Fitch: US Moderates Stance on G-SIB Limits, Aligning with Basel

NEW YORK--(BUSINESS WIRE)-- The Fed's recent proposal for large counterparty exposure rules should be manageable for the eight US global systemically important banks (G-SIBs), in part because the Fed plan will allow banks to use internal models to calculate exposure values while relaxing proposed G-SIB limits from 2011, Fitch Ratings says. The new proposal is in line with Basel rules set in 2014.

The Dodd Frank Act implements a basic single counterparty 'large exposure' limit of 25% of total capital and grants the Fed authority to assign tighter limits if justified. The Fed plans to use this discretion to apply tighter limits to the more systemic firms, as it believes multiple defaults would damage financial stability.

Consequently, G-SIBs are limited to 15% of Tier 1 capital for transactions with other systemic firms (G-SIBs plus other systemic firms such as the largest insurers). This level is less stringent than the Fed's 2011 proposed threshold of 10% of total regulatory capital on banks with assets greater than USD500bn.

Unlike the 2011 proposals, banks will be allowed to use internal models to calculate their exposures, although the Fed says it will consider adopting the Basel Committee's revised standardized approach for measuring counterparty exposure once it's been finalized. Such a move would likely represent a future tightening of the limits as standardized approaches often give higher results than the models.

Fed staff estimates that US banks would have to reduce exposures by around USD100bn to fall into line with the new proposals, with almost all of that attributable to exposures among G-SIBs. Banks have raised concerns that tighter limits for transactions between G-SIBs would have disruptive effects, such as reducing market liquidity, decreasing loan capacity, and driving financial services to the shadow banking sector. However, the Fed believes that initiatives such as the move to central clearing reduce bi-lateral exposures between G-SIBs and mitigate the effect of the proposed limits. Because the limits are applied to net exposures, institutions are allowed to reduce their exposures by raising collateral requirements, compressing derivatives, and greater use of central clearing.

The Fed's 2011 proposals had reserved the tightest limits for banks with more than USD500bn assets; the proposal to align with the G-SIB definition brings the two large custody banks (Bank of New York Mellon and State Street) into scope of the tightest 15% limit.

The Fed has also exercised its discretion to apply tighter limits to the larger non-G-SIB banks (those with assets greater than USD250bn). For these banks, the Fed proposes to express the limit in terms of Tier 1 rather than total regulatory capital. The basic 25% limit applies to all other banks with assets above USD50bn, and banks with assets below USD50bn would not be subject to the proposed limits.

Overall, for banks with assets greater than USD250bn (which the Fed views as large, internationally active banking organizations) this proposal is similar to the Basel framework. The proposal also extends the Fed's multi-tiered approach toward prudential regulation, implementing progressively more stringent requirements on banks as they grow in size and complexity. While Fitch views this approach as appropriate from a systemic view point, industry participants may be inclined to raise issues related to competitive fairness.

The comment period will end 3 June 2016. The proposed implementation period is one year from the effective date of the rule for banks with assets greater than USD250bn, and two years for banks between USD50bn and USD250bn of assets, positioning the Fed to implement the rule ahead of the Basel Committee on Banking Supervision's scheduled date of 1 January 2019.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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View source version on businesswire.com: http://www.businesswire.com/news/home/20160324005772/en/

Fitch Ratings
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Source: Fitch Ratings

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