When the Federal Reserve Board rejected the capital plans of three foreign-owned banks last week, it was easy to assume politics was involved.
That conclusion is probably wrong. Yes, foreign banks and Fed officials have tangled over capital matters lately, but insufficient preparation and the need to make multimillion-dollar investments in reporting systems were the main culprits, observers say.
The Fed tossed out capital plans submitted by five banks, three of those foreign-owned: HSBC North America Holdings, RBS Citizens Financial Group; and Santander Holdings USA. The capital tests applied to more banks this year, and foreign-owned banks were among those participating for the first time.
Because the U.S. regulatory situation was so fluid, many foreign banks didn't really get started in earnest on developing capital plans until late last year, says Anna Krayn, director of the risk and regulatory group at Moody's Analytics. Non-U.S. banks as a result had little time to make the kind of companywide upgrades that American banks have had years to work on, she says.
"The process and controls and questions that the Fed has raised, you can't fix that in a three- to six-month period," Krayn says.
The results could have an immediate impact on the foreign banks' strategic considerations. Royal Bank of Scotland (RBS), for example, may need to switch gears on plans for its RBS Citizens Bank, either postponing or canceling an initial public offering for the unit. (An RBS spokesman said the companys plans are still on track.)
Indeed, foreign banks had complained that they shouldn't be subjected to the same tough standards as U.S. banks in the Fed's annual exercise known as Comprehensive Capital Analysis Review (CCAR).
"For a while, you heard that foreign banks were thinking that the Fed was picking on them," says Erin Davis, an equity analyst at Morningstar who follows foreign banks.
After Fed Gov. Daniel Tarullo, in November 2012, said the central bank would supervise foreign banks via the same standards as U.S. banks, the head of the Institute of International Bankers cried foul. The Fed should "take into account comparable home country standards" when regulating foreign banks, Sally Miller, the institute's president said.
Institute officials did not respond to requests for comment on the Feds rejection of the three foreign banks' capital plans.
The Fed did not comment Thursday, but it acknowledged last week that banks new to the review process "may face challenges in developing appropriate capital planning processes that meet" its high standards.
Even with these sentiments lurking in the background, the Fed probably was not trying to exact revenge by tossing out capital plans from HSBC, Santander and RBS Citizens, says Greg Lyons, an attorney at Debevoise & Plimpton who has represented banks before the Fed.
"I'm certainly not aware of any political reasons involved," Lyons says.
Fed Gov. Tarullo "was quite unrepentant about the foreign bank rules and almost seemed to be encouraging foreign governments to be doing" the same thing as the Fed, Lyons says.
Tarullo, on March 27, said foreign banks relied on the Fed for liquidity at the outset of the financial crisis, one factor prompting the tougher regulation of foreign banks.
"We do retain the responsibility to maintain the stability of the U.S. financial system," Tarullo said on Feb. 18 when the Fed finalized the rules for foreign banks.
The Fed rejected the three foreign banks' plans for "qualitative" reasons even though they exceed the requirement of 5% Tier 1 common. HSBC and RBS Citizens' plans were tossed out because of "significant deficiencies" in their planning process, including "inadequate governance and weak internal controls around the process." Santander had deficiencies in its capital planning process, with the Fed citing governance, internal controls, risk identification, risk management and management information systems.
These banks need to make significant technology upgrades in order to collect and aggregate data from their numerous business units around the world, Krayn says.
"[A bank's] risk group owns data with respect to loan characteristics," Krayn says. "And there is a financial group responsible for planning. And the treasury group will own the interest-generation data. CCAR requires bringing those all together."
"It's not a short-term, quick-fix model," Krayn says.
Foreign banks also have a challenge in adjusting for different regulatory structures in the multiple countries where they operate, Davis says.
"For a bank to try to estimate its loss under its worst-case scenario is worthwhile, but it's inherently difficult," Davis says.
Foreign banks had to make significant financial investments for the CCAR round of tests, or they will need to make those investments, Krayn says. She estimated it will cost banks between $10 million and $100 million, spread out over multiple years, to make the upgrades.
Those planned tech upgrades come at a time when First Niagara Financial Group (FNFG), PNC Financial Services Group (PNC) and other U.S. banks plan to spend hundreds of millions on technology, often to improve regulatory compliance.
It's yet another cost of doing business in the U.S., though these foreign banks are more likely to eat the costs than pull out of the U.S., Lyons says.
"These banks have a substantial presence in the U.S., so although the cost is high, it's hard to imagine them pulling out," Lyons says.
HSBC "came through our first stress test with the highest total capital position of any of the 30 banks put to the most severe test," Gerard Mattia, chief financial officer of HSBC North America, said in an email. HSBC is working closely with regulators to improve its CCAR capital-plan submission process, he says.
Santander will resubmit its capital plan to the Fed, the Spanish company said in a March 26 news release. Santander noted that the Fed did not object to its plan to pay a dividend on its preferred stock.
RBS Citizens said in a news release it will resubmit its capital plan "as soon as practicable."
Another group of foreign-owned banks may be required to submit to the tougher U.S. stress tests next year, depending on whether they are required to form an intermediate holding company. Those include Toronto-Dominion Bank's TD Bank and BNP Paribas' Bank of the West.