April 15, 2012 9:33 pm

Banks urge Fed retreat on credit exposure

Wall Street banks are resisting a Federal Reserve plan to limit their exposure to individual companies and governments, warning it will cut a combined $1.2tn from credit commitments at Goldman Sachs, JPMorgan Chase, Morgan Stanley, Bank of America and Citigroup.

David Viniar, chief financial officer of Goldman, Ruth Porat, chief financial officer of Morgan Stanley and their counterparts at six other banks argued that the plan would harm liquidity at a meeting three weeks ago with Daniel Tarullo, Fed governor, according to people familiar with the talks.

The banks warned the proposed measures would also send ripples through international markets because their government bond holdings could be snared by the caps.

The single counterparty limit was part of the Dodd-Frank Act reforms which are being implemented by regulators including the Fed, and is due to come into force next year.

In an effort to prevent dangerous domino collapses, the law restricts the amount of exposure banks can have to a single counterparty to 25 per cent of their regulatory capital. The Fed is proposing to go further, adding a 10 per cent limit to the amount of exposure that financial groups with more than $500bn in assets can have to each other.

In an unpublished preliminary study, The Clearing House, a trade association for the banking industry, has used data provided by the five biggest US Wall St banks to estimate the effect of the proposal. It found 65 breaches of the limit with 22 different counterparties and $1.2tn of credit that would have to be cut.

Banks are pushing the Fed to allow them to use their internal models to calculate counterparty exposure – which would reduce excess exposure to $450bn, according to The Clearing House’s study, which is due to be expanded with more bank data and submitted to the Fed later this month.

“The key issue is how to define and measure credit exposures,” said Bob Chakravorti, chief economist at The Clearing House, himself a former Fed official. He said the Fed’s suggested way was “a crude measure that overstates exposures under any reasonable calculation methodology by a significant multiple”.

However, at meetings Fed officials have not shown appetite for allowing banks to use their own models, according to people familiar with the discussions, fearing that it could make evasion easier. Calculating exposure through derivatives is one of the thorniest areas of the debate.

Proponents of the rule say the limit is appropriate and there is no reason why financial groups need to have tens of billions of dollars in exposure to a single counterparty.

On one area the Fed has shown it might compromise by loosening the limit for exposure to “central counterparties” such as clearing houses, which are designed to reduce risk by standing between buyers and sellers. Banks have argued it is perverse to limit exposure to central counterparties because other new rules force them to push more over-the-counter derivatives through clearing houses in an effort to reduce risk.

The industry is likely to try to enlist foreign governments in its campaign as it did with the argument over the Volcker rule element of the Dodd-Frank Act, which prohibits banks from speculating with their own capital. As under the Volcker rule, US Treasuries are exempt from the counterparty limit but other government bonds are not.

“It would reduce liquidity if nothing changed,” said one senior bank executive. “It can restrict the amount of trading you could do in Japanese bonds for example.”

The Fed’s proposal offers little chance that foreign government debt will be exempt. It specifically says that exposure to “governmental entities create risks to the covered company similar to those created by large exposures to other types of entities”.

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