Challenges in Oversight of Foreign Bank Intermediate Holding Companies

The IHC requirement comes from Section 165 of the Dodd‑Frank Act, permitting the Federal Reserve to enforce enhanced prudential standards on significant bank holding companies and foreign banks with notable U.S. operations. While not specified in the Dodd-Frank Act, the Federal Reserve mandated the IHC format to implement these standards across U.S. subsidiaries of foreign banks.

A foreign bank with $50 billion or more in U.S. non-branch assets must place nearly all its U.S. subsidiaries under the IHC, which acts as the primary U.S. entity for bank regulation. The Federal Reserve oversees the IHC, treating it similarly to U.S. bank holding companies, meaning the IHC must adhere to capital, liquidity, stress-testing, and risk management requirements analogous to those imposed on domestic banks.

Moreover, the Federal Reserve has supervisory power over other U.S. entities owned by the foreign bank, including branches. These branches also face enhanced prudential standards related to risk management, capital, and liquidity. However, the overall supervision of the foreign bank, including its U.S. operations, still falls under the jurisdiction of its home-country regulatory authority. This dual oversight means that U.S. subsidiaries are regulated under both the home and host countries' frameworks.

Foreign banks significantly contribute to the U.S. economy by offering credit and financial services to diverse sectors. Their U.S. branches and subsidiaries are pivotal in supporting corporate lending, trade finance, and various capital markets activities. They bridge U.S. companies with global capital sources, aiding foreign direct investment and large-scale business financing. By fostering competition and market depth, foreign banks play a crucial role in enhancing liquidity and reducing market dependencies.

While the IHC structure plays a vital role in ensuring financial safety and security, it often faces challenges when applying prudential rules meant for bank holding companies (BHCs) at the subsidiary level. The BHC, as an ultimate parent, is supervised on a consolidated basis, unlike the IHC, which is merely a subsidiary. This discrepancy can lead to regulatory burdens that detract from operational effectiveness without improving safety measures.

Current rules for total loss-absorbing capacity (TLAC) and long-term debt (LTD) often impose redundant requirements on IHCs, especially for global systemically important banks (GSIBs), to ensure U.S. operations can function without taxpayer support. However, these calibrations may inadvertently increase internal funding burdens without enhancing stability. For instance, the Federal Reserve's requirement for a 90% internal TLAC can lead to significant capital being immobilized within the IHC, limiting its operational flexibility.

Regulators should reconsider these internal TLAC requirements and their impact, particularly regarding the TLAC scalar that might compel IHCs to hold more capital than necessary for effective operation. This could hinder business growth and lead firms to shift activities out of the U.S.

Furthermore, the treatment of inter-affiliate exposures may not adequately consider the unique nature of IHC operations, often misclassifying low-risk inter-company activities as high-risk transactions with third parties. This can inflate risk-based indicators and impact foreign banks' commitment to the U.S. market.

Proposals aimed at revising operational risk frameworks and stress testing methodologies also risk being overly punitive for IHCs, not accurately reflecting their operations. For instance, changes in stress test calculations could distort true performance by applying inappropriate benchmarks drawn from dominant U.S. institutions.

Moreover, the dividend add-on requirement for IHCs to hold capital for planned dividends is misaligned with their operational realities, as IHCs cannot typically distribute capital through share repurchases, making dividends their primary method for managing surplus capital.

In conclusion, while the IHC structure remains essential for regulating foreign banks in the U.S., it is necessary to recalibrate certain rules originally designed for top-tier BHCs. A more nuanced approach will strengthen the regulatory framework and maintain the benefits foreign banks provide to the U.S. economy.