Bloomberg News

Fed Bolsters Tools to Avert Collapse of Big Financial Firms

December 20, 2011

(Updates markets in sixth paragraph.)

Dec. 20 (Bloomberg) -- The Federal Reserve sought to curb the risk of financial turmoil by strengthening the central bank’s tools for preventing the collapse of large firms and demanding stricter oversight by companies’ boards of directors.

“The proposal would create an integrated set of requirements that seeks to meaningfully reduce the probability of failure of systemically important companies and minimize damage to the financial system and the broader economy in the event such a company fails,” the Fed said in the draft rules today.

The central bank’s proposed standards, aimed at averting a recurrence of instability following the collapse of U.S. mortgage finance, target banks with assets totaling $50 billion or more and financial firms deemed “systemically important.” The Fed delayed releasing rules for supervision of foreign firms and for risk-based capital and leverage requirements.

The proposed Fed rules require boards of directors to oversee and approve plans for limiting liquidity risk, while imposing enforcement triggers for firms deemed to have weaknesses in capital and risk management. The standards are mandated under the Dodd-Frank regulatory overhaul law passed in July 2010.

Comments on the proposal are due by March 31, the Fed said today.

Shares of U.S. lenders have trailed the broader market this year, with the 24-company KBW Bank Index dropping 30 percent in 2011 through yesterday, compared with a 4.2 percent decline for the Standard & Poor’s 500 Index. The KBW Bank Index rose 4.2 percent at 2:40 p.m. in New York.

Revenue Pinched

Bank revenue has been pinched by new regulations on retail banking, such as the Fed’s cap on debit-card transaction fees, and weaker results at trading operations.

“The rules are really going to be quite different for the largest institutions,” Gary Townsend, a founder of Hill- Townsend LLC in Chevy Chase, Maryland, said on Bloomberg Television. “It seems foolish to me to be basing this on size” rather than on business model and complexity, he said.

Under the proposal banks’ boards of directors would be required to review regular reports from senior management on capital adequacy and sign off on plans to fund institutions in times of liquidity stress and economic strain.

The boards would annually need to approve internal liquidity proposal and set levels of risk gauged to a companies’ “financial condition and funding capacity on an ongoing basis,” the central bank said.

Failure of a Company

The Fed would curb a larger firm’s exposure to a single counterparty “in order to limit the risks that the failure of any individual company could pose to a covered company,” according to the proposal.

The central bank would set a limit of 10 percent for credit risk between a company considered systemically important and a counterparty that each have more than $500 billion in total assets. This is tougher than the Dodd-Frank act, which allowed for a 25 percent limit.

Goldman Sachs Group Inc., the fifth-biggest U.S. bank by assets, said in a regulatory filing that its credit risk to any single counterparty didn’t exceed 2 percent of the firm’s $949 billion in total assets as of Sept. 30. By that measure, the company’s maximum credit risk to any counterparty as of September would be $19 billion, or about 25 percent of its $77 billion in total capital.

‘Early Remediation’

The Fed would require “early remediation” for large firms that show weakness in capital, stress test results and risk management. Regulators would be allowed to impose restrictions on a company’s growth, capital distributions, executive compensation and asset sales.

Designing the early remediation regime was one of the toughest tasks for regulators, a Fed official said today in a conference call with reporters. The central bank sought to design remedial steps that didn’t hasten a firm’s demise, the official said on condition of anonymity.

Regulators already could pursue such supervisory steps toward banks through prompt corrective action, mandated by a law in 1991. Today’s proposal increases that authority to holding companies.

--Editors: James Tyson, Kevin Costelloe

To contact the reporters on this story: Cheyenne Hopkins at Chopkins19@bloomberg.net; Phil Mattingly in Washington at pmattingly@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net


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