Alert December 20, 2011

FRB Issues Proposed Rule for the Supervision and Regulation of Large Bank Holding Companies and Systemically Important Nonbank Financial Firms

The FRB issued a proposed rule (the “Proposed Rule”) for the supervision and regulation of large bank holding companies and systemically important nonbank financial firms which implements Sections 165 and 166 of the Dodd-Frank Act.  The Proposed Rule includes a wide range of measures addressing issues such as capital, liquidity, credit exposure, stress testing, risk management, and early remediation requirements.  The Proposed Rule generally applies to all U.S. bank holding companies with consolidated assets of $50 billion or more and any nonbank financial companies designated by the Financial Stability Oversight Council (“FSOC”) as systemically important nonbank financial companies (“Covered Companies”).  Please see the February 1, 2011 Financial Services Alert and the February 15, 2011 Financial Services Alert regarding the designation of systemically important nonbank financial companies.  The FRB stated that it will issue a proposal regarding foreign banking organizations.  In general, savings and loan holding companies would not be subject to the requirements in the Proposed Rule, except certain stress test requirements.  The FRB indicated that it plans to issue a separate proposal to address the applicability of the enhanced standards to savings and loan holding companies.  The Proposed Rule states that the FRB may determine that a bank holding company that is not a Covered Company shall be subject to one or more of the standards established under the Proposed Rule if the FRB determines that doing so is necessary or appropriate to protect the safety and soundness of such bank holding company or to promote financial stability.

The Proposed Rule includes the following requirements:

  • Risk-based capital requirements and leverage limits. Under the Proposed Rule, risk‑based capital and leverage requirements would be implemented in two phases.  In the first phase, Covered Companies would be subject to the capital plan rule issued by the FRB in November 2011 (the “Capital Plan Rule”).  Please see the December 6, 2011 Financial Services Alert regarding the Capital Plan Rule.  The Capital Plan Rule requires large bank holding companies to develop annual capital plans, conduct stress tests, and maintain adequate capital, including a Tier I common risk-based capital ratio greater than five percent, under both expected and stressed conditions.  In the second phase, the FRB stated that it would issue a proposal to implement a risk-based capital surcharge based on the framework and methodology developed by the Basel Committee on Banking Supervision.  Please see the November 15, 2011 Financial Services Alert regarding the risk-based capital surcharge.

  • Liquidity requirements.  The liquidity requirements set forth in the Proposed Rule would also be implemented in multiple phases.  First, Covered Companies would be subject to qualitative liquidity risk-management standards generally based on the interagency policy statement on funding and liquidity risk-management practices.  Please see the March 23, 2010 Financial Services Alert regarding the interagency policy statement on funding and liquidity risk-management practices.  The liquidity standards set forth in the Proposed Rule would require Covered Companies to conduct internal liquidity stress tests and set internal quantitative limits to manage liquidity risk.  In the second phase, the FRB stated that it would issue one or more proposals to implement quantitative liquidity requirements based on the Basel III liquidity rules.  Please see the January 4, 2011 Financial Services Alert regarding the Basel III liquidity rules. 

  • Single-counterparty credit limits.  The Proposed Rule sets forth requirements that would limit the credit exposure of a Covered Company to a single counterparty to 25 percent of the capital stock and surplus of the Covered Company.  Credit exposure between the largest financial companies would be subject to a stricter limit of ten percent of the capital stock and surplus of the Covered Company.

  • Risk management and risk committee requirements.  The Proposed Rule requires all Covered Companies to implement enterprise-wide risk management practices that are overseen by a risk committee of the Covered Company’s Board of Directors and a Chief Risk Officer with appropriate levels of independence, expertise and stature.  The Proposed Rule requires any publicly-traded bank holding company with $10 billion or more in consolidated assets to establish a risk committee.  Such risk committee must be comprised of an appropriate number of independent directors and include at least one risk management expert.

  • Stress testing requirements.  The Proposed Rule provides that stress tests of Covered Companies would be conducted annually by the FRB using three economic and financial market scenarios.  A summary of the results of such stress tests, including company-specific information, would be publicly disclosed.  In addition, the proposal requires Covered Companies to conduct one or more company-run stress tests each year and to publicly disclose a summary of the results of such stress tests.  The requirement to conduct an annual stress test applies to any financial company with more than $10 billion in total consolidated assets that is regulated by a primary federal financial regulatory agency.

  • Debt-to-Equity limits for certain Covered Companies.  The Proposed Rule provides that a Covered Company must maintain a debt-to-equity ratio of no more than 15-to-1 upon a determination by the FSOC that (a) such Covered Company poses a “grave threat to the financial stability of the United States” and (b) the imposition of such a requirement is necessary to mitigate such risk posed by the Covered Company.

  • Early remediation requirements.  The Proposed Rule contains measures designed to identify emerging or potential issues of Covered Companies before any such issue develops into a larger problem.  The Proposed Rule sets forth a number of triggers for early remediation, including regulatory capital levels, stress test results, market indicators, and weaknesses in enterprise-wide and liquidity risk-management.  Several such triggers are calibrated to be forward-looking.  The Proposed Rule also describes the regulatory restrictions that a Covered Company must comply with at certain remedial stages.  Under the Proposed Rule, required actions would vary based on the severity of the situation, but could include restrictions on growth, capital distributions, and executive compensation, as well as required capital raising or asset sales.

Covered Companies would be required to comply with many of the enhanced standards set forth in the Proposed Rule one year after the effective date of the final rule.  The requirements relating to enhanced risk-based capital and leverage requirements, single‑counterparty credit limits and stress testing requirements would be implemented under different timetables.  The FRB noted that it consulted with other members of the FSOC in developing the Proposed Rule.  Comments on the Proposed Rule are requested by March 31, 2012.

Future editions of the Financial Services Alert will provide further detailed analysis of the Proposed Rule.