- Key insight: By a 4-3 vote, the Federal Reserve Board approved an application by Morgan Stanley for an exception to foreign exposure limits. The approval will allow Morgan Stanley to reorganize its German investment bank affiliate into its bank holding company.
- What's at stake: The move was contested at the Fed board, with Vice Chair Philip Jefferson and Govs. Lisa Cook and Michael Barr voting against the resolution. Fed Chair Jerome Powell, Vice Chair for Supervision Michelle Bowman, and Govs. Stephen Miran and Christopher Waller voted for it.
- Expert quote: "If exemptions are granted in the future based on this precedent, the most systemic U.S. banking organizations could transfer foreign broker-dealer assets from nonbank holding company subsidiaries to subsidiaries of U.S. insured depository institutions." — Fed Vice Chair Philip Jefferson
The Federal Reserve Board Thursday approved an application by Morgan Stanley to incorporate its German investment bank into its holding company, a move that drew three dissents on the seven-member board over concerns that it could set a dangerous precedent and heighten systemic risks.
Section 23A of the Federal Reserve Act sets limits on the size and volume of transactions U.S. banks undertake with foreign affiliates. It generally requires U.S.-based Fed member banks to limit their transactions with their overseas nonbank affiliates to less than 10% of the U.S. bank's capital stock and surplus for a single overseas affiliate, or 20% of its capital stock and surplus for all overseas affiliates in aggregate.
The law allows for exceptions to those limits if the Fed Board and either Federal Deposit Insurance Corp. or Office of the Comptroller of the Currency jointly agree that the exception is in the public interest, and the FDIC determines that the exception does not pose an undue risk to the Deposit Insurance Fund. On Thursday, the OCC joined the Fed in the joint findings approving the proposed exception for Morgan Stanley.
Fed Vice Chair Philip Jefferson, along with Govs. Michael Barr and Lisa Cook, dissented from the majority, expressing concerns that the approval contravenes the statute's goal of limiting U.S. depositors' exposure to riskier overseas nonbank activities. They also argued that the vote could set a precedent for other large U.S. banks to follow, further compounding the heightened risk. Jefferson added that the matter should have been put up for public comment.
"I believe that this decision creates a precedent for granting similar section 23A exemptions," Jefferson said in a dissenting statement. "If exemptions are granted in the future based on this precedent, the most systemic U.S. banking organizations could transfer foreign broker-dealer assets from nonbank holding company subsidiaries to subsidiaries of U.S. insured depository institutions."
Barr, who served as Vice Chair for Supervision before stepping down from that role in February 2025, said the purpose of the statute is to prevent risky overseas nonbank exposures from posing a threat to the Deposit Insurance Fund or other U.S. emergency lending facilities. The proposed reorganization of Morgan Stanley's German affiliate raises precisely those kinds of concerns, he argued.
"The use of FDIC-insured funding to facilitate non-banking activities abroad, along with increased risks to MS Bank through the assumption of [the German affiliate's] activities and liabilities, increases the potential for losses to the deposit insurance fund," Barr said. "Morgan Stanley's arguments in support of the public interest, specifically that MS Bank would be better diversified and better able to provide products and services to customers, do not outweigh risks imposed [on] the deposit insurance fund or the extension of federal subsidies to foreign nonbank activities."
Cook echoed the concerns raised by Jefferson and Barr, adding that "Morgan Stanley remains globally competitive without an exception from the requirements of section 23A." She said she saw little reason to believe that granting the request would be "necessary to support Morgan Stanley's capacity to provide services to its customers or to avoid financial distress."
The Fed often has a mix of members nominated by both Republican and Democratic administrations, but such a large number of dissents on a board vote is rare. Just last week, the central bank voted to approve the publication of a
In the Morgan Stanley case, Fed Chair Jerome Powell, Vice Chair for Supervision Michelle Bowman and Govs. Stephen Miran and Christopher Waller voted in favor of the Section 23A exception.
Bowman said in her statement supporting the decision that the Federal Reserve Act allows U.S. banks to choose whether to operate their foreign bank presences as either direct subsidiaries subject to regulatory transaction limits or as affiliates not subject to those restrictions. Morgan Stanley has decided to reorganize itself, and other U.S. banks already operate in the same market under the organizational structure that Morgan Stanley intends to undertake, Bowman said, and the board has up to this point not objected to those arrangements.
"Other large banks already operate with a similar structure and engage in similar activities through a bank-owned subsidiary in Europe," Bowman said. "At no point has the Board challenged or expressed concern about these existing ownership structures in terms of safety and soundness, financial stability, or the risks to the deposit insurance fund. These risks have been managed through appropriate supervision by the primary federal regulator."
Bowman added that since 1999, when the Federal Reserve Act was amended as part of the Gramm-Leach-Bliley Act to allow investment banking and commercial banking to coexist under one roof, no material losses have been recorded because of these arrangements, suggesting the systemic risk fears expressed by her colleagues have been overstated.
"For as long as these foreign activities have been permitted, no U.S. bank has suffered material financial losses arising out of these overseas activities," Bowman said. "Today's action does not create precedent that would bind the Board in future cases. Similar exemption requests made by other firms will be reviewed based on the applicable legal standard as applied to the particular facts of that request."
