Implications, Implications, Implications: The Federal Reserve Prudential Regulatory Standards for Foreign Banking Organizations (FBOs) Operating in the U.S.

By Robert Lee, Executive Director, AxiomSL

On April 8, 2019, the Federal Reserve announced proposed revisions to the prudential regulatory standards for foreign banks operating in the U.S. The proposal introduces a tailored approach based on the risk profiles of the FBOs’ U.S. operations that is similar to the framework proposed on October 31, 2018 for large U.S. bank holding companies and certain savings and loan holding companies.

Risk profiles for FBOs are grouped into categories of prudential standards based upon asset size and risk-based activity indicators, as presented in the Federal Reserve’s following exhibit:

Concerns and Challenges for U.S. FBOs

Consolidation of Operations — Total Combined U.S. Assets

The proposal takes a risk-based view of foreign banks’ U.S. operations by combining the assets of the U.S. subsidiaries with the branch and agency network. This data is collected via the FR Y-7Q, The Capital and Asset Report for Foreign Banking Organizations.

Implication: Books and records of the branch and agency network are typically segregated from other U.S. subsidiaries. Data complexity across entities is traditionally maintained and reported in different dimensions (e.g., GL data for simple balance sheet reporting vs. granular positions for complex reporting requirements).

Under the proposal, a re-examination of data-management system strategies for distinct operating entities should take place. Implementing consolidated and standardized data architectures to address reporting and audit requirements will result in greater efficiencies.

On the surface, this may not seem difficult to do. However, without a sound automation strategy, it will prove challenging for FBOs to analyze and reconcile across entities with data granularity, consistency, accuracy, transparency and lineage.

Risk-Based Activity Indicators

In addition to basing asset size on total combined U.S. operations, the Federal Reserve is proposing to apply specific risk-based indicators to categorize FBOs into the Categories II, III or IV, shown in the previous exhibit. These risk-based indicators consist of metrics for:

Global systemically important banks (G-SIBs) have filed the FR Y-15 report since 2015. The data is used to assess systemic risk and calculate the capital surcharge held by these institutions. (Systemic risk is the risk of an industry or market collapse as a result of the interconnectedness of the participating institutions.)

Implication: Upon implementing this, G-SIBs experienced challenges with data strategies for completing the risk-based activity indicators from the FR Y-15 report because it is a hybrid of traditional financial-statement data and specific granular transactional data that includes the following:

  • Cross-jurisdictional activity: Requires added dimensions for country risk transfers and categorization of assets and liabilities on an ultimate country risk basis
  • Off-balance-sheet exposures: Requires calculation of specific types of activity arising from both on- and off-balance sheet activity (e.g., derivatives, security financing transactions, collateral associated with derivative contracts, etc.)
  • Weighted short-term wholesale funding (wSTWF): Requires liquidity data from the FR 2052a and consists of average values over a 12-month time frame
  • Nonbank assets: Consists of business activity derived from nonbank activities such as a broker/dealer

Single Counterparty Credit Concentration Limits (SCCL)

The proposal requires Category II and III institutions to comply with U.S. SCCL rules collected via the FR 2590 for their international holding companies (consolidated U.S. entities only) on a quarterly basis. U.S. SCCL is based on the Basel large exposures framework and limits aggregate net exposure to a single counterparty of no more than 25% of Tier 1 capital (15% if the counterparty is a G-SIB).

Implication: Institutions with standard centralized granular data-sources and robust data-quality controls for all regulatory reporting will be less challenged than those relying on multi-source legacy systems requiring intensive manual processes. But few institutions can claim to be well prepared to face the SCCL challenges. Unfortunately, most institutions rely on hybrid architectures of legacy systems and modern data marts where data quality and consistency remain a challenge.

FBOs also face challenges in the interpretation of SCCL rules for credit-risk shifting to arrive at aggregate net exposure, and in the identification of counterparty legal ownership necessary for determining control.

Liquidity Risk Requirements

The Fed is seeking industry comment on the application of liquidity reporting and risk requirements for U.S. FBOs. The proposal requires Category II, III and IV institutions to calculate wSTWF in addition to other asset-size and risk-based activity indicators to identify the appropriate category of prudential standards, as articulated in the Federal Reserve’s exhibit following:

Category II, III and IV institutions will have to comply with the following:

  • FR 2052a Complex Institution Liquidity Monitoring Report
  • Liquidity Coverage Ratio: Requires banks to hold a reserve of high-quality liquid assets (HQLA) to allow them to survive a period of significant liquidity stress lasting 30 calendar days
  • Net Stable Funding Ratio: Requires banks to maintain reliable capital and liabilities over a one-year time frame against balance-sheet assets and certain off-balance-sheet exposure. The ratio should always be greater than or equal to 100%, at a minimum
  • Liquidity stress-testing and risk-management standards: Banks are expected to implement and maintain Basel and Federal Reserve principles for managing liquidity risks

Implication: Compliance with liquidity risk requirements should be viewed as a strategic solution for effective liquidity management benefiting the organization, rather than as a stand-alone regulatory requirement. Institutions that adopt a strategic view achieve competitive advantages over peers that choose tactical solutions without adequately capturing the risk tolerance of their balance sheet.

Implications, Implications, Implications

The time is now to begin surfacing these concerns and challenges within your organizations — while there is still a window of time before the Federal Reserve’s proposed prudential regulatory revisions go into effect.

AxiomSL has built a community of clients across the FBO and U.S. banking marketplace that have implemented Balance Sheet, Capital, Single Counterparty Credit Limits and Liquidity requirements.

Engage with us to start a conversation here.