The Federal Reserve Board published a final enhanced supervision rule, known as Regulation YY, on 18 February, 2014. This regulation implements certain provisions of Section 165 and 166 of the Dodd-Frank Wall Street Reform and Consumer Protection Act to establish enhanced prudential standards for large US bank holding companies (BHC) and foreign banking organisations (FBO). The Federal Reserve pushed for these enhancements after the recent financial crisis demonstrated that some US financial companies, along with FBOs operating in the US, had grown so large and interconnected that their failure could pose a threat to the overall financial stability in the US and globally. The crisis revealed weaknesses in the existing framework for supervising, regulating and resolving significant US financial companies.
Regulation YY is meant to strengthen supervision and regulation of both BHCs and FBOs by incorporating new requirements to help increase the resiliency of their operations and ensure the stability of the US financial system and economy in the event of such a company failing. These requirements cover liquidity, risk management and capital. Furthermore, FBOs with a significant US presence must establish an intermediate holding company (IHC) over their US subsidiaries, which will facilitate more expansive Federal Reserve supervision with respect, not only to US banking officers, but also to their nonbanking activities and global risk profile.
US bank holding companies
Regulation YY requires US bank holding companies with total consolidated assets of more than $10 billion but less than $50 billion to conduct semi-annual company-run stress tests. This also applies to savings and loan holding companies and US banks with more than $10 billion in total consolidated assets. Furthermore, those BHCs with total consolidated assets of $10 billion or more that are publicly traded must establish risk committees to be responsible for overseeing the enterprise-wide risk management practices of the company.
BHCs with total consolidated assets of $50 billion or more must submit to the Board of Governors of the Federal Reserve an annual capital plan that demonstrates that the BHC is able to maintain capital above the Board’s minimum risk-based capital ratios under both baseline and stressed conditions. Additionally, BHCs will have to conduct their own stress tests in conjunction with the annual supervisory stress tests run by the Board to ensure that these organisations have the capital necessary to absorb loss if something were to happen. Lastly, as part of establishing a risk management framework, BHCs must appoint a chief risk officer and establish risk committees to approve and regularly review the risk management policies of the company.
Regulation YY incorporates enhanced capital planning, stress testing and risk management requirements as a way of ensuring that firms can continue to lend to households and businesses even in times of great financial stress.
Foreign banking organisations
The Federal Reserve Board recognised that US operations of foreign banking organisations have become more interconnected and complex in recent years. Regulation YY is meant to address these complexities through more rigid standards for FBOs that currently exist within the US.
FBOs with total global consolidated assets of more than $10 billion but less than $50 billion will face enhanced prudential standards, such as stricter capital stress testing requirements and tougher risk committee requirements. Those that have publicly traded stock must establish a risk management committee at their parent bank to focus solely on US operations and at least one member of this committee must have “appropriate risk expertise.”
FBOs with $50 billion or more US non-branch assets will be required to establish a US intermediate holding company over their US subsidiaries to organise their US operations. “US non-branch assets” consist of assets of an organisation’s top-tier US subsidiaries and exclude the assets of any US branch or agency as well as certain non-financial companies held under special authority. These foreign owned US IHCs will generally be subject to the same risk-based and leverage capital standards applicable to the US BHCs. They must establish a risk management committee and appoint a chief risk officer, both charged with responsibility to develop risk management programmes that meet the specific requirements of Regulation YY. The chief risk officer must be based in the US and employed by a US entity to ensure that the foreign bank understands the risks of combined US operations. In addition, FBOs will be subject to the Federal Reserve’s rules requiring regular capital plans and stress tests.
The requirements above had an implementation date of 1 July, 2016. Compliance with the enhanced prudential standards will no doubt have significant, as well as costly, effects on many large global institutions. Along with the compliance costs, the IHC requirement may require FBOs to restructure their US based operations.