WASHINGTON — International regulators and the institutions they supervise are objecting to a Federal Reserve Board proposal that would toughen oversight of foreign institutions operating in the U.S.

In dozens of letters, regulators from the European Union, Switzerland, Canada, Japan, South Korea and elsewhere raised a host of concerns with the plan, saying it would undermine global coordination on financial reform and risked retaliatory measures.

"If the proposals are implemented in their current form, it may well lead to other countries developing their own frameworks, leading to diverging regulatory frameworks, global inconsistency and an unwieldy cross-border regulatory regime across the globe," Tony Burke, director of industry, policy and strategy for the Australian Bankers' Association, wrote in an April 22 letter.

In the wake of the financial crisis, global policymakers agreed to impose a package of capital and liquidity rules that would provide the largest, most complex banks with an additional cushion to absorb the impact of any economic period of stress.

But many warned the Fed's proposal would weaken that effort, especially as a number of countries, including the United States and the European Union, have yet to fully adopt the Basel III rules.

"Certain elements" of the proposal for foreign bank organizations, or FBOs, "seem to be in substantial contradiction to the global regulatory convergence and could have a negative impact on the implementation of Basel III, jeopardizing and/or delaying the process," Michel Barnier, a commissioner for the European Commission, wrote in an April 18 letter. "This may also prove detrimental for the integration of international capital markets, and for the global economic recovery."

Barnier wrote that the Fed's plan was a "radical departure" from the agency's current regulatory policy, and that U.S. regulators would be better off implementing the package of Basel III rules as promised to the Group of 20 nations.

At issue is a proposal issued by the Fed in late November, which represented a sharp break from the way the central bank currently oversees foreign bank operations in the U.S. The plan would impose the same set of requirements that U.S. bank holding companies face.

The change in supervisory approach has long been expected since the financial crisis revealed significant flaws in the current regulatory process. Supporters of the proposal point to the failure of Lehman Brothers, which had a substantial broker-dealer subsidiary in the U.K., and severe distress at certain foreign banks with operations in the U.S. as a reason for the action.

Yet foreign banks have argued the proposal is too harsh, a criticism that Fed Gov. Daniel Tarullo dismissed last week when speaking at the Peterson Institute for International Economics.

"I'm a bit bemused by complaints that somehow we are doing something that is a break with what's been done before," Tarullo said during a question-and-answer session following his May 3 speech at the Peterson Institute. "I think there is a break with the practice that has allowed a large banking organization with a big broker-dealer to have negative capital in the United States; but we are not breaking with a fairly well-established practice in other parts of the world, which again I applaud, that do make sure that there are strong prudential capital standards applied as well as now liquidity standards."

In the comment letters, which were due April 30, international regulators and other critics disagreed. They said that the Basel III agreement was now being "eclipsed by nationally driven regulatory and economic policy measures" like the Fed's plan, Timothy Adams, president and chief executive of Institute of International Finance, wrote in an April 16 letter.

"Regulatory fragmentation can be seen through the increasingly national approaches in key reform areas, such as provisions for resolution of failing firms, and capital and liquidity requirements," Adams wrote. "Differentiation in the implementation of globally agreed standards and domestic bias in supervisory practices, have also contributed to a sense of financial 'Balkanization.' Incoherence and complexity are compounded by the extraterritorial overreach of some national measures."

Australian regulators said it was unfair to penalize foreign banks from countries that have already adopted Basel III, which their country did on Jan. 1.

"The proposals do not appear to give recognition to countries such as Australia that already have strong prudential regimes," wrote Burke, noting that the country was the first among the 27 members who signed off on the December 2010 pact to adopt a final package.

Fed officials have argued that Congress required regulators under the Dodd-Frank Act to reform the way they supervise foreign bank operations with $50 billion or more of globally consolidated assets and a presence in the U.S. A provision in the reform law by Sen. Susan Collins, R-Maine, also calls for large foreign banks to restructure their U.S. operations.

Tarullo, who pointed to the agency's statutory mandate as part of the reasoning for the changed approach, has also noted the growing presence of foreign banking organizations in the U.S., which during the financial crisis found themselves in liquidity and capital squeezes having to draw at the Fed's discount window.

"We, the Federal Reserve … were necessarily in the position of trying to keep the United States financial system from imploding," Tarullo said at the Peterson Institute. "We just can't get around the fact that included a lot of assistance to foreign banking organization. I think, under these circumstances, I think it's only prudent to make sure that the largest ones have minimum capital and liquidity obligations here."

Currently, foreign bank organizations own half of the 10 largest broker-dealers and nine of the 20 largest banks in the U.S. .

The scope of the Fed's plan will affect a total of 107 foreign banks operating in the U.S. However, the Fed opted to take a tailored approach with its plan, divvying up the banks into two buckets, with some having to face the toughest set of requirements.

Even so, European Banking Federation Chief Executive Guido Ravoet and others argued that the Fed did not offer enough tailoring to account for the various types of business models. He said the plan would in some cases unduly burden certain institutions.

"This one-size-fits-all approach is not required under Sec. 165 Dodd-Frank Act and does not take into account the various forms of doing business in the U.S. that the Federal Reserve has traditionally permitted FBOs to adopt," Ravoet wrote in an April 18 letter.

Others also pointed to the low threshold set in the proposal of a $10 billion and $50 billion cutoff in determining what set of requirements would apply to a foreign bank.

The Japanese government suggested that differential treatment should be based on a number of criteria, including asset size of the U.S. broker-dealer compared to the total U.S. assets of the foreign bank; the use of dollar funds raised in the U.S.; the proportion of stable funding for U.S. operations; and the amount of funds raised and invested in the U.S.

"Too much focus on the asset size could lead to distortion and misinterpretation of the risk characteristics of FBOs," Masamichi Kono, vice commissioner for international affairs at Japan's Financial Services Agency wrote in an April 30 letter. "The requirements should be proportionate and tailored to the differences in business models and risk characteristics of the relevant FBOs."

Banks that are likely to be affected by the proposed regulation include Barclays, Deutsche Bank, Credit Suisse and HSBC. Each submitted letters raising objection s to the Fed's plan.

Among their concerns is the far-reaching scope of the Fed's proposal that fails to take into account an institution's home-country requirements or whether a foreign bank owns an insured depository institution in the U.S.

"Congress articulated in Sections 115 and 165 (of the Dodd-Frank Act) that the board should give due regard to the principle of national treatment and equality of competitive opportunity and should take into account the extent to which an FBO is subject on a consolidated basis to home country standards that are comparable to those imposed upon U.S. domestic bank holding companies," Jacques Brand, chief executive of Deutsche Bank North America, wrote in an April 29 letter. "The proposal does not take this approach, but instead adopts one which is designed to simplify supervision and resolution of an FBO's U.S. operations without regards to the broader systemic implications or the congressional directive."

Shin Je-Yoon, chairman of the Republic of Korea's Financial Services Commission, said the best approach for U.S. regulators to take would be to keep "extraterritorial application at a minimum."

"FBOs will face a greater regulatory burden by having to meet the standards of both home and host countries," the chairman wrote in an April 30 letter. "This may also lower regulatory effectiveness, since the standards are likely to be inconsistent and overlapping."

Michael Ambuhl, state secretary for international financial markets at the Swiss Finance Department, raised separate concerns on the Fed's proposal, including the impact it would have on the ability to resolve global banks based on the single-point-of-entry approach endorsed by the Federal Deposit Insurance Corp.

"With its territoriality approach, the proposed rules seem to indicate a lack of confidence in international standards and in the ability of foreign home country regulators to oversee, and if necessary, resolve international firms in cooperation with the host country regulators concerned," Ambuhl wrote in an April 23 letter.

He also noted that the current proposal is "not comparable" to the Swiss emergency plan to guarantee systemically relevant functions in case of a failure of a systemically important financial institution.

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