Annual Report 2012
Other Federal Reserve Operations
Regulatory Developments: Dodd-Frank Act Implementation
In this Section:
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) (Pub. L. No. 111-203) is one of the most significant pieces of legislation affecting the U.S. financial regulatory framework in many years. Enacted on July 21, 2010, the Dodd-Frank Act seeks to address critical gaps and weaknesses in the U.S. regulatory framework that were revealed by the financial crisis. The act gives the Federal Reserve important responsibilities to issue rules and supervise financial companies to enhance financial stability and preserve the safety and soundness of the banking system.
Throughout 2012, the Federal Reserve continued to work diligently to implement the many regulatory changes required under the Dodd-Frank Act. As of December 31, 2012, the Board had issued 27 final rules required by the act and had proposed an additional 15 rules for public comment.1 The Board also continued to implement various international frameworks developed under the auspices of the Basel Committee on Banking Supervision (BCBS).
The following is a summary of key regulatory developments announced by the Federal Reserve during 2012 in connection with the implementation of the Dodd-Frank Act and BCBS international frameworks.
Enhanced Prudential Standards for Financial Firms
Enhanced Prudential Standards for Foreign Banking Organizations
The act requires the Board to establish heightened prudential standards for nonbank financial companies supervised by the Board and for bank holding companies (BHCs) with total consolidated assets of $50 billion or more (collectively, covered companies). These standards must be more stringent than the standards that apply to other nonbank financial companies and BHCs that do not pose similar risks to the financial system. Foreign banking organizations that are or are treated as BHCs for purposes of the Bank Holding Company Act and that meet the $50 billion asset threshold are also subject to the heightened prudential standards.
On December 14, 2012, the Board invited comment on a proposal to establish enhanced prudential standards for foreign banking organizations with global consolidated assets of $50 billion or more and with a U.S. banking presence (foreign proposal). The proposed standards for foreign banking organizations are broadly consistent with the standards that the Board proposed for U.S. covered companies in December 2011. Differences between the standards proposed for foreign banking organizations and U.S. covered companies reflect the different regulatory framework and structure under which foreign banking organizations operate.
The foreign proposal would require a foreign banking organization with $50 billion or more in global consolidated assets and $10 billion or more in total non-branch U.S. assets to organize its U.S. subsidiaries under a single U.S. intermediate holding company (IHC). IHCs of foreign banking organizations would be subject to the same risk-based and leverage capital standards applicable to U.S. BHCs, and IHCs with $50 billion or more in consolidated assets would be subject to the Board's capital plan rule. In addition, the U.S. operations of a foreign banking organization with combined U.S. assets of $50 billion or more would be required to meet enhanced liquidity risk-management standards, conduct liquidity stress tests, and hold a 30-day buffer of highly liquid assets. The proposal also imposes capital stress test, single-counterparty credit limit, overall risk-management, and early remediation requirements on U.S. operations of foreign banking organizations.
Annual Stress Tests
The act requires the Board to conduct supervisory stress tests of covered companies and requires financial companies with more than $10 billion in total consolidated assets to conduct annual stress tests. Covered companies are also required to conduct semiannual company-run stress tests.
On October 9, 2012, the Board published two final rules implementing these stress testing regimes. One rule implemented the supervisory stress test and semiannual company-run stress test requirements for covered companies, while one rule implemented the annual company-run stress test requirements for BHCs with total consolidated assets of more than $10 billion but less than $50 billion, and for state member banks and savings and loan holding companies (SLHCs) with total consolidated assets of more than $10 billion.
The Board began conducting supervisory stress tests in the fall of 2012 for 18 BHCs that participated in the 2009 Supervisory Capital Assessment Program and subsequent Comprehensive Capital Analysis and Reviews. These companies and their state-member bank subsidiaries also conducted their own company-run stress tests in the fall of 2012. Other companies subject to the Board's final rules for Dodd-Frank Act stress testing will be required to comply with the final rule beginning in October 2013. Companies with between $10 billion and $50 billion in total assets that begin conducting their first company-run stress test in in the fall of 2013 will not have to publicly disclose the results of that first stress test.
Changes to Banking Regulation and Supervision
Regulatory Capital Framework
On June 12, 2012, the Board and other federal banking agencies approved a final rule to implement changes to the market risk capital rule, which requires institutions with significant trading activities to adjust their capital ratios to better account for the market risks of those activities.2 The final market risk capital rule implements certain revisions made by the BCBS to its market risk framework. The final rule is intended to enhance sensitivity to risks arising from trading activities, reduce procyclicality in the market risk capital requirements, and increase transparency through enhanced disclosures. Consistent with section 939A of the Dodd-Frank Act, which requires all federal agencies to remove from their regulations references to and requirements of reliance on credit ratings, the final rule does not include those aspects of the BCBS market risk framework that rely on credit ratings. Instead, the final rule includes alternative standards of creditworthiness for determining specific risk capital requirements for certain debt and securitization positions.
Also on June 12, 2012, the Board and other federal banking agencies invited comment on three notices of proposed rulemakings that would implement in the United States the Basel III regulatory capital reforms adopted by the BCBS and make other revisions to the agencies' regulatory capital requirements. The proposals would establish an integrated regulatory capital framework to address shortcomings in regulatory capital requirements that became apparent during the financial crisis. The proposed rules would be consistent with section 171 of the Dodd-Frank Act, which directs the Board to establish minimum risk-based and leverage capital requirements for BHCs and SLHCs that are not less than the "generally applicable" capital requirements for insured depository institutions and not "quantitatively lower than" the "generally applicable" capital requirements in effect for insured depository institutions when the Dodd-Frank Act was enacted.
The first notice of proposed rulemaking (Basel III NPR) is focused primarily on reforms that would improve the overall quality and quantity of capital held by all depository institutions, BHCs with total consolidated assets of $500 million or more, and all SLHCs (collectively, banking organizations). Consistent with the international Basel framework, the Basel III NPR would establish a new minimum common equity tier 1 ratio and common equity tier 1 capital conservation buffer; raise the minimum tier 1 capital ratio; revise the definition of capital to ensure that regulatory capital instruments can absorb losses; establish limitations on capital distributions and certain discretionary bonus payments if common equity tier 1 capital buffers are not met; and introduce a supplementary leverage ratio for banking organizations that are subject to the advanced approaches risk-based capital rules. The proposal includes transition provisions designed to provide sufficient time for banking organizations to meet the new capital standards while supporting lending to the economy.
The second notice of proposed rulemaking (Standardized Approach NPR) would revise the Board's rules for calculating risk-weighted assets to enhance their risk sensitivity and address weaknesses identified over recent years. Specifically, it would incorporate aspects of the BCBS's Basel II standardized framework (known as the International Convergence of Capital Measurement and Capital Standards), Basel III, and alternatives to credit ratings for the treatment of certain exposures, consistent with section 939A of the Dodd-Frank Act. The Standardized Approach NPR would apply to all banking organizations.
The third notice of proposed rulemaking (Advanced Approaches and Market Risk NPR) would revise the advanced approaches risk-based capital rule in a manner consistent with sections 171 and 939A of the Dodd-Frank Act and incorporate certain aspects of Basel III that the Board would apply only to advanced approaches banking organizations (generally, the largest, most complex banking organizations). In particular, the Advanced Approaches and Market Risk NPR would enhance the risk sensitivity of the current rules to better address counterparty credit risk and interconnectedness among financial institutions. The proposal also would codify the Board's market risk capital rule and, as described above, would apply consolidated capital requirements to SLHCs.
Registration of Securities Holding Companies (SHCs)
Section 618 of the Dodd-Frank Act permits a company that one or more securities broker or dealer registered with the Securities and Exchange Commission (SEC), and that is required by a foreign regulator or provision of foreign law to be subject to comprehensive consolidated supervision, to register with the Board as an SHC and become subject to supervision and regulation by the Board. An SHC that registers with the Board under section 618 is subject to the full examination, supervision, and enforcement regime applicable to a registered BHC, including capital requirements (although the statute allows the Board to modify its capital rules to account for differences in activities and structure of SHCs).
On May 30, 2012, the Board adopted a final rule to implement section 618 of the act. The final rule, which became effective July 20, 2012, specifies the information that an SHC must provide to the Board as part of registration, including information relating to organizational structure, capital, and financial condition. Under the final rule, an SHC's registration becomes effective no later than 45 days from the date the Board receives all required information. Consistent with the act, the restrictions on nonbanking activities in section 4 of the Bank Holding Company Act would not apply to a supervised SHC.
Bank Secrecy Act (BSA) Regulations
On November 29, 2012, the Board and the Financial Crimes Enforcement Network, a bureau of the U.S. Department of Treasury, proposed a rule to amend the definitions of "funds transfer" and "transmittal of funds" under regulations implementing the BSA. The proposed amendments would maintain the current scope of funds transfers and transmittals subject to the BSA in light of an ambiguity caused by amendments to the Electronic Fund Transfer Act made by the Dodd-Frank Act.
Financial Market Utilities (FMUs) and Payment, Clearing, and Settlement Activities
Title VIII of the act establishes a new supervisory framework for systemically important FMUs and systemically important payment, clearing, and settlement activities conducted between financial institutions. Under the framework, the Board is authorized to prescribe risk-management standards governing the operations of FMUs that are designated as systemically important by the Financial Stability Oversight Council (FSOC) (other than a designated FMU that is registered with the Commodity Futures Trading Commission as a derivatives clearing organization (DCO) or registered with the SEC as a clearing agency) as well as the conduct of payment, clearing, and settlement activities by financial institutions if such activities have been designated as systemically important by the FSOC. On July 18, 2012, the FSOC voted unanimously to designate eight FMUs as systemically important under the act.
On July 30, 2012, the Federal Reserve announced the approval of a final rule (Regulation HH) to implement certain provisions of title VIII of the act. The final rule creates risk-management standards governing the operations related to the payment, clearing, and settlement activities of FMUs designated as systemically important by the FSOC (other than registered DCOs or clearing agencies). The risk-management standards are based on the recognized international standards developed by the Committee on Payment and Settlement Systems and the Technical Committee of the International Organization of Securities Commissions that were incorporated previously into the Board's Policy on Payment System Risk.
Regulation HH also establishes requirements for advance notice of proposed material changes to the rules, procedures, or operations of a designated FMU for which the Board is the supervisory agency as specified in title VIII of the act. The advance notice requirements set the threshold above which a proposed change would be considered material and thus require an advance notice to the Board, and also include provisions on the length of the review period.
Section 1075 of the act restricts the interchange fees that issuers may receive for electronic debit card transactions. Specifically, the interchange fee an issuer receives for a particular transaction must be reasonable and proportional to the cost incurred by the issuer with respect to the transaction. The Board's Regulation II, adopted in 2011, sets standards for determining whether an interchange fee is reasonable and proportional to the issuer's cost. In addition, the Board concurrently promulgated an interim final rule to permit an issuer to receive a fraud-prevention adjustment to the issuer's interchange fee.
On July 27, 2012, the Board announced the approval of a final rule that permits a debit card issuer subject to the interchange fee standards of Regulation II to receive a fraud-prevention adjustment. Under the fraud-prevention adjustment final rule, an issuer is eligible for an adjustment of no more than 1 cent per transaction (unchanged from the previous interim final rule) if it develops and implements policies and procedures that are reasonably designed to take effective steps to reduce the occurrence of, and costs to all parties from, fraudulent debit card transactions. The final rule simplifies the elements required to be included in an issuer's fraud-prevention policies and procedures. To receive an adjustment, an issuer is required to review its fraud-prevention policies and procedures, and their implementation, at least annually. An issuer also is required to update its policies and procedures as necessary in light of their effectiveness and cost-effectiveness and, as previously required, in light of changes in the types of fraud and available methods of fraud prevention.
The final rule retains and clarifies the requirement that an issuer that meets these standards and wishes to receive the adjustment must annually notify the payment card networks in which it participates of its eligibility to receive the adjustment. In addition, the final rule explicitly prohibits an issuer from receiving or charging a fraud-prevention adjustment if the issuer is substantially noncompliant with the Board's fraud-prevention standards and sets forth a timeframe within which such an issuer must stop receiving or charging a fraud-prevention adjustment.
Consumer Financial Protection
On August 15, 2012, the Board--jointly with the Consumer Financial Protection Bureau, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, the National Credit Union Administration, and the Office of the Comptroller of the Currency--proposed a rule to implement section 129H of the Truth in Lending Act (TILA), added by the Dodd-Frank Act, which requires a creditor to obtain an appraisal before issuing a "higher-risk mortgage." Under the act, mortgage loans are higher-risk if they are secured by a consumer's home and have interest rates above a certain threshold.
For higher-risk mortgage loans, the proposed rule would require creditors to use a licensed or certified appraiser who prepares a written appraisal report based on a physical inspection of the interior of the property. The proposed rule also would require creditors to disclose to applicants information about the purpose of the appraisal and provide consumers with a free copy of any appraisal report. Creditors would have to obtain an additional appraisal at no cost to the consumer for a home-purchase higher-risk mortgage loan if the seller acquired the property for a lower price during the past six months. This requirement would address fraudulent property flipping by seeking to ensure that the value of the property being used as collateral for the loan legitimately increased.
The Board of Governors and the Government Performance and Results Act
In this Section:
The Government Performance and Results Act (GPRA) of 1993 requires that federal agencies, in consultation with Congress and outside stakeholders, prepare a strategic plan covering a multiyear period and submit an annual performance plan and performance report. The GPRA Modernization Act of 2010 refines those requirements to include quarterly performance reporting. Although the Board is not covered by GPRA, the Board follows the spirit of the act and, like federal agencies, prepares a performance plan and performance report.
Strategic Plan, Performance Plan, and Performance Report
The Board's 2012-2015 strategic plan articulates the Board's mission in the context of what it would take to meet Dodd-Frank Act mandates, close any cross-disciplinary knowledge gaps, develop appropriate policy, and continue effectively addressing the recovery of a fragile global economy. The plan sets forth major goals, outlines strategies for achieving those goals, identifies key quantitative measures of performance and discusses the evaluation of performance.
The performance plan includes specific targets for some of the performance measures identified in the strategic plan and describes the operational processes and resources needed to meet those targets. The performance report discusses the Board's performance against the strategic goals.
The strategic plan, performance plan, and performance report are available on the Board's website at www.federalreserve.gov/publications/gpra/default.htm.
1. These figures include Board actions since the enactment of the act on July 21, 2010. Return to text
2. The market risk capital rule applies to a BHC or bank with aggregate trading assets and liabilities equal to 10 percent of total assets, or $1 billion or more. Separately, the Board proposed to apply the market risk capital rule to SLHCs that meet the thresholds described in the rule. Return to text