26 April 2017

Foreign Banks Brace for Fed Stress Tests

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The Federal Reserve’s growing scrutiny of global banks has set off a scramble among foreign firms as they staff up and revamp operations to meet the central bank’s rising expectations. The Fed’s stress tests are expected to find shortcomings in risk management at the U.S. units of some foreign banks, including Deutsche Bank AG and Banco Santander SA, according to people familiar with the matter. The Fed announces preliminary results of this year’s tests on Thursday and full results on March 11.

The foreign banks are finding themselves tripped up not by capital requirements but by what the Fed sees as flaws in how they measure and predict risks and losses at their sprawling operations, including businesses that haven’t been heavily regulated in the past. The potential stress-test failures would mark the second straight year multiple European firms didn’t meet the Fed’s expectations for the qualitative, rather than quantitative, part of the tests.

Overseas lenders such as Deutsche Bank, Barclays PLC, Credit Suisse AG, and UBS AG are now spending heavily and recruiting project managers, data experts and other staff needed to run the complex computer models involved in the Fed’s annual exercise. The outlays here are in addition to even larger sums devoted to compliance in Europe. The U.S. test assesses whether a bank could keep lending during a severe downturn and determines whether the central bank permits a firm to return capital to shareholders.

At HSBC Holdings PLC, whose U.S. unit failed the Fed tests in 2014, global regulatory and compliance costs increased by $774 million last year to $2.4 billion, including investments needed to restructure the bank in the U.K. and to run U.S. and European stress tests, executives said on a Feb. 23 conference call.

The Fed, concerned about a repeat of the 2008 financial crisis, last year began making the U.S. operations of foreign firms subject to the same regulatory regime that has already forced U.S.-based banks like J.P. Morgan Chase & Co. to change the way they do business. Overseas banks are required by the Fed to organize their U.S. operations under a single holding company by mid-2016. By 2017, they must comply with a rule that will force them to maintain minimum capital levels here.

The Fed declined to comment on the stress-test performance of specific banks. Officials at the central bank have justified the extra capital and stress-testing requirements for U.S. units of foreign banks by noting their activities have expanded significantly in recent decades and could affect financial stability here.

During the 2008 financial crisis, foreign firms were relying heavily on overnight U.S. dollar loans when markets wobbled and froze. The U.S. central bank had to provide what it called “extraordinary support” in the form of dollar funding to those firms. Still, some European officials have chafed at the added U.S. oversight, saying it isn’t necessary to require minimum capital levels at U.S.-based subsidiaries because European parent companies have significantly improved their capital positions.

Failing the test is both a public-relations hit and a financial constraint, though the impact is more pronounced for U.S. banks than foreign firms, whose U.S. units are a small part of their overall business. It usually raises questions among investors about banks’ ability to manage U.S. regulations. U.S. subsidiaries of banks that fail face limitations on moving profits back to the parent companies.

Deutsche Bank and Santander’s challenges aren’t unique. Seven foreign-owned firms are taking the stress test this year, but according to Fed projections, 10 additional foreign banks will eventually be subject to new, stricter rules requiring a single U.S. holding company with minimum capital levels. By 2018, all those firms’ U.S. holding companies will be subject to the stress tests, according to the projections.

Click here to access the full article on The Wall Street Journal. 

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