Board of Governors of the Federal Reserve System

The final rule before us today is another component of our ongoing effort under Section 165 of the Dodd-Frank Act to put in place a set of prudential standards for large banking organizations that become progressively more stringent as the systemic importance of the regulated entity increases.

The liquidity risk and risk-management standards in the regulation will be added to the final resolution plan and stress testing regulations that are already in place. In the coming months we will be considering final or proposed rules covering other elements of this set of enhanced prudential standards--including risk-based capital surcharges, a supplemental leverage ratio, minimum levels of long-term debt, and quantitative liquidity standards.

The requirements applicable to foreign banking organizations with a large U.S. presence are an essential part of regulatory reform in the aftermath of the financial crisis. Beginning in the mid-1990s, the profile of foreign bank operations in the United States changed significantly. Foreign banks became more concentrated, more interconnected, and increasingly reliant on the kind of less stable, short-term wholesale funding that proved so volatile when financial stress developed. Many reoriented their operations toward borrowing large amounts of U.S. dollars, often in demand elsewhere in the world, to provide to their parents abroad. Meanwhile, the mix of FBO activities in the United States shifted decidedly toward capital markets, to the point that in recent years the top 10 broker-dealers in the United States have included either four or five foreign-owned firms.

The consequences of these changes in foreign bank activities were seen dramatically during the crisis, when the funding vulnerabilities of numerous foreign banks and the absence of adequate support from their parents made them disproportionate users of the emergency facilities established by the Federal Reserve. Yet the United States actually lags some other important financial jurisdictions in assuring that large domestic operations of foreign banking organizations have enough capital and liquidity to help provide stability when stress develops.

Just as Congress and the Federal Reserve in the past have adapted the regulatory system applicable to foreign banking organizations in response to important changes in their activities, so today we must address the risks to financial stability posed by the more recent changes I have noted. The proposed final rule before us today would mitigate these risks in an appropriately modulated fashion. Staff recommends various changes from the proposed rule. Many of these are responsive to suggestions made by commenters, and would reduce compliance and other costs without detracting from the overall financial stability benefits the rule will provide.

Finally, I would suggest that the objections raised by those who say this rule would undermine the gains that come from global capital flows overlook or downplay some important points. First, those gains are most endangered when financial activity contracts rapidly in periods of high stress, which underscores the imperative of sound prudential policies. Second, as we have seen repeatedly, ad hoc ring-fencing becomes more likely precisely in those periods of stress, when it is far more damaging to a vulnerable financial system than a well-conceived set of generally applicable ex ante measures imposed in normal times. Third, the rule before us walks a middle road between the vulnerabilities of the status quo and a complete subsidiarization model by, for example, continuing to permit branching. In sum, I would say that the most important contribution we can make to the global financial system is to ensure the stability of the U.S. financial system.