Federal regulators unveiled a highly-anticipated proposal Tuesday that details how they plan to regulate the largest domestic financial firms, including new capital and liquidity requirements.
The Federal Reserve Board's 173-page proposal — considered by industry analysts to be the core of new rules required by the Dodd-Frank Act — would apply to all bank holding companies with more than $50 billion of assets as well as nonbank financial firms designated as systemically important by the Financial Stability Oversight Council (FSOC).
The plan touched on several critical areas governing bank regulation, including risk-based capital and leverage requirements, resolution planning and concentration limits.
Regulators opted to roll out risk-based capital and leverage requirements in two phases. First, firms will be required to follow the Fed's November guidelines to capital planning, which require companies to conduct stress tests and maintain adequate capital, including a Tier 1 risk-based ratio of greater than 5%, both under expected and stress conditions.
As part of the second phase, the Fed will issue a proposal to implement a risk-based capital surcharge for systemically important firms based on principles already agreed upon by the Basel Committee on Banking Supervision.
It is not clear exactly which institutions will face a surcharge. The largest eight U.S. banks have already been targeted by international regulators for a surcharge of between 1% to 2.5%.
But Fed Gov. Dan Tarullo has previously suggested that all firms with greater than $50 billion of assets could face at least a "modest" surcharge. Fed officials did not provide any further information Tuesday on what kind of surcharge such firms would pay.
The Fed also opted to provide multiple phases for firms to fulfill new liquidity requirements. Firms will initially conduct internal liquidity stress tests and set internal quantitative limits to manage liquidity risk based on guidance issued in March 2010. In the second phase, banks will comply with Basel III liquidity rules, which have not been finalized yet by global regulators.
Stress testing will be conducted each year using three economic and financial market scenarios as previously announced by the central bank. The results of that testing will be made public. Holding companies will have to meet those requirements shortly after the rule is completed.
Under the proposal, firms must also limit credit exposure to a single counterparty as a percentage of the firm's regulatory capital. Credit exposure between the biggest banks will be subject to a tighter limit, according to the Fed.
Separately, the central bank proposed early remediation requirements in order to address any financial weakness at an early stage. Regulators listed a number of triggers for remediation including capital levels, results of stress tests and risk-management weakness.
Savings and loan holding companies, generally, will not be subject to the requirements in the proposal, except to adhere to the Fed's stress test requirement. The Fed will issue a separate proposal later to address issues if enhanced standards should be applied to those firms.
The proposal would apply to more than 30 U.S. banks, which have total assets of more than $50 billion and are already supervised by the Fed. Nonbank financial firms will be subject to the same set of rules once they are designated by the FSOC.
Fed officials said they would show some flexibility on how the rules would apply to nonbank financial firms once they are designated.
The Fed opted to postpone its proposal governing regulation of foreign banks, which will also be subject to additional capital rules, until later, given the number of outstanding issues that still need to be resolved. Roughly 100 foreign banks could potentially be subject to the rule, according to Fed officials.
Given the complexity and the breadth of the rule, Fed officials offered to give industry more than 90 days to comment on the proposal. The comment period is set to close on March 31, 2012