions”, the act will establish prudential standards for non-bank financial companies with total consolidated assets equal to or greater than $50 billion.

Under the new rules, foreign banks will be subject to the same capital rules as US banks whereas previously they could rely on an exemption set out in a Federal Reserve letter dating back to 2001 that allowed non-US bank groups to hold a bank through a locally registered holding company without having to comply with US capital adequacy requirements, as long as the parent company is subject to consolidated capital adequacy regulations.

The detailed provisions, outlined in December, will require the largest foreign banks with more than $50 billion in US assets to establish separately capitalised interbank holding companies (IHCs) with a US governance framework for liquidity, leverage ratio, stress testing and counterparty credit limits. Japanese banks are among the most affected in Asia with both MUFJ and Mizuho exceeding the de minimus threshold to set up an IHC.

Kenji Fujii, chief risk officer at Mizuho in Tokyo, says the Federal Reserve’s rules will be particularly damaging to Japan, where a high household savings rate means large amounts of yen flow out of the country to be invested abroad.

“Japan has a consistent surplus in the household sector, which helps to support overseas deficit sectors through global capital market activities. Ring-fencing of liquidity country by country, together with new Basel III capital rules, would be harmful to the flows in global capital markets, which is necessary for a thriving world economy,” says Fujii.

A further potential area of tension is double supervision between the home and host jurisdictions – something that may be exacerbated as countries set implementation guidelines for Basel III. A senior strategy adviser to another Japanese bank says the link between Basel III and the US regulations of foreign banks is a cause of uncertainty. “From the industry viewpoint, more international co-ordination is necessary instead of unilateral enhancements,” he says.

As the Japan Financial Services Agency is already implementing Basel III for Japanese banks while the US and Europe have announced a delay in the timetable, there is also a risk of conflict between the US version of Basel III and the Japanese version for the US operations of Japanese banks.

Lawyers and bankers are busy preparing responses to the controversial US proposal that is set to come into force in July 2015. The deadline for comments ends on March 31.


This article was first published on Risk

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