Fed Sets Tougher Rules for Big Banks on Liquidity, Credit Exposure

The largest U.S. banks and some non-banking financial firms deemed systemically vital face stricter rules on liquidity and credit exposure that were proposed today by the Federal Reserve to head off another crisis.

The Fed’s proposed steps to strengthen supervision over large bank holding companies includes a range of measures covering requirements on capital and liquidity, credit exposure, stress testing and risk management – all actions mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The proposed rules – which will undergo the standard period of public feedback before implementation – applies mostly to U.S. bank holding companies with consolidated assets of $50 billion or more – including JPMorgan Chase, Bank of America, Citibank and Wells Fargo.

They also apply to any nonbank financial firms that could be designated by the Financial Stability Oversight Council as systemically important.

The council, also created by the Dodd-Frank legislation, consists of mostly existing regulators and will monitor systemic risk with recommendations made to the Federal Reserve in times of economic crises.

A key new requirement proposed by the Fed would limit credit exposure of a covered financial firm to a non-affiliated entity as a percentage of the firm’s capital. Credit exposure between the largest financial companies would be subject to a tighter limit.

“As demonstrated in the crisis, interconnectivity among major financial companies posesrisks to financial stability,” the Fed wrote in its proposed rule. “The effects of one large financial company’s failure or near collapse may be transmitted and amplified by the bilateral credit exposures between large, systemically important companies.”

The financial crisis also revealed significant weaknesses in liquidity safeguards and liquidity risk management practices throughout the financial system, the Fed said.

The proposed rules would also require covered companies to conduct internal stress tests at least monthly to measure their liquidity needs at 30-day, 90-day and one-year intervals during times of instability in the financial markets.

The firms must also hold liquid assets that would be “sufficient to cover 30-day stressed net cash outflows under their internal stress scenarios,” the Fed said.

Here is the Fed’s proposal and request for public comment.