The Committee on Capital Markets Regulation yesterday submitted a comment letter to the Federal Reserve regarding its proposed rule that would, among other things, require foreign banks with U.S. operations to “ring-fence” additional capital and liquid assets in the United States, in large part at U.S. intermediate holding companies.

The Committee does not believe that the proposed rule addresses the Federal Reserve’s concern that excessive reliance on short-term funding could prove destabilizing to the financial system. Capital and liquidity requirements are insufficient for addressing risks posed by short-term funding, because neither addresses short-term creditors incentive to run during a crisis.

The Committee is also concerned that the proposed rule may increase systemic risk, because:

(1)  The failure of a large foreign parent bank could set off a panic in the United States and the proposed rule would weaken a foreign parent bank’s ability to withstand a shock or a run because the capital and liquid assets “ring-fenced” in the U.S. would no longer be accessible to the foreign parent bank. The reduction in available capital and liquid assets due to the proposed rule is substantial. The Committee’s research has shown that for 5 foreign banks the proposed rule would “ring-fence” at least $27 billion in additional capital in the United States.

(2)  Foreign regulators are expected to respond with similar “ring-fencing” requirements on the foreign operations of U.S. banks. These rules would similarly weaken a U.S. bank’s ability to withstand a shock or a run, because it could no longer access the capital and liquidity “ring-fenced” at foreign affiliates. During the financial crisis U.S. banks relied on $500 billion in funding from their foreign operations.

Additionally, the proposed rule would exceed Basel III requirements, which would be costly for foreign banks, and is generally expected to result in these banks reducing U.S. lending.

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The Committee on Capital Markets Regulation is an independent and nonpartisan 501(c)(3) research organization dedicated to improving the regulation of U.S. capital markets. The Committee’s membership includes thirty-two leaders drawn from the finance, investment, business, law, accounting, and academic communities. The Committee is chaired jointly by R. Glenn Hubbard (Dean, Columbia Business School) and John L. Thornton (Chairman, The Brookings Institution) and directed by Prof. Hal S. Scott (Nomura Professor and Director of the Program on International Financial Systems, Harvard Law School).