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Board of Governors of the Federal Reserve System
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Federal Reserve Board of Governors

Statement by Governor Daniel K. Tarullo

December 14, 2012

The draft regulation being presented to us this afternoon would make a significant change in the Board's approach to regulating the activities of foreign banks in the United States. Applicable regulations have changed relatively little in the last decade, despite a significant and rapid transformation in the activities of foreign banks, many of which moved beyond their traditional lending activities to engage in substantial, and often complex, capital market activities. The crisis revealed the resulting risks to U.S. financial stability.

We have received a very good staff memo, and Molly will explain the main features of the proposal in a few minutes. So I will offer a few more general comments.

First, the proposal is directly responsive to the vulnerabilities in foreign bank activities observed during and after the financial crisis. In particular, as Governor Stein will discuss in a bit more detail, many large foreign banking organizations came to rely heavily on short-term, wholesale U.S. dollar funding and thereby became subject to destabilizing runs.

Second, the proposal is both consistent with, and complementary to, our past and proposed measures to address the risks associated with large, interconnected U.S.-based banks. Consider, for example, that five of the top 10 U.S. broker-dealers are owned by foreign banks. Like their U.S.-owned counterparts, large foreign-owned U.S. broker-dealers became highly leveraged and highly dependent on short-term funding in the years leading up to the crisis. We would be negligent if we did not adapt our oversight of foreign banking operations that include these very large broker-dealers, as we have our domestic bank holding companies.

Third, again consistently with our plan for domestic firms, the proposal creates a graduated approach to the regulation of foreign banks, with standards that increase in stringency depending on the size and scope of the U.S. operations of those banks. The regulations will thus be calibrated to the degree of risk posed.

Fourth, the proposal takes a middle road among the various possible alternative approaches. Let me mention two examples of roads not taken. One would have us refrain from making any generally applicable changes in our regulatory system for foreign banks and simply intensify ad hoc supervision. This approach seems to me neither prudent nor practical. Given the size, scope, and importance of the largest foreign banking operations in the United States, it would be imprudent not to have a mix of strong, uniform regulatory standards and more tailored supervisory oversight, as we do for domestic banks of similar importance for financial stability.

Such a heightened ad hoc approach would not, in any case, be practical, at least not if it were to be rigorous. In fact, such an approach might result in the worst of both worlds--an ongoing intrusiveness into the home country regulator's consolidated supervision of foreign banks without the ultimate ability to evaluate those banks comprehensively, or to direct changes in a parent bank's practices necessary to mitigate risks in the United States.

At the other end of the spectrum is the approach of a fully territorial form of foreign bank regulation. This approach would prohibit foreign bank branching and require any commercial banking to be done through U.S.-chartered bank subsidiaries. This approach has appeal from a strictly supervisory perspective. However, there is a significant chance that prohibiting branching by foreign banks would lead to reduced availability of credit in the United States. Historically, branches of foreign banks have been important providers of credit, both to foreign non-financial businesses operating here and to U.S. business. Indeed, these branches have at times provided countercyclical benefits, because branches of foreign banks that can draw on the capital of their entire bank often expand lending in the United States when U.S. banking firms labor under common domestic economic strains. Problems arose over the last decade as some branches began raising large amounts of short-term wholesale dollar funding for use in long-term lending abroad.

The proposed regulation would create liquidity standards for branches of foreign banks with large U.S. operations that should protect against branches reverting to this practice. But even if we adopt the approach proposed today, we should monitor carefully the practices of large branches and, if necessary, revisit this issue and take additional supervisory or regulatory action.

Fifth, and finally, while I endorse the approach taken in the proposed regulation, I will be interested in the answers given by the public to the questions posed by the staff in the Federal Register notice. As is always the case, I am sure we will all learn from the public comments and may well want to adjust some elements of the proposal before adopting a final rule.

Last update: August 2, 2013