How the Fed's New Rules Could Make Deutsche Bank and Barclays Even Riskier

New Fed rules for foreign banks require stronger local balance sheets, but is that really what we’re getting?

Apr 2, 2014 at 7:00AM

Source: Wikimedia Commons.

The Fed's new rules for foreign banks are intended to bring balance sheet requirements in line with those of American banks. While European regulators have complained, the rule makes sense: foreign banks were, in the words of Fed Governor Daniel K. Tarullo, "disproportionate users" of emergency funding during the financial crisis. The Fed doesn't want to rely on foreign regulators to ensure the health of the local financial system. 

Barclays & Deutsche Bank Prepare
While there are 15 to 20 banks that will be affected by the rule, Barclays (NYSE:BCS) and Deutsche Bank (NYSE:DB) are presented with a particularly wide divide to cross. Both banks primarily deal in trading activities in the U.S. and adjusted their structures to avoid regulation under Dodd-Frank. They have much more work to do in shoring up their balance sheets ahead of the Fed's deadlines.

Both banks have taken steps to meet requirements. Deutsche Bank recently confirmed plans to pull about $100 billion in assets from the U.S., or about 25% of its balance sheet, and it has transferred capital into the U.S. from foreign operations. 

Barclays has been preparing for the rule "for more than a year," which is good because the bank is also facing more stringent rules in the UK. This means that Barclays is facing higher capital requirements on both sides of the Atlantic, so there's less wiggle room in adapting.

Movement of assets: It's a concern
The first thing I thought of when I heard about Deutsche Bank's operations movements was regulatory arbitrage. Of course, as a concept it makes sense. If a country becomes costly to operate in, its not surprising that a bank would shift its activities to places that are cheaper. By "reassigning operations to its other offices in Europe and Asia," as Marketwatch put it, Deutsche Bank is continuing the pattern of finding the cheapest way to go about its business. For its part, Barclays will have every reason to do the same, particularly since it's also facing additional capitalization pressures in the UK.

Risks to your investment
Does this reduce risk? Well, it reduces the risks in the U.S., but it doesn't change the risks facing the bank. By moving operations from one place to another, Deutsche Bank might be ensuring that its American holding company is well capitalized, but it doesn't tell you about the stability of the bank as a global institution. 

Taking advantage of differences in regulation is sensible from a profit-maximizing standpoint, but it also means that the riskiest activities will go to the cheapest (or least demanding) places. I don't think this will be good for Deutsche Bank in the long run -- or for Barclays, if it goes in that direction. 

Risks to the economy
Advisory bodies like Basel propose global standards for banks to avoid domino effects due to poor capitalization and risk controls. Imposing standards on the banks in one place is sort of like vaccinating half the population; it will hopefully protect those banks (or, in this case, those subsidiaries), but it won't stop the spread of the disease. 

If banks start playing in regulatory arbitrage to free up their scope for movement and reduce headaches, I think we'll have the same problem. Maybe their American operations won't require capital infusions during crises, but I think we're fooling ourselves to believe that such a thing wouldn't have an effect on American financial markets. As we've already seen, if things fall apart in Europe, it's unavoidable that we feel the effects here. 

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Anna Wroblewska has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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