WASHINGTON - The Federal Reserve Board is expected to issue a proposed rule today that could force many banks to overhaul their correspondent relationships.
Under the proposal, banks that are less than "well capitalized may have to limit their overnight federal funds trading and other interbank credit or deposit exposures.
Smaller institutions that rely on a single correspondent institution, such as a bankers' bank, may have to diversify their business among several providers.
Sketchy Details
Details of the plan, which is part of an overall effort to reduce risk in the banking system, were not available in advance of today's Fed meeting. But industry sources said the Fed has developed a sliding scale, linked to capital adequacy, to determine how much a bank can lend other institutions.
A variety of interbank transactions that could be halted by an unexpected insolvency - including federal funds and letters of credit - would be subject to the rule, along with interbank deposit relationships. Banks that are less than well capitalized - meaning adequately capitalized or undercapitalized - are expected to face restrictions.
Congress directed the Fed last year to control interbank exposures as part of a wider effort to prevent problems at troubled banks from infecting healthier banks that do business with them. The rule must be implemented by December.
The law and its correspondent banking implications attracted little notice at the time but is beginning to cause considerable consternation in the industry.
"These rules have the potential to redefine the payment system, correspondent banking, and the relationship between large and small banks," said Karen Shaw, president of the Institute for Strategy Development, a Washington consulting firm.
A 25% Cap Suggested
The Fed had aired the possibility of limiting each bank's exposure to another institution to 25% of risk-based capital.
That cap "could be really problematic for small banks," said Diane Casey, executive director of the Independent Bankers Association of America.
She said a 25% limit could drive some of the 16 independent bankers' banks out of business.
Exemptions Sought
Bankers' banks are formed by groups of independent institutions who prefer to get correspondent services from a bank they own, rather than a big-city commercial bank.
Bankers' banks have been lobbying for an exemption from the Fed rules, and they have found support from Sen. Donald W. Riegle, D-Mich., chairman of the Senate Banking Committee.
One critical question is whether cash items in the process of collection would be exempted from any interbank exposure rule. Most experts believe they will be.
If those checks are not exempt, "it will force a lot of banks into dealing with the Fed [for check-clearing], and take the check business out of private hands," said an industry lobbyist who asked not to be identified.
Industry Surveys
To get a rip on the extent of bank's financial exposure to one another, the Fed last spring asked the IBAA and the American Bankers Association to survey their members.
According to a Fed staff memorandum, key findings included: * At 67% of the banks, the largest daily average exposure to any single institution was less than 50% of capital. * Federal funds sold were the largest source of exposure for 58% of respondents. Interbank deposits were the main exposure for 38%.
