Fed Sets Loan Exposure Limits on Major Wall Street Banks
Of late, the Federal Reserve has been busy making economic conditions favorable for banks while also keeping in mind the lessons learnt in 2008 when the banking sector was on the verge of collapse.
The regulator has placed single-counterparty credit limits on banks with assets of more than $250 billion to protect the economy from any severe downturn. The final rule is a relaxed version of the one proposed in 2016, under which banks were required to curtail their exposure by nearly $100 billion.
However, the Fed’s calculations per the final rule show that the concerned firms are currently well within the credit limits and would face no material impact from the changes.
Introduction of credit exposure limits will help ensure financial stability as it would greatly reduce the risk of a bank’s failure or financial distress from its own wrongdoing or because of failure of an interconnected bank.
In 2008, banks had experienced dearth of liquidity that kept them from preventing each other’s collapse, as they had significant credit exposures among each other. Failure of one large institution — Lehman Brothers Holdings Inc. — had put all other banks, with which it had financial connections, in trouble.
At a meeting held on Thursday, the board unanimously approved the decision to keep interdependence among the Wall Street biggies under control. The Fed Chair Jerome H. Powell remarked, “This final rule is another step in sustaining an effective and efficient regulatory regime that keeps our financial system strong and protects our economy while imposing no more burden than is necessary to get the job done.”
The Final Rule
The Fed has set a limit on the amount of loans that banks with total consolidated assets of more than $250 billion can provide to each other to 15% of their tier 1 capital. However, the total credit exposure for these banks to an institution, other than those considered systemically important, has been ordered to not exceed 25% of their tier 1 capital.
Some Wall Street biggies such as JPMorgan Chase JPM, Goldman Sachs GS, Bank of America BAC and Citigroup C fall under this category. These institutions are required to comply with a new filing requirement in order to show their current exposures.
The Fed expects to introduce some changes in the rule later on to set a credit limit on banks with assets between $100 billion and $250 billion.
Further, the final rule extends to foreign banks with total global consolidated assets of more than $250 billion as well, under which they are required to meet similar credit limits. However, an addition has been made for such banks.If the concerned foreign firm is successful in proving that it faces similar supervision from regulators in its home country, it would not be required to comply with this rule.
Golden Era for Banking Sector
The banking sector is benefiting the most from the recent changes including the decline in commercial tax rate, easing of regulations and rising interest rates. The Fed raised interest rates to 1.75-2% on Jun 13 as expected by the market. These factors are likely to benefit the bottom line of banking institutions. Moreover, improvement in economic activities along with rise in consumer confidence is likely to further support the top line.
Moreover, upliftment of SIFI threshold came as a major tailwind for smaller banks by giving them room for increasing assets without worrying about higher compliance costs. This also benefitted the mid-sized banks, freeing them from strict oversight, higher capital requirements and annual stress tests. Such easing of regulations coupled with the improving domestic economy is likely to give solid boost to banks’ profitability and lead their stocks to touch all-time highs.
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