BANK CAPITAL 

REQUIREMENTS

Potential Effects of 

New Changes on 

Foreign Holding 

Companies and U.S. 

Banks Abroad

Report to Congressional Committees

January 2012

GAO-12-235

United States Government Accountability Office

GAO
United States Government Accountability Office

Highlights of GAO-12-235, a report to 

congressional committees

January 2012

BANK CAPITAL REQUIREMENTS

Potential Effects of New Changes on Foreign 

Holding Companies and U.S. Banks Abroad

Why GAO Did This Study

During the 2007-2009 financial crisis, 

many U.S. and international financial 

institutions lacked capital of sufficient 

quality and quantity to absorb 

substantial losses. In 2010, the DoddFrank Wall Street Reform and 

Consumer Protection Act (the DoddFrank Act) introduced new minimum 

capital requirements for bank and 

savings and loan (thrift) holding 

companies—including intermediate 

holding companies of foreign banks. 

Intermediate holding companies are 

the entities located between foreign 

parent banks and their U.S. subsidiary 

banks. These companies held about 9 

percent of total U.S. bank holding 

companies’ assets as of September 

2011. The Dodd-Frank Act also 

required GAO to examine (1) 

regulation of foreign-owned 

intermediate holding companies in the 

United States, (2) potential effects of 

changes in U.S. capital requirements 

on foreign-owned intermediate holding 

companies, and (3) banks’ views on 

the potential effects of changes in U.S. 

capital requirements on U.S. banks 

operating abroad. To conduct this 

work, GAO reviewed legal, regulatory, 

and academic documents; analyzed 

bank financial data; and interviewed 

regulatory and banking officials and 

market participants.

GAO makes no recommendations in

this report. GAO provided a draft to the 

federal banking regulators (Federal 

Reserve, Federal Deposit Insurance 

Corporation and Office of the 

Comptroller of the Currency) for their 

review and comment. They provided

technical comments that were

incorporated, as appropriate. 

What GAO Found

Foreign-owned intermediate holding companies can engage in the same 

activities as and generally are regulated similarly to their U.S. counterparts. The 

Board of Governors of the Federal Reserve System (Federal Reserve) oversees 

the regulation, supervision, and examination of foreign and U.S. bank and thrift 

holding companies. As of the end of 2010, four qualifying foreign-owned 

intermediate holding companies (exempt holding companies) were relying on a 

capital exemption, which allowed them to operate with significantly lower capital 

than U.S. peers. Federal Reserve officials noted that allowing capital to be held 

at the foreign parent bank (consolidated) level was consistent with its supervision 

for U.S. bank holding companies and met international standards for home-host 

supervision. The Dodd-Frank Act eliminated the capital exemption in order to 

enhance equal treatment of U.S.- and foreign-owned holding companies by 

requiring both types of companies to hold similar capital levels in the United 

States. As a result, these exempt holding companies must meet minimum capital 

standards that are not less than those applicable to Federal Deposit Insurance 

Corporation-insured depository institutions by July 2015. 

The four exempt holding companies have been considering various actions to 

comply with new capital requirements, and the effects of eliminating the capital 

exemption on competition and credit cost and availability likely would be small. 

Specifically, these companies are considering raising capital, decreasing their 

holdings of risky assets, restructuring, or adopting a combination of these 

actions. GAO’s analysis of loan markets suggests that the elimination of the 

capital exemption likely would have a limited effect on the price and quantity of

credit available because the affected banks have relatively small shares of U.S. 

loan markets, which are competitive. These four companies accounted for about 

3.1 percent of the loans on the balance sheets of all bank holding companies in 

the United States as of year end 2010. In addition, GAO’s review of the academic 

literature and econometric analysis both suggest that changes in capital rules 

that affect the exempt companies would have a limited effect on loan volumes 

and the cost of credit and add minimally to the cumulative cost of new financial 

regulations. Although the impact on the price and quantity of credit available may 

vary across regions, modeling limitations restricted GAO’s ability to identify 

regional differences.

Market participants expressed uncertainty about how changes in capital 

requirements might affect the competitiveness of U.S. banks operating abroad, 

partly because international regulatory capital requirements have yet to be 

implemented. The largest internationally active U.S. banks derived about onethird of their 2010 revenues from operations abroad. They face a variety of 

domestic and foreign competitors and are subject to multiple regulatory regimes. 

Bank officials expressed uncertainty about how changes in capital requirements 

will affect their cost of capital, lending ability, and competitiveness. Furthermore, 

they were concerned that fragmented or conflicting regulations across national 

jurisdictions might restrict banks’ ability to use capital efficiently. Many U.S. 

banks GAO interviewed expressed concerns about the added costs of 

compliance with multiple regulatory regimes and the impact of the Act on the

global competitiveness of U.S. banks, but these concerns would need to be 

considered against the potential benefits of a safer and sounder financial system. 

View GAO-12-235. For more information, 

contact Thomas J. McCool at (202) 512-2642 

or mccoolt@gao.gov. 
Page i GAO-12-235 Bank Capital Requirements 

Letter 1 

Background 4

Organization of Foreign Banks in the United States 5

U.S. Regulation of Foreign-owned Holding Companies Intended to 

Achieve Equivalency with Domestic Counterparts 11

Overall Effects of Capital Changes for Exempt Foreign-owned 

Intermediate Holding Companies Likely to Be Limited 18

Market Participants Concerned about Differing Capital Regimes 

and Competitive Effects Abroad 31

Agency Comments 39

Appendix I Objectives, Scope, and Methodology 40

Appendix II Impact of Reducing the Risk-Weighted Assets of Exempt Holding 

Companies to Comply with New Requirements 48

Appendix III GAO Contact and Staff Acknowledgments 51

Tables

Table 1: U.S. Operations of Foreign Banks, as of September 30, 

2011 5

Table 2: Basel Capital Accord Framework, from 1988 through 2010 8

Table 3: Bank Holding Company Loan Market Shares, as of 

December 31, 2010 22

Table 4: Capital Ratios and Capital Deficits for the Four Exempt 

Holding Companies Relative to Certain Capital Levels, as 

of December 31, 2010 26

Table 5: Aggregate Impacts of Eliminating the Capital Exemption 29

Table 6: Decrease in Risk-Weighted Assets Necessary to Meet 

Certain Capital Levels 49

Contents
Page ii GAO-12-235 Bank Capital Requirements 

Figures

Figure 1: Capital Relationships in Foreign and Domestic 

Intermediate Holding Companies, after the Dodd-Frank 

Act 16

Figure 2: Herfindahl-Hirschman Index of Concentration in Loan 

Markets, as of December 31, 2010 24

Figure 3: Percentage and Dollars of Domestic versus Foreign 

Revenues of the Six Largest Internationally Active U.S. 

Banks, from 2005 to 2010 (dollars in billions) 32

Figure 4: Foreign Revenues of Six Largest Internationally Active 

U.S. Banks in 2010, by Region 33
Page iii GAO-12-235 Bank Capital Requirements 

Abbreviations 

CCS comprehensive consolidated supervision 

CRD3 Capital Requirement Directive 3

CRD4 Capital Requirement Directive 4

DOJ Department of Justice

DSGE dynamic stochastic general equilibrium model

FBSEA Foreign Bank Supervision Enhancement Act of 

 1991

FDIC Federal Deposit Insurance Corporation

FTC Federal Trade Commission

G-20 The Group of Twenty

GDP gross domestic product 

HHI Herfindahl-Hirschman Index

IBA International Banking Act of 1978

OCC Office of the Comptroller of the Currency

OTS Office of Thrift Supervision

SEC Securities and Exchange Commission

SIFI systemically important financial institution

UK United Kingdom 

VAR vector autoregression model

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Page 1 GAO-12-235 Bank Capital Requirements 

United States Government Accountability Office 

Washington, DC 20548

January 17, 2012

The Honorable Tim Johnson

Chairman

The Honorable Richard C. Shelby

Ranking Member

Committee on Banking, Housing, and Urban Affairs

United States Senate

The Honorable Spencer Bachus

Chairman

The Honorable Barney Frank

Ranking Member

Committee on Financial Services

House of Representatives

The 2007-2009 financial crisis revealed that many U.S. and international 

financial institutions lacked capital of sufficient quality and quantity to 

absorb substantial losses.1 In response, banking regulators around the 

world moved to strengthen requirements for capital adequacy. In the United 

States, the Dodd-Frank Wall Street Reform and Consumer Protection Act 

(Dodd-Frank Act) introduced new capital requirements for bank and 

savings and loan (thrift) holding companies.2 These requirements also 

apply to intermediate holding companies of foreign banking organizations 

(hereafter, such foreign banking organizations will be referred to as foreign 

parent banks or foreign banks).3

 

1

Capital is a source of long-term funding, contributed largely by an institution’s equity 

stockholders and its own returns in the form of retained earnings, that provides institutions 

with a cushion to absorb unexpected losses. 

These intermediate holding companies 

held approximately $1.6 trillion in U.S. assets in 2011, representing about 9 

2

Pub. L. No 111-203, § 171, 124 Stat. 1376, 1435 (2010). This section is also known as 

the Collins Amendment. A bank or thrift holding company owns or controls one or more 

banks or thrifts or owns or controls one or more bank or thrift holding companies. The 

company at the top of the ownership chain is commonly called the top-tier entity. 

3

Foreign banks may have their U.S. subsidiaries owned or controlled by an intermediate 

holding company in the United States (the organization between the subsidiary bank and 

the foreign parent bank) primarily to take advantage of tax or regulatory benefits.

 
 

Page 2 GAO-12-235 Bank Capital Requirements 

percent of total U.S. bank holding companies’ assets.4

Section 174(b) of the Dodd-Frank Act requires us to study the effects of the 

new U.S. capital requirements on foreign-owned intermediate holding 

companies, taking into account the principles of national treatment and 

equality of competitive opportunity, which accord foreign banks the 

opportunity to compete in the United States on the same basis as domestic 

banks. This report examines (1) the regulation of foreign-owned intermediate 

holding companies in the United States, (2) the potential effects of changes 

in U.S. capital requirements on foreign-owned intermediate holding 

companies, and (3) banks’ views on the potential effects of changes in U.S. 

capital requirements on U.S.-owned banks operating abroad.

The Dodd-Frank Act 

requires these holding companies to meet minimum risk-based capital and 

leverage requirements that are not less than those applicable to depository 

institutions that the Federal Deposit Insurance Corporation (FDIC) insures. 

These requirements are intended to improve the capital and liquidity 

positions of such holding companies so that they may survive periods of 

financial and economic stress—thereby making the financial system more 

stable and reducing the likelihood or severity of future financial crises.

To describe how foreign bank and thrift holding companies are regulated 

in the United States, we reviewed laws and regulations relevant to federal 

and state bank and thrift holding companies, regulatory documentation, 

and published reports, testimonies, speeches and articles; interviewed a 

state bank regulator, the European Commission (a European Union entity 

that, among other things, sets out general capital rules that each of the 27 

European Union member countries can adopt at their discretion), bank 

holding companies, and industry experts; and reviewed prior GAO 

reports. In addition, we received written responses to questions from the 

European Banking Authority (European banking regulator) and attended a 

foreign bank conference on the implications of new capital rules. To 

assess the potential effects of changes in capital requirements for foreignowned intermediate holding companies, we reviewed section 171 of the 

Dodd-Frank Act and proposed and final capital rules for foreign-owned 

intermediate holding companies and related comment letters. We also 

reviewed various proposed and final international capital rules. In 

addition, we reviewed Securities and Exchange Commission (SEC) 

 

4

Data as of September 30, 2011 according to the Board of Governors of the Federal 

Reserve System (Federal Reserve). 
 

Page 3 GAO-12-235 Bank Capital Requirements 

regulatory filings of foreign bank holding companies. Moreover, we 

interviewed officials from the European Commission, foreign and U.S. 

bank holding companies, credit rating agencies and industry experts on 

the effects of the new capital requirements on foreign banks operating in 

the United States. We used the Herfindahl-Hirschman Index (HHI)—a 

measure of industry concentration that reflects both the number of firms in 

the industry and each firm’s market share—to track loan market 

concentration.5 We compared market shares for foreign-owned 

intermediate holding companies (that were and were not subject to U.S. 

capital requirements) and U.S. bank holding companies. We obtained 

data on assets of foreign-owned intermediate holding companies and 

U.S. bank holding companies from SNL Financial—a private financial 

database. We obtained a list of foreign-owned intermediate holding 

companies and information on whether they were subject to U.S. capital 

requirements from the Board of Governors of the Federal Reserve 

System (Federal Reserve), which is the consolidated regulator for all 

bank and thrift holding companies in the United States.6

To estimate the effect of capital requirements on the cost and availability of 

credit, we developed a modified version of a model commonly used in the 

macroeconomics and monetary literature. The data for the model were 

obtained from Thomson-Reuters Datastream, the Federal Reserve, and the 

We also obtained 

the views of foreign and domestic banks, credit rating agencies, and 

industry experts on the cost of capital and lending. 

 

5

The HHI is one of the concentration measures federal agencies, including the 

Department of Justice (DOJ) and the Federal Trade Commission (FTC), use when 

assessing market concentration to enforce U.S. antitrust laws. 

6

The Dodd-Frank Act eliminated the Office of Thrift Supervision (OTS), which chartered 

federal savings and loan associations (thrifts) and savings and loan holding companies 

(thrift holding companies), and supervised federally and state-chartered thrifts and thrift 

holding companies. 12 U.S.C § 5413. Rulemaking authority previously vested in OTS was 

transferred to the Office of the Comptroller of the Currency (OCC) for federally chartered 

thrifts and to the Federal Reserve for thrift holding companies and their subsidiaries, other 

than depository institutions. 12 U.S.C. § 5412(b). Supervision of state-chartered thrifts was 

transferred to the FDIC. 12 U.S.C. § 5412(b)(2)(C). The transfer of these powers was 

completed on July 21, 2011, and OTS was officially abolished 90 days later (October 19, 

2011). 12 U.S.C. §§ 5411, 5413. OTS supervised one foreign-owned intermediate thrift 

holding company, ING Direct Bancorp, which agreed in June 2011 to sell its U.S. banking 

operations (ING Direct USA) to Capital One Financial Corporation. This report does not 

discuss OTS’s past oversight of thrift holding companies. The Federal Reserve noted that, 

to the extent possible, it will apply bank holding company supervision, capital 

requirements, and regulatory reporting requirements to thrift holding companies.
 

Page 4 GAO-12-235 Bank Capital Requirements 

Federal Reserve Bank of St. Louis. Because of the limitations associated 

with the modeling technique and uncertainty in the parameter estimates, 

we compared our results with those of a wider body of research on the 

effects of bank capital on lending activity. We obtained and analyzed 

relevant empirical studies and applied the estimates from these studies to 

the expected changes in capital stemming from the elimination of the 

Federal Reserve’s capital exemption for certain institutions.

To identify banks’ views on the potential risks from changes in capital 

requirements on U.S. banks operating abroad, we interviewed officials 

from three U.S. bank holding companies that engaged in significant 

international operations and officials from the European Commission. We 

summarized studies and congressional testimonies of the potential effects 

on U.S. banks’ funding costs, product pricing, and lending activity abroad.

For all of our research objectives, we obtained the views of officials from 

the Federal Reserve, Office of the Comptroller of the Currency (OCC), 

Office of Thrift Supervision (OTS), FDIC, and the U.S. Department of the 

Treasury. We also conducted assessments of the reliability of data 

obtained from SNL Financial and other sources and determined that they 

were reliable for our purposes. For additional information on the scope 

and methodology for this engagement, see appendix I.

We conducted this performance audit from December 2010 to January 

2012 in accordance with generally accepted government auditing 

standards. Those standards require that we plan and perform the audit to 

obtain sufficient, appropriate evidence to provide a reasonable basis for 

our findings and conclusions based on our audit objectives. We believe 

that the evidence obtained provides a reasonable basis for our findings 

and conclusions based on our audit objectives.

Foreign banks have been cited as important providers of capital to the

U.S. economy. According to Federal Reserve data, as of September 30, 

2011, 216 foreign banks from 58 countries had banking operations in the 

United States. They held about $3.4 trillion, or about 22 percent of total 

U.S. banking assets; about 25.7 percent of total U.S. commercial and 

industrial loans; about 17.5 percent of total U.S. deposits; and about 14.9 

percent of total U.S. loans. 

Background 
 

Page 5 GAO-12-235 Bank Capital Requirements 

Foreign banks may operate in the United States under several different 

structures, which include branches, agencies, subsidiary banks, 

representative offices, Edge Act corporations, Agreement corporations, 

and commercial lending companies (see table 1). Most operate through 

branches and agencies because as extensions of the foreign parent 

bank, they do not have to be separately capitalized and can conduct a 

wide range of banking operations.

Table 1: U.S. Operations of Foreign Banks, as of September 30, 2011

Dollars in billions

Organizational 

structure

Number 

of entities

Total 

assets Description

Branches and 

agencies

246 $2,207 Branches and agencies may be licensed under federal or state law. They are not 

separate legal entities from their foreign parents. Federal branches have limited authority 

to take deposits, but may generally conduct the activities that a national bank can 

conduct. Agencies have more restricted deposit-taking authority but may undertake a 

broad range of banking activities. They generally are not FDIC-insured, and are not 

subject to U.S. capital requirements.a

Subsidiary 

banks

 

50 1,031 Subsidiary banks are chartered in the United States with shares owned or controlled by a 

parent foreign bank. They are separate legal entities from their foreign parents. They 

have the same banking powers and legal or regulatory restrictions as those of any other 

domestic bank. As such, they are subject to U.S. capital requirements.

Representative 

offices

138 Not 

applicable

Representative offices allow foreign banks to attract business for the parent bank and to 

develop correspondent relationships with local U.S. banks. However, they cannot engage in 

banking activities, although they may conduct administrative functions such as receiving 

checks to forward to their home offices and handling the signing of loan papers.

Edge Act/

Agreement 

corporations

9 7.5 Edge Act corporations are established as separate legal entities and may conduct a 

range of international banking and other financial activities in the United States. By 

agreement with the Federal Reserve, state-chartered Agreement corporations essentially 

have the same powers as Edge Act corporations.

Other entities 18 109.7 Other entities include commercial lending companies/investment companies and savings 

associations. For example, commercial lending companies are specialized nondepository 

institutions authorized under state law. They may engage in borrowing and lending 

activities and have numerous other powers. They may maintain credit balances but may 

not accept deposits.

Total 461 $3,355 

Sources: GAO and Federal Reserve data.

a

Before December 1991, a limited number of foreign branches had obtained FDIC deposit insurance 

under provisions of the International Banking Act of 1978 and thus were allowed to accept retail 

deposits (currently up to $250,000 per depositor). But passage of the Foreign Bank Supervision 

Enhancement Act of 1991 prohibits any foreign branch from applying for federal deposit insurance. 

Foreign branches that had received insured deposits were grandfathered (allowed to continue to 

receive insured retail deposits). As of June 30, 2011, 10 such foreign branches operate. A foreign 

bank that wishes to accept insured deposits may do so through a de novo subsidiary or acquiring a 

separately chartered U.S. bank or thrift subsidiary. 

Both domestic banks and U.S. subsidiary banks of foreign banks may be 

owned or controlled by a bank holding company. Holding companies are 

legally separate entities from their subsidiary banks, are subject to 

separate capital requirements, and are supervised and regulated by the 

Organization of 

Foreign Banks in the 

United States 
 

Page 6 GAO-12-235 Bank Capital Requirements 

Federal Reserve. In the United States, bank holding companies are 

common and function as the top-tier entity in the corporate structure. In 

many foreign countries, notably in Europe, the deposit-taking bank is the 

top-tier entity in the corporate structure and bank holding companies are 

less common. According to the Federal Reserve, as of September 30, 

2011, there were 29 foreign-owned intermediate holding companies in the 

United States. This report focuses on changes to the capital requirements 

for these entities under the Dodd-Frank Act.

Bank and thrift organizations are required to hold capital so that certain 

parties, such as depositors and taxpayers, would not be harmed if the 

bank or thrift faced unexpected substantial losses. There are many forms 

of capital, the strongest of which do not have to be repaid to investors, do 

not require periodic dividend payments, and are among the last claims to 

be paid in the event of bankruptcy. Common equity, which meets all of 

these qualifications, is considered the strongest form of capital. Weaker 

forms of capital have some but not all of the features of common equity. 

National banking regulators classify capital as either tier 1—currently the 

highest-quality form of capital and includes common equity—or tier 2, 

which is weaker in absorbing losses.7 Different entities within a banking 

organization may have different capital requirements. For example, a 

subsidiary bank and a broker-dealer in the same corporate structure may 

be required to hold different levels of capital, and those capital 

requirements are established and supervised by different regulators.

In the 1980s, U.S. and international regulators recognized that common 

borrowers and complex products and funding sources had made the world’s 

financial markets increasingly interconnected. Regulators also acknowledged 

that bank regulatory capital standards generally were not sensitive to the risks 

inherent in a bank’s activities and that distressed or failing large, internationally 

active banks posed a significant global risk to the financial system. These 

concerns underscored the need for international regulatory coordination and 

harmonization of capital standards. As a result, in 1988 the Basel Committee 

on Banking Supervision (Basel Committee) adopted a risk-based capital 

 

7

Tier 1, or core, capital consists primarily of common equity. Tier 2 is supplementary 

capital and includes limited amounts of subordinated debt, loan loss reserves, and certain 

other instruments.

International Efforts to 

Enhance Bank Supervision 

and Stability of the 

Financial System
 

Page 7 GAO-12-235 Bank Capital Requirements 

framework known as the Basel Capital Accord (Basel I).8 Basel I aimed to 

measure capital adequacy (that is, whether a bank’s capital is sufficient to 

support its activities) and establish minimum capital standards for 

internationally active banks. It consisted of three basic elements: (1) a target 

minimum total risk-based capital ratio of 8 percent and tier 1 risk-based capital 

ratio of 4 percent, (2) a definition of capital instruments to constitute the 

numerator of the capital-to-risk weighted assets ratio, and (3) a system of risk 

weights for calculating the denominator of the ratio. While the framework was 

designed to help improve the soundness and stability of the international 

banking system, reduce some competitive inequalities among countries, and 

allow national discretion in implementing the standards, it did not explicitly 

address all types of risks that banks faced. Rather, it addressed credit risk, 

which the Basel Committee viewed as the major risk banks faced at the time.9

Over time it became apparent to bank regulators that Basel I was not providing 

a sufficiently accurate measure of capital adequacy because of the lack of risk 

sensitivity in its credit risk weightings, financial market innovations such as 

securitization and credit derivatives, and advancements in banks’ risk 

measurement and risk management techniques. The accord was revised and 

enhanced multiple times after 1988 because of its shortcomings. For example, 

in 1996, Basel I was amended to take explicit account of market risk in trading 

accounts.10

 

8

The framework is outlined in the July 1988 International Convergence of Capital 

Measurement and Capital Standards. Established in 1974, the Basel Committee seeks to 

improve the quality of banking supervision worldwide in part by developing broad 

supervisory standards. Its members represent central bank and regulatory officials from 

The market risk amendment allowed banks to use internal models 

of risks to determine regulatory capital levels. Table 2 identifies some key 

features of capital regime enhancements to the Basel accords.

Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong, 

India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, 

Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United 

Kingdom, and the United States. The Basel Committee’s supervisory standards are also 

often adopted by nonmember countries. 

9

Credit risk is the potential for loss resulting from the failure of a borrower or counterparty 

to perform on an obligation. 

10Market risk is the potential for loss resulting from movements in market prices, including 

interest rates, commodity prices, stock prices, and foreign exchange rates. Generally, 

under the market risk amendment, a bank’s internal models are used to estimate the 99th 

percentile of the bank’s market risk loss distribution over a 10-business-day horizon (in 

other words, a solvency standard designed to exceed trading losses for 99 of 100 10-

business-day intervals). 
 

Page 8 GAO-12-235 Bank Capital Requirements 

Table 2: Basel Capital Accord Framework, from 1988 through 2010 

Capital regime

Year adopted 

by Basel 

Committee

Year(s) to be 

implemented Risk enhancements

Minimum ratio of capital to riskweighted assets

Basel I 1988 1992 • Credit risk Tier 1 4% a

Totalb 8%

Basel I market risk 

amendment

1996 1996 • Market risk 

Basel II 2004 2011 • Credit risk

• Operational risk

• Market risk

c

Tier 1 4%

Total 8%

Basel II.5 market 

risk amendment

2009 2011 • Market risk (updates 1996 

market risk amendment)

Basel III 2010 2013-2019 • Higher counterparty credit 

risk charges

• New leverage ratio (onand off-balance-sheet 

assets) 

• Improved quality and 

increase of capital

• New liquidity ratios

Tier 1 6%

Common equity tier 1 4.5% d

Total 8%

Additional capital requirements

Capital 

conservation 

buffer

2.5%

e

Countercyclical 

buffer

0-2.5% f

Leverage ratio (a nonrisk-based ratio)Currently set at 

3%, with final 

percent to be

determined

g

Sources: GAO analysis of Basel accords capital requirements and Barclays Capital.

a

Tier 1 ratio is tier 1 capital divided by risk-weighted assets. 

b

The total risk-based capital ratio consists of the sum of tier 1 and tier 2 capital divided by riskweighted assets. Tier 1 capital consists primarily of common equity. Tier 2 capital includes limited 

amounts of subordinated debt, loan loss reserves, and certain other instruments. 

c

Operational risk is the potential for unexpected financial losses due to a wide variety of institutional 

factors including inadequate information systems, operational problems, breaches in internal controls, 

and fraud. 

d

Common equity tier 1 ratio is common equity to risk-weighted assets. 

e

The capital conservation buffer, composed of common equity tier 1, is to be used by financial 

institutions to absorb losses during periods of financial and economic stress. The ratio is calculated 

as tier 1 capital minus regulatory deductions divided by total risk-weighted assets. 

f

The countercyclical buffer would be in effect during periods of excessive credit growth. The buffer 

would be set by each national authority with respect to the loan book and other credit exposures in its 

jurisdiction, and would be applied on a consolidated level on a weighted-average basis. 

g

The leverage ratio is tier 1 capital divided by average total assets (not adjusted for risk) plus certain 

off-balance-sheet exposures. 
 

Page 9 GAO-12-235 Bank Capital Requirements 

Basel II, adopted in June 2004, aims to better align minimum capital 

requirements with enhanced risk measurement techniques and 

encourage banks to develop a more disciplined approach to risk 

management.11 It consists of three “pillars”: (1) minimum capital 

requirements, (2) a supervisory review of an institution’s internal 

assessment process and capital adequacy, and (3) effective use of 

disclosure to strengthen market discipline as a complement to 

supervisory efforts. Basel II established several approaches (of increasing 

complexity) to measuring credit and operational risks. The “advanced 

approaches” for credit risk and operational risk use parameters 

determined by a bank’s internal systems as inputs into a formula 

supervisors developed for calculating minimum regulatory capital. In 

addition, banks with significant trading assets, which banks use to hedge 

risks or speculate on price changes in markets for themselves or their 

customers, must calculate capital for market risk using internal models.12

The advanced approaches allow some bank holding companies to reduce 

capital from the levels required under Basel I. Large internationally active 

U.S. holding companies are implementing the first qualification phase—

known as the parallel run—of the Basel II advanced approaches.13

 

11In June 2004, the Basel Committee published Basel II: International Convergence of 

Capital Measurement and Capital Standards: A Revised Framework. 

Although some of these large companies have begun to report Basel II 

capital ratios to their bank regulators, they still are subject to Basel I 

12The advanced approaches generally apply to large internationally active banks. 

According to the U.S. Basel II advanced approaches rule, such banks are defined as 

those with consolidated total assets of $250 billion or more or with consolidated total onbalance-sheet foreign exposure of $10 billion or more. 

13Prior to the Dodd-Frank Act, the four phases for the advanced approaches qualification 

were (1) the parallel run—four consecutive quarters in which a bank meets the 

qualification requirements and is subject to the Basel I rules but simultaneously calculates 

its risk-based capital ratios under the advanced approaches; (2) the first transitional 

period—a period of at least four consecutive quarters in which the bank computes its riskbased capital ratios using the Basel I rule and the advanced approaches rule, and 

required risk-based capital must be at least 95 percent of the Basel I requirement; (3) the 

second transitional period—a period of at least four consecutive quarters in which the 

bank computes its risk-based capital ratios using the Basel I rule and the advanced 

approaches rule, and required risk-based capital must be at least 90 percent of the Basel I 

requirement; and (4) the third transitional period—a period of at least four consecutive 

quarters in which the bank computes its risk-based capital ratios using the Basel I rule and 

the advanced approaches rule, and required risk-based capital must be at least 85 

percent of the Basel I requirement. The Dodd-Frank Act had the effect of eliminating the 

transitional periods as they would apply in the United States and established a permanent 

capital floor. 
 

Page 10 GAO-12-235 Bank Capital Requirements 

capital requirements, as are other U.S. banks. Financial institutions in 

most other industrialized countries are subject to the Basel II capital 

standards. In response to the 2007-2009 financial crisis, Basel II was 

amended in 2009 by Basel II.5 to enhance the measurements of risks 

related to securitization and trading book exposures.14

Also in response to the 2007-2009 financial crisis, in 2010, the Basel 

Committee developed reforms, known as Basel III, which aim to improve 

the banking sector’s ability to absorb shocks arising from financial and 

economic stress, whatever the source; improve risk management and 

governance; and strengthen banks’ transparency and disclosures. The 

reforms target (1) bank-level, or microprudential, regulation to enhance 

the resilience of individual banking institutions to periods of stress and (2) 

systemwide risks that can build up across the banking sector as well as 

the amplification of these risks over time. These two approaches to 

supervision are complementary, as greater resilience at the individual 

bank level reduces the risk of systemwide shocks. Specifically, Basel III 

significantly changes the risk-based capital standards for banks and bank 

holding companies and introduces new leverage and liquidity 

requirements.15 The new standards include a higher minimum common 

equity capital requirement of 4.5 percent of risk-weighted assets (the 

capital needed to be regarded as a viable concern); a new capital 

conservation buffer of 2.5 percent to provide a cushion during financial 

shocks to help companies remain above the 4.5 percent minimum; and 

more stringent risk-weights on certain types of risky assets, particularly 

securities and derivatives. Basel III also defines capital more narrowly 

than the previous accords. The new common equity tier 1 capital 

measure is limited mainly to common equity because common equity is 

generally the most loss-absorbing instrument during a crisis.

 

14Revisions to the Basel II market risk framework, July 2009 (updated December 31, 

2010, February 2011), and Guidelines for computing capital for incremental risk in the 

trading book, July 2009. 

15Basel III: A Global Regulatory Framework for More Resilient Bank and Banking 

Systems, December 2010. 
 

Page 11 GAO-12-235 Bank Capital Requirements 

U.S regulation of foreign-owned intermediate holding companies is 

intended to be equivalent to regulation of domestic counterparts to help 

ensure that foreign bank operations have the opportunity to compete on a 

level playing field in the U.S. market. Several laws enacted since 1978 

have shaped the regulation of foreign-owned intermediate holding 

companies and other foreign-owned banking operations. The 

International Banking Act of 1978 (IBA) is the primary federal statute 

regulating foreign bank operations in the United States.16 In passing IBA, 

Congress adopted a policy of “national treatment,” the goal of which is to 

allow foreign banks to operate in the United States without incurring either 

significant advantage or disadvantage compared with U.S. banks. To 

implement this policy, IBA brings branches and agencies of foreign banks 

located in the United States under federal banking laws and regulations. 

IBA and subsequent laws and regulations give foreign banks operating in 

the United States the same powers and subject them to the same 

restrictions and obligations as those governing U.S. banks, with some 

adaptations for structural and organizational differences.17 For example, 

most foreign banks’ operations are conducted through branches, and they 

generally can engage in the same activities as branches of U.S. banks. 

However, the U.S. branches of foreign banks are prohibited by law from 

acquiring deposit insurance from FDIC, and therefore may not accept 

retail deposits, whereas branches of U.S. banks can.18

In 1991, Congress passed the Foreign Bank Supervision Enhancement 

Act (FBSEA).19 This Act, which amended IBA, authorizes the Federal 

Reserve to oversee all foreign bank operations in the United States.20

 

16Pub. L. No. 95-369, 92 Stat. 607 (1978).

Foreign banking organizations seeking to establish subsidiaries, 

branches, or agencies in the United States must apply for an operating 

17For example, foreign and U.S. banking institutions can engage in interstate branch 

banking and nonbanking activities such as securities underwriting and both are subject to 

reserve requirements, federal supervision, and capital adequacy standards.

18As previously noted in the report, a few foreign branches were exempted 

(grandfathered). Retail deposits are deposits of $250,000 or less. 

19Pub. L. No. 102-242 tit. II subtit. A, 105 Stat. 2236, 2286 (1991).

20The Federal Reserve has regulatory authority for overseeing U.S. and foreign banks’ 

international banking activities, which it administers through Regulation K. 12 C.F.R. § 

211.20(a). It conducts supervisory activities through the 12 Federal Reserve Banks across 

the United States.

U.S. Regulation of 

Foreign-Owned 

Holding Companies 

Intended to Achieve 

Equivalency with 

Domestic 

Counterparts
 

Page 12 GAO-12-235 Bank Capital Requirements 

charter from either OCC (national charter or federal license) or state 

banking agency (state license). The Federal Reserve must also approve 

these applications. The Federal Reserve’s approval process involves 

determining the soundness of the foreign parent bank’s activities. 

Specifically, the Federal Reserve assesses, among other factors, the 

extent to which the home country supervisor (1) ensures that the foreign 

parent bank has adequate procedures for monitoring and controlling its 

activities globally, (2) obtains information on the condition of the foreign 

bank and its subsidiaries and offices outside the home country through 

regular reports of examination and audits, (3) obtains information on the 

dealings and relationships between the foreign bank and its affiliate 

companies, and (4) receives from the bank consolidated financial reports 

for analyzing the bank’s global financial condition.

Another important requirement in the Federal Reserve’s approval process 

includes assessing the quality of supervision provided by the applicant’s 

home country supervisor. Specifically, the Federal Reserve determines 

the extent to which (1) the home country supervisor evaluates prudential 

standards, such as capital adequacy and risk asset exposure, on a global 

basis, and (2) the foreign parent bank is subject to comprehensive 

consolidated supervision—that is, the home country supervisor monitors 

the organization’s overall operations across all legal subsidiaries and 

national jurisdictions. If the Federal Reserve is satisfied with the bank 

applicant’s safety and soundness and the quality of the home country 

supervision, it can approve the foreign bank applicant (including its bank 

and nonbank affiliates) to do business in the United States. As the host 

country consolidated supervisor, the Federal Reserve retains full 

oversight authority over the foreign bank’s U.S. operations.21

The Federal Reserve’s determination that an institution is subject to 

comprehensive supervision or regulation on a consolidated supervision

(CCS) basis by the appropriate authorities in its home country is an 

institution-specific finding.22

 

21U.S.-owned banks with foreign operations are generally regulated and supervised in the 

same manner. This meets elements of consolidated bank supervision and home-host 

supervisor relationship under the Basel Committee’s “Core Principles Methodology.” 

If the Federal Reserve determined that a 

foreign bank was not subject to CCS, it still could approve the bank’s 

2212 U.S.C. § 3105(d)(2)(A); see also item 15 of Attachment A to Federal Reserve Form 

FR K-2. International Applications and Prior Notifications under Subpart B of Regulation K. 
 

Page 13 GAO-12-235 Bank Capital Requirements 

application if it found that the home country supervisor actively was 

working to establish arrangements for such supervision and all other 

factors were consistent with approval.23

FBSEA also established uniform standards for all U.S. operations of 

foreign banks, generally requiring them to meet financial, management, 

and operational standards equivalent to those required of U.S. banking 

organizations. For example, FBSEA required the Federal Reserve to 

establish guidelines for converting data on the capital of foreign banks to 

the equivalent risk-based capital measures for U.S. banks to help 

determine whether they meet the U.S. standards. Additionally, foreign 

banks’ U.S. operations must be examined regularly for unsafe or unsound 

banking practices and are subject to regulatory financial reporting 

requirements similar to those for their U.S. counterparts.

The Gramm-Leach-Bliley Act permitted foreign and U.S. bank holding 

companies to become financial holding companies, which are authorized 

to engage in a wider range of financial activities (such as insurance 

underwriting and merchant banking) compared with bank holding 

companies.24 In response to the Gramm-Leach-Bliley Act, the Federal 

Reserve modified its long-standing practice of applying its capital 

adequacy standards to foreign-owned intermediate holding companies. 

Specifically, in its January 5, 2001, Supervision and Regulation Letter 01-

1, the Federal Reserve provided an exemption from complying with its 

capital adequacy guidelines (capital exemption) to foreign banks that are 

financial holding companies.25

 

23The Federal Reserve also must consider whether the home country supervisor has 

adopted and implemented procedures, or is developing a legal regime or participating in 

multilateral effort to combat money laundering.

The Federal Reserve’s supervisory letter 

stated that this action was consistent with its treatment of domestic banks 

and financial holding companies. Officials noted that domestic firms were 

expected to hold capital on a consolidated basis at the parent level, not 

24Pub. L. No. 106-102, 113 Stat. 1338 (1999). The Gramm-Leach-Bliley Act allows those 

bank holding companies that meet certain capital, managerial, and other requirements to 

engage in securities underwriting, merchant banking, and insurance underwriting. As of 

September 30, 2011, 420 domestic bank holding companies and 40 foreign banking 

organizations had financial holding company status. 

25Federal Reserve, Application of the Board’s Capital Adequacy Guidelines to Bank 

Holding Companies Owned by Foreign Banking Organizations (Washington, D.C.: Jan. 5, 

2001). 
 

Page 14 GAO-12-235 Bank Capital Requirements 

the intermediate holding company level. According to the supervisory 

letter, the capital exemption recognized that the foreign parent bank 

should be able to hold capital on a consolidated basis on behalf of its 

subsidiaries.

To qualify for the exemption, the foreign-owned intermediate holding 

company had to meet the standards for financial holding company status. 

Specifically, for a foreign bank to qualify as a financial holding company, 

the Federal Reserve was required to determine that the intermediate 

holding company’s parent foreign bank was well capitalized and well

managed on a consolidated basis.26 Also, its U.S. depository subsidiaries 

were required to be well capitalized and well managed.27 The bank 

subsidiaries of foreign bank organizations still were subject to the capital 

adequacy framework (risk-based capital and leverage standards) for 

insured depository institutions.28

A relatively small number of foreign-owned intermediate holding 

companies have relied on the capital exemption. The Federal Reserve 

reported that 6 of the approximately 50 foreign-owned intermediate 

holding companies used the capital exemption (exempt holding company) 

at some point during the period from 2001 to 2010. At the time the DoddFrank Act was enacted, in July 2010, 5 foreign-owned intermediate 

holding companies were relying on the capital exemption. By the end of 

December 2010, 1 of these 5 holding companies restructured its U.S. 

operations and no longer relied on the capital exemption. Exempt holding 

companies generally have operated with less capital than their foreign 

and domestic peers in the United States, with 1 such institution operating 

with negative risk-based capital ratios. 

 

 

26The foreign parent bank must be well capitalized according to the capital standards in 

effect in the United States for bank holding companies. Currently, to be well capitalized, a 

bank holding company must meet a tier 1 risked-based capital ratio of 6 percent or 

greater, a total risked-based capital of 10 percent or greater, and certain other standards. 

See 12 CFR § 225.2(r). A bank holding company is considered well managed if the 

composite rating for its U.S. combined operations is at least satisfactory, and it has at 

least a satisfactory rating for management if such a rating is given. See 12 CFR § 

22.5.2(s). 

27If the foreign parent bank owns a U.S. depository bank subsidiary, the bank subsidiary 

must maintain a total risk-based capital ratio of at least 10 percent, a tier 1 risk-based 

capital ratio of at least 6 percent, and leverage ratio of at least 5 percent. 

28See Federal Deposit Insurance Act, § 38, 64 Stat. 873 (1950) (codified, as amended, at 

12 U.S.C. § 1831o).
 

Page 15 GAO-12-235 Bank Capital Requirements 

The Dodd-Frank Act eliminated the capital exemption that the Federal 

Reserve provided to certain foreign-owned intermediate holding 

companies. The act requires that after a 5-year phase-in period after 

enactment of the act, these companies must satisfy the capital 

requirements at the intermediate holding company level. The change 

requires capital in the United States to support the foreign bank’s U.S. 

operations conducted through a holding company and provides ready 

capital access for depositor and creditor claims in case the subsidiary 

depository or holding company fails and needs to be liquidated.29

According to FDIC, the elimination of the capital exemption also was 

intended to better ensure that the foreign-owned intermediate holding 

company served as a “source of strength” for the insured depository 

institution.30

 

29This is considered a form of ring fencing, which refers to the practice by which local 

authorities set aside or shield assets of a local subsidiary from the failed institution and 

insist that local creditors get paid first, before any funds are transferred to satisfy claims 

made against the failed parent.

Furthermore, according to FDIC, subjecting previously 

exempted foreign-owned intermediate holding companies to capital 

standards would discourage excessive financial leveraging. FDIC and 

some market participants have noted that the elimination of the 

exemption enhances the equal treatment of U.S. and foreign-owned 

holding companies by requiring both types of companies to hold similar 

capital levels in the United States. Figure 1, compares the capital 

structure of U.S.- and foreign-owned holding companies.

30Section 616(d) of the Dodd Frank Act confirmed the Federal Reserve’s authority to 

require a bank or thrift holding company to serve as a source of strength to any subsidiary 

depository institution. 

U.S. Regulatory Reform 

Eliminated Capital 

Exemption for Certain 

Intermediate Holding 

Companies
 

Page 16 GAO-12-235 Bank Capital Requirements 

Figure 1: Capital Relationships in Foreign and Domestic Intermediate Holding Companies, after the Dodd-Frank Act

Federal bank regulators have been finalizing proposed rules to implement 

the various capital requirements under the Dodd-Frank Act. According to 

regulators, they expect to issue final rules in 2012 but did not provide a 

specific date. The act requires that the previously exempted holding 

companies comply with the new capital adequacy guidelines by July 

2015.31

 

31Capital requirements affecting hybrid instruments issued after the cutoff date of May 19, 

2010, would be immediately applicable.

According to the Federal Reserve, it retains its supervisory 

authority to require any bank holding company to maintain higher levels of 

capital when necessary to ensure that its U.S. activities are operated in a 

safe and sound manner. This authority may be exercised as part of 

ongoing bank supervision or through the bank application process. We 
 

Page 17 GAO-12-235 Bank Capital Requirements 

describe the different ways in which the exempted companies can satisfy 

the new capital requirements later in this report.

In addition to eliminating the capital exemption for certain foreign-owned 

intermediate holding companies, the Dodd-Frank Act requires that bank 

and thrift holding companies—domestic or foreign—meet minimum riskbased capital and leverage requirements that are not less than those that 

apply to insured depository institutions. The existing minimum capital 

requirements (general risk-based capital guidelines) for insured 

depository institutions are largely based on Basel I (see fig. 1). Certain 

institutions—the largest internationally active holding companies and 

insured depository institutions—are subject to the U.S. implementation of 

the advanced approaches in the Basel II framework (advanced 

approaches capital guidelines). These large internationally active 

institutions are required to use their internal models to determine their 

risk-based capital levels, but under the Dodd-Frank Act they generally 

cannot hold less capital than would be required under the general riskbased capital guidelines for insured depository institutions.32

The Dodd-Frank Act requires the federal banking regulators to implement 

the act’s new requirements by January 2012. On June 14, 2011, the 

Federal Reserve, FDIC, and OCC approved an interagency final rule to 

implement the risk-based capital floors on the Basel II advanced 

approaches and published the final rule on June 28, 2011, thereby 

partially completing the requirements of the Dodd Frank Act.

These 

institutions will be required to calculate their capital under both the 

general risk-based capital guidelines and the advanced approaches 

capital guidelines.

33

 

32Sections 171(b)(1) and (2) of the Dodd-Frank Act specify that the minimum leverage and 

risk-based capital requirements established under that section shall not be less than the 

“generally applicable’’ capital requirements, which shall serve as a floor for any capital 

requirements the agencies may require. Moreover, sections 171(b)(1) and (2) specify that 

the federal banking agencies may not establish leverage or risk-based capital 

requirements for covered institutions that are quantitatively lower than the generally 

applicable leverage or risk-based capital requirements in effect for insured depository 

institutions as of the date of enactment of the Dodd-Frank Act. 12 U.S.C. § 5371(b)(1)-(2). 

However, 

the Federal Reserve has not addressed other items required under 

section 171, such as the phase-out of hybrid capital instruments from the 

33Risk-Based Capital Standards: Advanced Capital Adequacy Framework—Basel II; 

Establishment of a Risk-Based Capital Floor, 76 Fed. Reg. 37, 620 (June 28, 2011).

Stricter Capital Adequacy 

Standards Also Will Apply 

to Foreign and U.S. 

Holding Companies 
 

Page 18 GAO-12-235 Bank Capital Requirements 

tier 1 capital of bank holding companies. It is expected that the Federal 

Reserve will address such items in 2012.

Finally, the Dodd-Frank Act also made changes that restricted the types 

of capital instruments that can be included in tier 1. Prior to the Act, the 

general risk-based capital guidelines for bank holding companies allowed 

such institutions to include hybrid debt and equity instruments in tier 1 

capital whereas such instruments did not count in the tier 1 capital of 

insured depository institutions. Insured depository institution regulators 

(Federal Reserve, FDIC, and OCC) determined that such instruments did 

not have the ability to absorb losses as effectively as other forms of tier 1 

capital. The specific requirements for the exclusion of hybrid debt or 

equity instruments from tier 1 capital vary according to the asset size and 

nature of the holding company.34

The elimination of the Federal Reserve’s capital exemption for foreignowned intermediate holding companies likely will result in exempt holding 

companies restructuring or taking other actions, but the overall effects of 

this change on competition among bank holding companies and cost and 

availability of credit are likely to be small for various reasons. First, our 

analysis of loan markets suggests that eliminating the exemption likely 

would have a limited effect on the price and quantity of credit available 

because the four banks most affected have relatively small shares of 

relatively competitive U.S. loan markets. Second, our review of the 

academic literature and our econometric analysis suggest that changes in 

capital rules that could affect certain foreign-owned intermediate holding 

companies would have a limited effect on loan volumes, and the increase 

in the cost of credit likely will add minimally to the cumulative cost of new 

financial regulations.

 

34Previously, the Federal Reserve allowed bank holding companies to use hybrid capital 

instruments, such as trust-preferred securities and cumulative-preferred securities, to 

compose up to 25 percent of their tier 1 capital amount. Internationally active banks were 

limited to a 15 percent of tier 1 capital threshold for hybrid instruments. For a greater 

discussion of hybrid capital instruments and the potential effects of the restriction on 

institutions’ operations, see GAO, Dodd-Frank Act: Hybrid Capital Instruments and Small 

Institution Access to Capital, GAO-12-237 (Washington, D.C.: Jan. 18, 2012). 

Overall Effects of 

Capital Changes for 

Exempt Foreignowned Intermediate 

Holding Companies 

Likely to Be Limited 
 

Page 19 GAO-12-235 Bank Capital Requirements 

Foreign parent banks may take a variety of actions, including 

restructuring, to comply with the new requirements, although most are 

waiting for final rules on capital requirements and other Dodd-Frank Act–

related provisions before making a decision. To date, banking and other 

financial regulators have not issued final rules implementing many of the 

Dodd-Frank Act requirements. Foreign bank officials we interviewed told 

us that they needed a better understanding of all the new regulatory 

provisions in the Dodd-Frank Act before deciding what action to take. 

Most of these bank officials told us they have been monitoring how 

regulators are implementing certain Dodd-Frank Act provisions, and the 

final rules likely will have a great effect on their decisions. These 

provisions include the designation and orderly liquidation of systemically 

important financial institutions (SIFI) and a prohibition on proprietary 

trading.35

Additionally, questions about how the new Basel III accord and other global 

capital rules will be implemented and how they will interact with U.S. 

banking regulations have added to foreign banks’ uncertainty about 

planning for compliance with the Dodd-Frank Act. For example, in 

November 2011, the Basel Committee introduced a framework for 

designating global SIFIs.

One foreign bank official told us that implementation of these 

provisions could have a major impact on her bank’s U.S. operations.

36

Despite the uncertainties about the specifics of the regulations, foreign 

banks have been considering a variety of actions to comply with the act, 

according to officials we contacted. Eliminating the capital exemption will 

have the most significant impact on the four foreign-owned intermediate 

Under the Basel framework, global SIFIs would 

be required to hold additional capital to absorb losses to account for the 

greater risks that they pose to the financial system. Foreign bank officials 

we interviewed stated that it is too early to tell how new global requirements 

will interact with U.S. requirements under the Dodd-Frank Act.

 

35The Financial Stability Oversight Council (established under the Dodd-Frank Act) can 

designate a nonbank financial company as a systemically important financial institution 

(SIFI). Such an entity would be supervised by the Federal Reserve and would be required

to comply with enhanced supervision and prudential standards consistent with the DoddFrank Act. 12 U.S.C. § 5325. 

36On November 4, 2011, the Financial Stability Board, which is responsible for 

coordinating and promoting the implementation of international financial standards (such 

as the Basel III accord), designated 29 financial institutions as global SIFIs. See 

http://www.financialstabilityboard.org/about/mandate.htm. 

Foreign Parent Banks May 

Restructure or Take Other 

Actions to Comply with 

New Requirements
 

Page 20 GAO-12-235 Bank Capital Requirements 

holding companies that relied on it.37 These exempt holding companies 

and their foreign parent banks can comply in several ways. First, foreign 

parents could issue securities (debt or equity) and inject the capital as 

equity into the intermediate holding companies. Second, they could 

change the mix of risky assets they hold. For example, banks must hold 

more capital against certain assets in their portfolio that are considered 

higher-risk. The exempt holding companies could sell off these assets 

and acquire higher-quality or less-risky assets. Third, they could pass 

down profits or retain earnings from foreign parents to U.S. holding 

companies. Fourth, foreign parents could restructure their U.S. operations 

by removing any activities not considered banking activities from the 

exempt holding companies.38

One foreign parent bank restructured its exempt holding company by 

deregistering it in the fall of 2010. Prior to restructuring, the exempt 

holding company had a bank subsidiary, a broker-dealer subsidiary, and 

several other subsidiaries. The bank accounted for a small percentage of 

the exempt holding company’s consolidated assets and revenues, but the 

holding company would be subject to the new capital requirement 

because it was supervised as a bank holding company by the Federal 

Reserve. After the restructuring, the small bank became a subsidiary of 

one bank holding company, while the broker-dealer and the other 

nonbank entities became subsidiaries of a different holding company that 

is not a bank holding company and therefore not subject to bank holding 

capital requirements. The foreign bank stated that restructuring would 

better align both foreign parent bank and U.S. bank holding company with 

new capital requirements.

Finally, the foreign parent banks could close 

the exempt holding companies and leave the U.S. banking market.

How the four foreign parent banks with exempt holding companies 

choose to comply will vary. For example, officials from one exempt 

holding company told us that the foreign parent bank might inject several 

billions of dollars in common equity into the intermediate U.S. holding 

company. Officials from a second exempt holding company told us they 

 

37We interviewed officials from three of the banks that did not rely on the exemption and 

they all said that they did not expect to take any immediate action, including raising 

additional capital, because their holding companies already met the new capital 

requirement under the Dodd-Frank Act. 

38Examples of nonbank activities are financial management, mortgage and investment 

banking, insurance, and broker-dealer activities. 
 

Page 21 GAO-12-235 Bank Capital Requirements 

were considering a combination of actions, including recapitalizing its 

holding company by retaining earnings, reducing the risky assets against 

which it must hold capital, and potentially restructuring the holding 

company. Officials from another exempt holding company said that it 

would review business activities under the holding company to reduce 

risky assets that would require holding higher amounts of capital. Finally, 

the fourth exempt holding company stated in its annual report to SEC that 

the holding company might restructure, increase its capital, or both.

Given the size of the market and the holding companies affected, 

elimination of the capital exemption for foreign-owned holding companies 

under the Dodd-Frank Act likely will have limited effects on the overall 

competitive environment and the cost and availability of credit to 

borrowers. Our analysis assesses the impact of the four exempt holding 

companies exiting the U.S. banking market or raising additional capital to 

meet regulatory standards.

The number of exempt holding companies and their shares of most 

national loan markets are small. As of December 31, 2010, four exempt 

holding companies relied on the Federal Reserve’s capital exemption. 

These exempt holding companies accounted for about 3.1 percent of the 

loans on the balance sheets of all bank holding companies in the United 

States (see table 3).39 Therefore, any actions they may take to respond to 

the elimination of the capital exemption likely will have a small effect on 

the overall credit market.

 

39Our analysis generally covers bank holding companies with total consolidated assets of 

$500 million or more. Including smaller bank holding companies in the analysis would 

reduce the fraction of loans on the balance sheets of exempt holding companies.

Eliminating the Exemption 

Likely Will Have Limited 

Effects on Overall 

Competition and Credit

The Number and Market Shares 

of Exempt Holding Companies 

Are Small 
 

Page 22 GAO-12-235 Bank Capital Requirements 

Table 3: Bank Holding Company Loan Market Shares, as of December 31, 2010 By 

Percentage

Bank holding company type

Loan market

Exempt 

foreign-owned 

Nonexempt 

foreign-owned U.S. 

Total net loans and leases 3.1% 6.6% 90.3% 

Residential construction loans 3.0 5.2 91.9

Nonresidential construction, land 

development, and other land loans

2.2 6.8 91.0

Agricultural real estate loans 10.4 1.5 88.1

Home equity lines of credit 1.8 6.2 92.0 

First-lien residential mortgages 1.9 8.1 90.0

Junior-lien residential mortgages 1.9 10.1 88.0

Multifamily residential property loans 1.8 5.2 92.9

Owner-occupied commercial real estate 

loans

3.6 4.9 91.5

Nonowner-occupied commercial real 

estate loans

3.8 5.7 90.5

Agricultural production loans 11.4 3.0 85.7

Commercial and industrial loans 3.9 7.0 89.1

Consumer loans 1.5 6.7 91.7

Lease financing receivables 4.5 4.0 91.4

Sources: GAO analysis of Federal Reserve and SNL Financial data.

Note: Bank holding companies include top-tier bank holding companies and are grouped by type. 

Calculations are for domestic offices of bank holding companies only. Exempt and nonexempt holding 

companies were identified by the Federal Reserve as of December 31, 2010. Market shares may not 

sum to 100 percent because of rounding. 

Exempt holding companies accounted for varying amounts of different 

types of loans. In 2010, they accounted for less than 5 percent each of 

the construction and land loans, residential real estate loans, commercial 

real estate loans, commercial and industrial loans, consumer loans, and 

leases on the balance sheets of bank holding companies in the United 

States. However, they accounted for more than 10 percent each of 

agricultural real estate loans and agricultural production loans. Although 

exempt holding companies and their foreign parent banks can take a 

variety of approaches to comply with the new capital rules, the effects of 

those approaches on credit markets—overall or in specific segments—

likely will be small because of the relatively small share of the market that 

exempt holding companies hold.
 

Page 23 GAO-12-235 Bank Capital Requirements 

U.S. credit markets likely would remain unconcentrated even if exempt 

holding companies exited the market and sold their loans to other bank 

holding companies. To assess the impact of eliminating the Federal 

Reserve’s capital exemption on competition among bank holding 

companies, we calculated the HHI, a key statistical indicator used to 

assess the market concentration and the potential for firms to exercise 

market power.40 As figure 2 shows, the HHI for the overall loan market for 

2010 is well below 1,500—the threshold for moderate concentration—as 

are the HHIs for the 13 specific loan markets we analyzed.41

 

40The HHI is one of the market concentration measures that government agencies, 

including the Department of Justice (DOJ) and the Federal Trade Commission (FTC), use 

when assessing concentration to enforce U.S. antitrust laws. DOJ and FTC often calculate 

the HHI as the first step in providing insight into potentially anticompetitive conditions in an 

industry. However, the HHI is a function of firms’ market shares, and market shares may 

not fully reflect the competitive significance of firms in the market. Thus, DOJ and FTC use 

the HHI in combination with other evidence of competitive effects when evaluating market 

concentration. The HHI reflects the number of firms in the market and each firm’s market 

share, and it is calculated by summing the squares of the market shares of each firm in 

the market. For example, a market consisting of four firms with market shares of 30 

percent, 30 percent, 20 percent, and 20 percent has an HHI of 2,600 (900 + 900 + 400 + 

400 = 2,600). The HHI ranges from 10,000 (if there is a single firm in the market) to a 

number approaching 0 (in the case of a perfectly competitive market). DOJ and FTC 

guidelines as of August 19, 2010, suggest that an HHI between 0 and 1,500 indicates that 

a market is not concentrated, an HHI between 1,500 and 2,500 indicates that a market is 

moderately concentrated, and an HHI greater than 2,500 indicates that a market is highly 

concentrated, although other factors also play a role in determining market concentration. 

Because 

these loan markets appear to be unconcentrated, bank holding 

companies in these markets likely have little ability to exercise market 

power by raising prices, reducing the quantity of credit available, 

diminishing innovation, or otherwise harming customers as a result of 

diminished competitive constraints or incentives at least at the national 

level. As we discuss later, to the extent that markets are segmented by 

regions, or small businesses are limited in their ability to access credit, 

these results may not hold for all customers.

41For this analysis, we defined the market as the collection of bank holding companies for 

which we could obtain balance sheet data from the Federal Reserve’s Consolidated 

Financial Statements for Bank Holding Companies (FR Y-9C) through SNL Financial. This 

definition excludes other types of institutions that make loans, including bank holding 

companies with less than $500 million in assets (which are not required to file form FR Y9C), savings and loans and finance companies that are not subsidiaries of a bank holding 

company. Credit unions are another source of loans, and capital markets are yet another 

source of funds for certain entities. Thus, the HHIs we calculate may either understate or 

overstate the amount of concentration in loan markets, depending on the number and 

market shares of other credit providers. 

Foreign Banks’ Exit from 

Credit Markets Would Have a 

Limited Effect on Competition 

and Cost and Availability of 

Credit
 

Page 24 GAO-12-235 Bank Capital Requirements 

Figure 2: Herfindahl-Hirschman Index of Concentration in Loan Markets, as of December 31, 2010 

Faced with the elimination of the Federal Reserve’s capital exemption 

and new minimum capital requirements under the Dodd-Frank Act, 

foreign banks with exempt holding companies could choose to divest their 

banks and exit the U.S. banking market. To estimate the effect of this 

particular response on loan market concentration, we estimated the 

change in loan market concentration on loan markets in two alternative 

scenarios in which all four of the exempt holding companies cease 

making loans and sell their portfolios to other bank holding companies. In 

the first scenario, the assets of exempt holding companies are acquired 

by remaining bank holding companies in proportion to their market share. 

In the second scenario, the assets of exempt holding companies are 

acquired by the largest bank holding company remaining in the loan 

market. Since not all exempt holding companies are likely to exit the U.S. 
 

Page 25 GAO-12-235 Bank Capital Requirements 

market, these scenarios provide estimates of the effect of the elimination 

of the Federal Reserve’s capital exemption on market concentration in the 

most extreme cases.

Estimated changes in the HHIs for the overall loan market in these 

alternative scenarios indicate that the overall loan market is unlikely to 

become concentrated even if all exempt holding companies exited the 

U.S. market. As figure 2 shows, the overall loan market remains 

unconcentrated in both scenarios, suggesting that the remaining bank 

holding companies still would not have sufficient potential to use market 

power to increase loan prices above competitive levels or reduce the 

quantity of loans available to borrowers. Similar results were obtained 

when we applied the alternative scenarios to various segments of the 

credit market. 

The total capital that the four exempt holding companies would need to 

raise to meet the same capital standards as their domestic counterparts is 

small relative to the total capital in the U.S. banking sector, thus limiting 

the effect on the cost and availability of credit. Of the four exempt holding 

companies remaining at the end of 2010, three have indicated they might 

undertake actions to comply with the minimum capital standards. As table 

4 shows, to be considered as meeting the minimum capital requirements 

under the Dodd-Frank Act, the three exempt holding companies 

collectively would need $3.2 billion in additional capital, only $530 million 

of which would need to be in the form of tier 1 common equity to meet the 

leverage ratio requirement. This amount is less than 0.21 percent of the 

approximate $1.5 trillion in total equity outstanding for the U.S. banking 

sector. Two of the exempt holding companies have sufficient tier 1 capital 

and would be able to meet the total capital requirement by raising 

cheaper supplementary capital.42

 

42Supplementary capital is tier 2 capital.

If the exempt holding companies 

decided to exceed the minimum requirements and meet the equivalent of 

the well-capitalized requirements for banks and thrifts, the difference, 

$6.6 billion, would be less than 0.44 percent of the total equity 

outstanding. Although this is a sizable capital deficit at the individual 

holding company level, it would represent a small shock to the aggregate 

U.S. banking sector.

If Exempt Holding Companies 

Take Actions to Comply, 

Effects on the Cost and 

Availability of Credit Would Be 

Small
 

Page 26 GAO-12-235 Bank Capital Requirements 

Table 4: Capital Ratios and Capital Deficits for the Four Exempt Holding Companies Relative to Certain Capital Levels, as of 

December 31, 2010

Tier 1 risk-based ratio

Total risk-based ratio 

(tier 1 + tier 2) Tier 1 leverage ratio

Capital levels

Dodd-Frank Act minimum capital requirements 4% 8% 3%-4%

Well-capitalized standard

a

6% b 10% 5%

Exempt holding companies’ capital ratios

Company 1 Exceeds minimum Does not meet minimum Does not meet minimum

Company 2 Exceeds minimum Does not meet minimum Exceeds minimum

Company 3 Exceeds minimum Does not meet minimum Exceeds minimum

Company 4 Does not meet minimum c Does not meet minimum Does not meet minimum

Capital deficit (dollars in billions)

Amount needed to meet Dodd-Frank Act minimum capital

Company 1 0 $0.99 $0.53

Company 2 0 1.23 0 

Company 3 0 0.97 0 

Company 4 $10.3 c 14.2 21.5

Total company 1–company 4 $10.3 $17.4 $22.0

Total company 1–company 3 0 $3.19 $0.53

Amount needed to be well capitalized

Company 1

b

0.7 $2.7 $3.76

Company 2 0.8 2.3 0.91

Company 3 0.5 1.6 0.68

Company 4 12.2 c 16.2 31.6

Total company 1–company 4 $14.2 $22.8 $37

Total company 1–company 3 $2.0 $6.6 $5.4

Sources: GAO analysis of Federal Reserve and SNL Financial data.

a

The minimum leverage ratio is 3 percent for bank and thrift holding companies with the highest 

examination ratings and not exhibiting rapid growth or other indicators of heightened risk, and for 

those that have implemented a risk-based capital measure for market risk, otherwise a 4 percent 

minimum leverage ratio applies. 

b

The analysis uses the explicit criteria for “well capitalized” that apply to banks and thrifts. 

c

Because of various factors, it is possible that company 4 will not take actions to meet the new 

requirements, and its foreign parent bank has been considering plans to restructure its operations, 

which would eliminate the need to raise capital. As a result, we include capital deficit totals that 

exclude company 4. 
 

Page 27 GAO-12-235 Bank Capital Requirements 

The remaining exempt holding company (company 4, in table 4) would be 

significantly below the new minimum capital requirements, with a capital 

shortfall of over $21.5 billion. However, domestic loans make up 11 

percent of its total assets, while its broker-dealer operations are much 

larger. Therefore, maintaining a holding company designation, which 

creates a significant capital requirement on its entire asset pool, appears 

unlikely. As discussed earlier, the company has stated that it has been 

considering a variety of options, including restructuring. A restructuring 

may reduce the consolidated capital requirements applied to the foreign 

holding company and thus mitigate the need to raise capital to meet the 

new minimum capital requirements.43

However, as mentioned previously, exempt holding companies have 

other ways of adjusting to the elimination of the capital exemption and the 

forthcoming, more stringent capital requirements. For example, in addition 

to reducing assets or shifting portfolios toward less-risky assets, foreign 

parent banks also can issue new common equity (diluting existing 

shareholders), reduce or suspend dividend payments, or employ other

strategies to increase retained earnings.44

 

43For the remainder of this section, we assume, based on information available to us and 

the degree of undercapitalization, that the fourth exempt holding company would 

restructure its operations.

Because these alternatives 

each could imply different effects on credit markets, estimating the 

potential impact of heightened capital requirements for exempt holding 

companies on credit markets empirically would be useful (based on 

estimates of the relationship between capital and lending activity 

observed through rigorous analysis of data). We used a methodology 

designed to (1) leverage information about key relationships embedded in 

aggregated historical data, (2) account for feedback between economic 

variables, (3) control for other forces that might affect loan credit markets 

outside of capital positions, and (4) provide the opportunity to evaluate 

the dynamic response of loan volume growth and other important

44See appendix II for further discussion of the effects of reducing assets on the availability 

of credit. 
 

Page 28 GAO-12-235 Bank Capital Requirements 

variables to shocks to bank capital.45

Although the econometric model we developed indicates that stronger 

capital requirements negatively affect lending activity, the impacts at the 

aggregate level are small. We evaluated the impact of the new 

requirements using two scenarios—exempt holding companies 

experienced a capital deficit when compared with the (1) minimum capital 

requirements under the Dodd-Frank Act or (2) the well-capitalized 

standard that applies to banks and thrifts. Specifically, our model 

suggests the elimination of the capital exemption would lead aggregate 

loan volumes to decline by roughly 0.2 percent even if the affected 

exempt holding companies desired to meet the equivalent of the wellcapitalized standard (see table 5). If the affected banks desired to meet 

the minimum capital requirements under the Dodd-Frank Act, loan 

volumes would decline by less than 0.1 percent. Because the exempt 

holding companies would face capital deficits, the impact on the affected 

banks could be significant and would vary with the degree of 

undercapitalization. For example, loan growth would decline by 5.0

percentage points at company 1, 6.6 percentage points at company 2, 

and 7.9 percentage points at company 3 if the targeted total capital ratio 

was 10 percent under the well-capitalized standard, and total loan 

volumes would fall by $14.2 billion, or 0.2 percent of total loans for the 

banking sector. If the affected banks’ targeted total capital ratio was 8 

percent (that is, the minimum capital requirement), our model suggests 

total loan growth at the three banks would decline by $6.8 billion, or 0.09 

percent of total loans for the banking sector.

The methodology does not assume 

any particular manner of adjustment by the holding companies but 

focuses on the ultimate impact on loan volumes and spreads.

46

 

45Specifically, we employ the vector autoregression (VAR) methodology. See C. Lown and 

D. Morgan. “The Credit Cycle and the Business Cycle: New Findings Using the Loan

Officer Opinion Survey,” Journal of Money, Credit, and Banking 38, 6 (2006): 1575–97; 

and J. Berrospide and R. Edge (2010) ‘The Effects of Bank Capital on Lending: What Do 

We Know, and What Does It Mean?’’, International Journal of Central Banking, vol. 6 

(December), 5-54. Our model is a version of the VAR models found in the macroeconomic 

and monetary literature extended to include a banking sector. It comprises four variables 

that capture supply, demand, output, and prices that make up the “macroeconomy.” We 

then extend the model to include the credit market using various proxies for loan volumes, 

bank capital, loan spreads, and information on lending standards. See appendix I for a 

fuller discussion of the methodology, assumptions, and model.

However, these estimates 

46In our model, values reflect peak estimates reached from three to five quarters out, 

diminish after about 2 years, and assume no transition period.
 

Page 29 GAO-12-235 Bank Capital Requirements 

may overstate the impact on aggregate loan volumes because we 

assume no transition period for adjusting to the higher capital 

requirements and that other banks do not immediately replace the decline 

in loan volumes at the affected institutions.47

Table 5: Aggregate Impacts of Eliminating the Capital Exemption

Impact if the exempt holding companies needed to take actions to meet certain 

capital levels

Minimum capital requirement under the 

Dodd-Frank Act Well capitalized standard

Loan volumes

a

GAO model -0.09% -0.19%

Estimate using other studies (average) -0.06% -0.12%

Lending spreads (basis points)

GAO model 0.51 1.06

Estimate using other studies (average) 0.49 1.00

Sources: GAO and various empirical studies evaluating the relationship between bank capital and lending activity.

Notes: A basis point is a common measure used in quoting yield on bills, notes, and bonds and 

represents 1/100 of a percent of yield. Lending spreads are the commercial and industrial loan rate 

relative to the federal funds rate. 

a

Because the capital exemption affects only a few institutions operating in 

highly competitive loan markets, the impact on the cost of credit, although 

uncertain, is likely to be small. Our model suggests that a capital shock 

equivalent to that implied by the elimination of the capital exemption 

(small at the aggregate level) would lead to an industrywide increase in 

lending spreads of a little over 1 basis point (0.01 percentage points).

The analysis uses the explicit criteria for “well-capitalized” that apply to banks and thrifts. 

48

 

47We also elected to use commercial loans as the appropriate proxy for loan volumes in 

our model. The literature has found these loans to be more sensitive to capital. Using total 

loans for commercial banks and savings institutions produced effects that were less than 

half as large. 

If 

the exempt companies were measured against the minimum capital 

requirements, the impact on lending spreads would be less than 1 basis 

point. However, because the elimination would not result in a general 

48Lending spreads measure loan rates relative to the banks’ costs of funds. In our model, 

the lending spread is the difference between the commercial and industrial loan and 

federal funds rates. 
 

Page 30 GAO-12-235 Bank Capital Requirements 

shock across all banks, whether any impact on lending rates would be felt 

at the aggregate level is unclear. The competitive nature of loan markets 

makes passing on the higher cost of holding more capital to borrowers in 

the form of higher loan rates difficult for a bank experiencing a firmspecific capital shock. Because the loan markets are not highly 

concentrated and are competitive (as discussed earlier), the affected 

exempt holding companies likely would lose business to other banks if 

they chose to increase loan rates significantly.

49 Some studies have found 

evidence of a relationship between higher capital holdings and market 

share during and following banking crises.50

In general, our results for loan volumes and cost and availability of credit 

should be interpreted with caution because of the methodological and 

other limitations associated with our approach. For example, our 

estimates have wide confidence intervals suggesting considerable 

uncertainty in the results (see app. I for limitations). As such, considering 

our results in the context of a wider body of empirical literature is useful. 

Table 5 also includes the average impact on loan volumes and lending 

rates based on other studies combined with our calculation of the capital 

deficit stemming from the elimination of the capital exemption.

To avoid losing business to 

well-capitalized institutions, the affected holding companies likely would 

reduce the amount of risky assets to some extent or undertake other 

actions rather than attempting to pass the full cost of holding additional 

capital to select customers. Appendix II contains more information on our 

analysis of these types of scenarios.

51

 

49The higher loan rate may not be a social cost because it may reduce excessive lending. 

For example, see A. R. Admati, P. M. DeMarzo, M. F. Hellwig, and P. Pfleiderer, 

“Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank 

Equity is Not Expensive,” working paper, Stanford University Graduate School of Business 

(2010).

The 

results from our model, although larger for both loan growth and lending 

spreads, are consistent with the average we calculated from a number of 

empirical studies examining the relationship between bank capital and 

50See for example Allen Berger, and Christa Bouwman, “Bank Capital, Survival, and 

Performance around Financial Crises,” Wharton Financial Institutions Center Working 

Paper 09-24 (2009).

51Each study allowed us to determine the impact of a 1 percentage point change in capital 

on loan volumes and lending rates. For example, in our model, a 1 percentage point 

change in capital translates to a change in loan volumes of about 2.41 percentage points. 

We then scale the estimates by the size of the expected capital deficit as a result of the 

elimination of the capital exemption.
 

Page 31 GAO-12-235 Bank Capital Requirements 

lending activity. These studies represent a variety of methodologies, each 

with its own limitations. Nevertheless, even the largest estimate we 

identified in the literature still would imply a relatively small impact of the 

exemption on credit markets.

Particular segments of the market may be affected more than others. For 

example, customers in agricultural real estate and agricultural production 

loan markets may experience impacts larger than those suggested by the 

aggregate analysis. Similarly, two of the exempt holding companies have 

a significant presence in the western states, while another has a 

significant presence on the East Coast. While the impact on the price and 

quantity of credit available may vary across regions, modeling limitations 

restrict our ability to estimate potential regional differences. Such regional 

impacts should be mitigated to a significant extent by the national nature 

of many loan markets. This analysis becomes much more complicated 

and uncertain once consideration is given to the impact of the various 

provisions of the Dodd-Frank Act and Basel III, which may result in a 

large number of institutions looking to replace and raise capital if banks 

seek to exceed the new regulatory minimums by the same margin they 

exceed them now. However, our results indicate that the elimination of 

the capital exemption would add minimally, if at all, to the cumulative 

economic impacts of these regulations.

Market participants expressed uncertainty about how changes in capital 

requirements might affect the competitiveness of U.S. banks operating 

abroad, partly because the international regulatory landscape remains 

unsettled. The largest internationally active U.S. banks derive a significant 

portion of their revenues from their operations abroad and are subject to 

multiple regulatory regimes. Regulatory capital requirements have 

become more stringent globally with the goal of reducing bank failures 

and creating a more stable financial system. However, bank officials we 

contacted were uncertain how changes in capital requirements might 

affect their competitiveness abroad and were monitoring U.S. and 

international reforms closely to assess any impact on their cost of capital, 

lending ability, and business competitiveness. They were concerned that 

fragmented or conflicting regulations might restrict banks’ ability to use 

capital efficiently. Some U.S. banks believed that they might be at a 

competitive disadvantage to the extent that U.S. banks would be subject 

to higher capital requirements than banks from other countries. Finally, as 

major regulatory changes stemming from the Dodd-Frank Act, Basel III, 

and country-specific reforms are finalized and implemented, many U.S. 

Market Participants 

Concerned about 

Differing Capital 

Regimes and 

Competitive Effects 

Abroad
 

Page 32 GAO-12-235 Bank Capital Requirements 

bank officials we interviewed expressed concerns about the added costs 

of compliance with multiple regulatory regimes.

The largest internationally active U.S. banks maintained a strong 

presence in major foreign markets, where they derived close to one-third 

of their revenues on average in 2010 (see fig. 3). One of the largest 

internationally active U.S. banks derived close to 60 percent of its total 

revenues from foreign operations in 2010. In the last 3 years, revenues 

from foreign operations, although varying by bank and geographical 

region, have decreased slightly on a percentage basis.

Figure 3: Percentage and Dollars of Domestic versus Foreign Revenues of the Six Largest Internationally Active U.S. Banks, 

from 2005 to 2010 

The Largest Internationally 

Active U.S. Banks Derive 

Significant Revenues from 

International Operations
 

Page 33 GAO-12-235 Bank Capital Requirements 

Generally, the largest internationally active U.S. banks divide their 

operations into the following four geographical regions: (1) North America; 

(2) Europe, the Middle East, and Africa; (3) Asia or Asia/Pacific; and (4) 

Latin America or Latin America/Caribbean.52

Figure 4: Foreign Revenues of Six Largest Internationally Active U.S. Banks in 2010, 

by Region

As figure 4 shows, Europe, 

the Middle East, and Africa provided the biggest share (about 50 percent) 

of all foreign revenues. Revenues from the Asian and Pacific countries 

accounted for about 30 percent of foreign revenues compared with 

approximately 19 percent from Latin America.

The large internationally active U.S. banks compete with large foreignbased banks and other internationally active U.S. banks across various 

product and geographic markets. Internationally active U.S. banks have 

varying lines of business. Although some focus on wholesale activities, 

one (Citigroup) is engaged in retail banking activities in more than 100 

countries. In wholesale markets, some U.S. banks, like JPMorgan Chase 

and Bank of America, are active in making commercial and industrial 

 

52In 2010, Bank of America, Citigroup Inc. and JPMorgan Chase & Co. reported revenues 

from foreign operations derived from Europe, the Middle East and Africa, Asia/Pacific, and 

Latin America. In addition, JPMorgan Chase & Co. and Bank of New York Mellon 

Corporation report foreign revenues that do not fit in any of the other segments in a 

category called “Other” (other non-U.S. revenues). The Goldman Sachs Group, Inc., and 

Morgan Stanley did not report revenues from Latin America, as their non-U.S. business 

activities are principally conducted through European and Asian locations.
 

Page 34 GAO-12-235 Bank Capital Requirements 

loans, while others, like Goldman Sachs and Morgan Stanley, hold a 

larger percentage of their assets as trading assets and engage in market 

making and trading in securities and derivative instruments. One of the 

largest internationally active U.S. banks, Bank of New York Mellon, 

primarily provides custody and asset management services and securities 

servicing. In this capacity, it competes with the largest U.S. banks and 

foreign-based banks that provide trust as well as banking and brokerage 

services to high-net-worth clients. 

In the wake of the 2007-2009 financial crisis, international jurisdictions 

have pursued more stringent capital requirements, and large, 

internationally active U.S. banks will be subject to the regulatory 

requirements of various foreign regulators. For example, in Europe, large 

internationally active U.S. banks will be subject to major new regulations, 

including those created by the Basel Committee and the European 

Commission.53 The G-20 countries, which include the United States, 

adopted the Basel III agreements in November 2010, and the individual 

countries are responsible for incorporating the new agreements into 

national laws and regulations.54

On July 20, 2011, the European Commission published a legislative 

proposal known generally as Capital Requirement Directive 4 (CRD4) to 

implement the proposals of Basel III into European Union law. The 

commission staff we spoke with indicated that there are many legislative 

initiatives at the European Union level that could affect U.S. 

internationally active banks operating in Europe, but some key ones, in 

addition to CRD4, are the Capital Requirement Directive 3 (CRD3) and 

the Crisis Management Directive. CRD3 puts in place stricter capital 

 

53The commission puts common European Union policies into practice, manages the 

European Union budget and programs, and can propose legislation to the European 

parliament.

54The Group of Twenty (or G-20) was established in 1999. Members originally consisted 

of representatives of 19 major economies and the European Union. The G-20 holds 

annual meetings at which finance ministers and central bank governors discuss measures 

to promote global financial stability and economic growth and development.

Internationally Active U.S. 

Banks Will Face Stricter 

Capital Regimes in 

Multiple Jurisdictions 
 

Page 35 GAO-12-235 Bank Capital Requirements 

requirements, some of which became effective at the end of 2011.55

Among other things, CRD3 requires banks to implement remuneration 

policies that are consistent with their long-term financial results and do 

not encourage excessive risk taking. For example, at least 40 percent of 

bonuses must be deferred 3-5 years and at least 50 percent must consist 

of equity or equity-like instruments or long-dated instruments that are 

convertible into tier 1 capital during emergency situations. The Crisis 

Management Directive will set out the different tools for resolutions of 

bank failures in Europe. It principally aims to provide the authorities with 

tools and powers to intervene in banks at a sufficiently early stage and is 

due to be adopted formally in November 2011.56

In addition to the European Union regulatory initiatives, individual 

countries plan to implement additional measures. For example, the United 

Kingdom (UK) independently introduced a permanent levy on banks’ 

balance sheets on January 1, 2011, to encourage banks to move to lessrisky funding profiles, according to the UK’s Her Majesty’s Treasury. The 

levy applies to some UK banks, building societies, and UK operations of 

foreign banks with more than £20 billion in liabilities. The rate for 2011 will 

be 0.05 percent, and it will rise to 0.075 percent in 2012. In June 2010, 

France and Germany agreed to similar measures and have been 

enacting them.

This resolution authority 

also will apply to the European subsidiaries of U.S. banks. 

U.S. financial regulators and market participants have expressed concern 

about the extent to which the capital requirements and other financial 

regulations resulting from Basel III could be harmonized across national 

jurisdictions and how consistently they would be enforced. For example, 

U.S. regulators noted that the supervisory standard for how banks 

measure risk-weighted assets—the basis for regulatory capital ratios—

 

55CRD3 implements the Basel Committee’s July 2009 updates to the market risk 

framework, informally known as Basel II.5. The updates reflect strengthened standards for 

measuring market risk and holding capital against those risks, and improve transparency, 

especially for securitization activities. The United States is planning to implement Basel 

II.5 in 2012.

56In the event that problems arise with a bank in breach of the prudential requirements, a 

harmonized set of early intervention measures (such as clear powers to prohibit payment 

of dividends, impose additional reporting requirements, require the replacement of 

managers or directors, or require the cessation of certain risky activities) would be made 

available to supervisors.

Differing International 

Regulations Could Affect 

U.S. Banks’ 

Competitiveness Abroad
 

Page 36 GAO-12-235 Bank Capital Requirements 

under Basel III could be more transparent. In June 2011, the FDIC 

Chairman stated that European banks continued to in effect set their own 

capital requirements using banks’ internal risk estimates—with risk-based 

capital determined by bank management assumptions, unconstrained by 

any objective hard limits and no leverage constraints.57

Additionally, U.S. regulators noted the potential for adverse competitive 

effects on banks with overseas operations from a Basel III provision for 

reciprocal countercyclical buffers.

Other, foreign 

regulators also stated that international differences in the calculation of 

risk-weighted assets could result from assigning inconsistent risk weights 

on the same types of assets and could undermine Basel III. Some foreign 

banks we interviewed told us that comparing risk-weighted assets across 

banks was challenging because of differing reporting, legal, and 

accounting frameworks. For example, comparisons of institutions from the 

United States with those from the European Union are difficult because 

U.S. banks still are transitioning from Basel I to Basel II and do not 

publicly report Basel II risk-based capital requirements. Conversely, 

banks in the European Union are operating under Basel II and are 

publicly reporting their risk-based capital ratios.

58

 

57FDIC Chairman Sheila Bair, testimony before the Committee on Financial Services of 

the U.S. House of Representatives, June 16, 2011.

If a regulator in one country issues an 

“excessive credit growth” declaration (that is, identifies a “bubble” when 

excess aggregate credit growth is judged to be associated with a buildup 

of systemwide risk), then all banks operating in that country would have to 

meet higher capital requirements. Regulators in other countries also could 

require banks operating in their countries to hold proportionately higher 

capital. For example, a U.S. bank operating in multiple countries would be 

subject to the cumulative effect of each country’s additional requirements 

in times of excess aggregate credit growth, and U.S. banking regulators 

would have no say over these declarations.

58The Basel Committee has expressed concern that the financial regulatory framework did 

not provide adequate incentives for firms to mitigate their procyclical use of leverage 

(debt). That is, firms tended to increase leverage in strong markets and decrease it when 

market conditions deteriorated, amplifying business cycle fluctuations and exacerbating 

financial instability. According to regulators, many financial institutions did not increase 

regulatory capital and other loss-absorbing buffers during the market upswing, when it 

would have been easier and less costly to do so. The Basel III countercyclical buffers are 

intended to help address concerns about procyclicality. 
 

Page 37 GAO-12-235 Bank Capital Requirements 

However, other factors may help ease concerns about inconsistent 

implementation of financial regulations. U.S. regulatory officials have 

observed that a high level of coordination among international regulators 

would help ensure that banks hold significantly more capital, that the 

capital will truly be able to absorb losses of a magnitude associated with 

the crisis without recourse to taxpayer support, and that the level and 

definition of capital will be uniform across borders. In addition, the 

quantity and quality of capital held by the largest internationally active 

U.S. and foreign banks has increased significantly in the past few years. 

Specifically, among the 50 largest global banks, tier 1 capital adequacy 

ratios have climbed from 8.1 percent in 2007 to 11.3 percent at the end of 

2010. Since the end of 2008, the 19 largest bank holding companies in 

the United States that were subjected to stress tests increased common 

equity by more than $300 billion. Furthermore, European banks raised 

$121 billion in capital since Europe’s June 2010 stress test exercise.

In addition to the specific concerns related to the implementation of Basel 

III, both U.S. and foreign bank officials we interviewed told us that they 

were concerned that fragmented or conflicting regulations in the United 

States and other jurisdictions might restrict banks’ ability to use capital 

efficiently. According to U.S. and foreign bank officials, inconsistent 

capital requirements among multiple regulatory regimes may restrict 

banks’ ability to move capital across jurisdictions. For example, according 

to regulators and U.S. banks we interviewed, since the 2007-2009 

financial crisis, foreign regulators have become more sensitive to how 

much capital foreign entities in their jurisdiction hold. Some foreign bank 

regulators have required banks to “ring fence” capital on the balance 

sheet as a way to protect and hold dedicated capital for that bank 

subsidiary in their legal jurisdiction in case of financial difficulties or 

bankruptcy. Foreign bank regulators were concerned that the parent 

company would reallocate capital in their jurisdiction to fund the parent 

company located outside of their jurisdiction, potentially resulting in the 

subsidiary being undercapitalized. According to some banks we 

interviewed ring fencing would be costly for banks operating abroad as it 

restricts capital and requires systems for keeping operations segregated 

across countries.

In another example, U.S. bank officials noted that recent reforms have 

changed what types of capital instruments can be counted as tier 1 

capital. As a result, U.S. banks may not have access to tax-efficient tier 1 

instruments that foreign bank competitors can issue because of 

differences in national tax policies. Specifically, prior to the recent 

changes under the Dodd-Frank Act and Basel III, U.S. bank holding 

Conflicting Regulations Might 

Restrict Banks’ Ability to Use 

Capital Efficiently
 

Page 38 GAO-12-235 Bank Capital Requirements 

companies could issue tier 1 trust-preferred securities with dividend 

payments that were tax-deductible. With the exclusion of trust-preferred 

securities from tier 1, large internationally active banks likely will not have 

any tax-efficient alternative in the United States, while foreign banks in 

certain jurisdictions will continue to have access to certain capital 

instruments, such as noncumulative perpetual preferred shares, that 

confer some tax benefits because of local tax laws.59

As major regulatory changes stemming from the Dodd-Frank Act, Basel 

III, and country-specific reforms are finalized and implemented, many 

U.S. and foreign bank officials we interviewed expressed concerns about 

the added costs of compliance with multiple regulatory regimes. Because 

these regulations have not been implemented yet, how they may affect 

the operations of U.S. banks abroad is not known. For example, 

according to U.S. bank officials, they cannot yet estimate the cost 

associated with implementing and complying with the new risk-based 

capital and leverage requirements under Basel III. Moreover, 

implementation of key provisions of the Dodd-Frank Act and the new 

Basel III capital and liquidity requirements will be particularly challenging 

because of the number of related provisions that must be considered 

together. According to a testimony given by the Acting Comptroller of 

OCC, regulators have been trying to understand not only how individual 

provisions will affect the international competitiveness of U.S. firms, but 

also how the interactions of the various requirements of the Dodd-Frank 

Act and Basel III will affect U.S. firms domestically.60

According to testimony from an industry expert, areas other than the bank 

capital provisions of the Dodd-Frank Act can affect costs (including 

compliance costs and competition): prohibition of proprietary trading by 

banks, exclusion of the use of external credit ratings for determining risk

weighting, regulations governing derivatives, the designation and 

regulation of SIFIs, and resolution of insolvent financial firms.61

 

59See 

For 

GAO-12-237. 

60Acting Comptroller of the Currency John Walsh, testimony before the Committee on 

Financial Services of the U.S. House of Representatives, June 16, 2011. 

61Hal S. Scott, Director of the Committee on Capital Markets Regulation; Professor and 

Director of the Program on International Financial Systems, Harvard Law School, 

testimony before the Committee on Financial Services of the U.S. House of 

Representatives, June 16, 2011. 

Banks Could Face Additional 

Costs to Comply with Multiple 

Regulatory Regimes 
 

Page 39 GAO-12-235 Bank Capital Requirements 

example, bank officials we interviewed told us that the Dodd-Frank Act’s 

exclusion of the use of external credit ratings for determining risk

weighting will create additional costs to U.S. banks. The banks would 

have to develop their own methods for performing these calculations, 

potentially putting them at a competitive disadvantage (including higher 

cost) internationally because European banks could still use such credit 

ratings, which are widely understood and used by investors. U.S. bank 

officials also noted that they would incur increased administrative costs 

under multiple regulatory regimes as they would have to implement and 

comply with multiple capital ratios, including those for the U.S. and foreign 

jurisdictions. Many U.S. banks GAO interviewed expressed concerns 

about the added costs of compliance with multiple regulatory regimes and 

the impact of the Dodd-Frank Act on the global competitiveness of U.S. 

banks, but these concerns would need to be considered against the 

potential benefits of a safer and sounder financial system.

We provided a draft of this report to the FDIC, the Federal Reserve and 

OCC for their review and comment. Each of the federal banking 

regulators provided technical comments that were incorporated in the 

report, as appropriate. 

We are sending copies of this report to appropriate congressional 

committees, FDIC, the Federal Reserve, OCC, and the Department of the 

Treasury, and other interested parties. In addition, the report is available 

at no charge on the GAO website at http://www.gao.gov. 

If you or your staff have any questions about this report, please contact 

me at (202) 512-2642 or mccoolt@gao.gov. Contact points for our Offices 

of Congressional Relations and Public Affairs may be found on the last 

page of this report. GAO staff who made key contributions to this report 

are listed in appendix VI.

Thomas J. McCool

Director, Center for Economics

Applied Research and Methods

Agency Comments
Appendix I: Objectives, Scope, and 

Methodology

Page 40 GAO-12-235 Bank Capital Requirements 

The objectives of the report were to examine (1) the regulation of foreignowned intermediate holding companies in the United States, (2) the 

potential effects of changes in U.S. capital requirements on foreignowned intermediate holding companies, and (3) banks’ views on the 

potential effects of changes in U.S. capital requirements on U.S.-owned 

banks operating abroad. This report focuses on intermediate holding 

companies owned by a foreign parent bank (that is, a foreign banking 

organization) and the largest internationally active U.S. banks based on 

their level of foreign business activity.1 The foreign parent bank may have 

its U.S. subsidiaries owned or controlled by an intermediate bank or thrift 

holding company in the United States (the organization between the 

subsidiary bank and the foreign parent bank) primarily to take advantage 

of tax or regulatory benefits.2

To describe how foreign holding companies are regulated and supervised 

in the United States, we reviewed relevant federal and state banking laws 

and regulations (such as the International Banking Act of 1978, Foreign 

Bank Supervision Enhancement Act of 1991, section 171 of the DoddFrank Wall Street Reform and Consumer Protection Act [Dodd-Frank Act], 

and New York state banking law). We reviewed regulatory documents such 

as the Federal Reserve’s Consolidated Financial Statements for Bank 

Holding Companies—FR Y-9C.

Under this corporate structure, the 

intermediate holding company represents the foreign parent bank’s toptiered legal entity in the United States and is regulated by the Board of 

Governors of the Federal Reserve System (Federal Reserve).

3

 

1

A foreign banking organization is defined as a company organized under the laws of a 

foreign country that engages in the business of banking.

Further, we reviewed supervisory 

guidance such as Supervision and Regulation Letter 01-1 (the capital 

exemption), the final rule that establishes a floor for the risk-based capital 

2

A bank or thrift holding company owns or controls one or more banks or thrifts, 

respectively, or one that owns or controls one or more bank or thrift holding company or 

owns or controls one or more bank or thrift companies. The company at the top of the 

ownership chain is commonly called the top-tier entity. 

3

The FR Y-9C is a Federal Reserve reporting form that collects basic financial data from a 

domestic bank holding company on a consolidated basis in the form of a balance sheet, 

an income statement, and detailed supporting schedules, including a schedule of off 

balance-sheet items. The information is used to assess and monitor the financial condition 

of bank holding company organizations, which may include parent, bank, and nonbank 

entities. The FR Y-9C is a primary analytical tool used to monitor financial institutions 

between on-site inspections and is filed quarterly as of the last calendar days of March, 

June, September, and December. 

Appendix I: Objectives, Scope, and Methodology 
Appendix I: Objectives, Scope, and 

Methodology

Page 41 GAO-12-235 Bank Capital Requirements 

requirements applicable to the largest internationally active banks, relevant

published reports, testimonies, speeches, articles, and relevant prior GAO 

reports.4 We interviewed supervisory officials at the Federal Reserve, 

Federal Deposit Insurance Corporation (FDIC), Office of the Comptroller of 

the Currency (OCC), Office of Thrift Supervision (OTS), New York State 

Banking Department, and officials at the Department of the Treasury, the 

European Commission (a European Union entity that, among other things, 

through capital directives sets out general capital rules to be transferred 

into national law by each of the 27 European Union countries as they deem 

appropriate), foreign and U.S. bank holding companies, a foreign trade 

association, credit rating agencies, and law firms.

5

To assess the potential effects of changes in capital requirements for 

foreign-owned intermediate holding companies, we reviewed section 171 

of the Dodd-Frank Act, and proposed and final capital rules for foreignowned intermediate holding companies and related comment letters. We 

reviewed various proposed and final international capital rules. We 

reviewed Securities and Exchange Commission (SEC) regulatory filings 

of foreign bank holding companies. We interviewed foreign bank 

regulators, foreign and U.S. bank holding companies, credit rating 

agencies, and industry experts on the effects of the new capital 

requirements on foreign banks operating in the United States. We also 

reviewed academic studies on the impact of higher capital requirements 

In addition, we received 

written responses to questions from the European Banking Authority 

(European banking regulator) and attended a conference on the 

implications of new capital rules for foreign banks. 

 

4

The Federal Reserve’s Supervision and Regulation Letter 01-1 of January 5, 2001, 

permitted a foreign-owned intermediate holding company whose foreign parent bank 

qualified to become a financial holding company to be exempt from complying with capital 

adequacy standards. For the final rule on capital floors, see 76 Fed. Reg. 37.620 (June 

28, 2011). According to the U.S. Basel II advanced approaches rule, internationally active 

banks are defined as those with at least $250 billion of consolidated total assets or at least 

$10 billion of consolidated total on-balance-sheet foreign exposure.

5

The Dodd-Frank Act eliminated the OTS, which chartered federal savings and loan 

associations (thrifts) and savings and loan holding companies (thrift holding companies), 

and supervised federally and state-chartered thrifts and thrift holding companies. 12 U.S.C 

§ 5413. Rulemaking authority previously vested in OTS was transferred to OCC for 

federally chartered thrifts and to the Federal Reserve for thrift holding companies and their 

subsidiaries, other than depository institutions. 12 U.S.C. § 5412(b). Supervision of statechartered thrifts was transferred to FDIC. 12 U.S.C. § 5412(b)(2)(C). The transfer of these 

powers was completed on July 21, 2011, and OTS was officially abolished 90 days later 

(October 19, 2011). 12 U.S.C. §§ 5411, 5413.
Appendix I: Objectives, Scope, and 

Methodology

Page 42 GAO-12-235 Bank Capital Requirements 

on the cost of capital and lending and obtained the views of foreign and 

domestic banks, credit rating agencies, and industry experts. 

To assess the extent to which credit markets are likely to be affected by 

removal of the capital exemption, we calculated market shares for each 

group of bank holding companies in loan markets as of December 31, 

2010. We obtained balance sheet data for bank holding companies as of 

December 31, 2010, from SNL Financial, which reports data for bank 

holding companies based on forms FR Y-9C submitted to the Federal 

Reserve. In general, only top-tier bank holding companies with 

consolidated assets of $500 million or more are required to submit FR Y9Cs. To avoid double-counting bank holding companies that are 

subsidiaries of other bank holding companies, we obtained lists of 

second-tier bank holding companies as of December 31, 2010, from the 

Federal Reserve’s National Information Center website and used this list 

to drop any second-tier bank holding companies from our analysis.6

We obtained lists of all top-tier foreign-owned intermediate holding 

companies—both exempt and nonexempt—operating in the United States 

as of December 31, 2010, from the Federal Reserve. We used these lists 

to classify bank holding companies in our sample as one of three types: 

exempt foreign-owned intermediate holding companies, nonexempt 

foreign-owned intermediate holding companies, and U.S. bank holding 

companies. We calculated the percentage of various types of loans on 

the balance sheets of each group, including the following: 

Our 

sample—our definition of the market—is thus the collection of top-tier 

bank holding companies with consolidated assets of $500 million or more 

that filed FR Y-9Cs with the Federal Reserve as of December 31, 2010.

• total domestic loans and leases,

• residential construction loans,

• nonresidential construction loans and all land development and other 

land loans,

 

6

The National Information Center is a central repository of data about banks and other 

institutions for which the Federal Reserve has a supervisory, regulatory, or research 

interest, including both domestic and foreign banking organizations operating in the United 

States
Appendix I: Objectives, Scope, and 

Methodology

Page 43 GAO-12-235 Bank Capital Requirements 

• agricultural real estate loans,

• home equity lines of credit,

• first-lien residential mortgage loans,

• junior-lien residential mortgage loans,

• multifamily residential property loans,

• owner-occupied commercial real estate loans,

• nonowner-occupied commercial real estate loans,

• agricultural production loans,

• commercial and industrial loans,

• consumer loans, and

• leases.

We used amounts reported for domestic offices only so that our 

comparisons were consistent across foreign-owned intermediate holding 

companies and U.S. bank holding companies. A group’s market share is 

the total dollar value of loans on the balance sheets of all bank holding 

companies in the group as a percentage of the total dollar value of loans 

on the balance sheets of all bank holding companies in the market. 

To assess the extent to which the price of credit and the quantity of credit 

available are likely to be affected because of the removal of the capital 

exemption, we used the used the HHI to measure market concentration. 

The HHI is a key statistical indicator used to assess the market 

concentration and the potential for firms to exercise market power. The 

HHI reflects the number of firms in the market and each firm’s market 

share, and it is calculated by summing the squares of the market shares 

of each firm in the market. For example, a market consisting of four firms 

with market shares of 30 percent, 30 percent, 20 percent, and 20 percent 

has an HHI of 2,600 (900 + 900 + 400 + 400 = 2,600). The HHI ranges 

from 10,000 (if there is a single firm in the market) to a number 

approaching 0 (in the case of a perfectly competitive market). That is, 

higher values of the HHI indicate a more concentrated market. 

Department of Justice and Federal Trade Commission guidelines as of 
Appendix I: Objectives, Scope, and 

Methodology

Page 44 GAO-12-235 Bank Capital Requirements 

August 19, 2010, suggest that an HHI between 0 and 1,500 indicates that 

a market is not concentrated, an HHI between 1,500 and 2,500 indicates 

that a market is moderately concentrated, and an HHI greater than 2,500 

indicates that a market is highly concentrated, although other factors also 

play a role in determining market concentration.7

We calculated the HHI for 2010 for each of the loan markets listed above. 

Each bank holding company is a separate firm in the market, and its 

market share is equal to the dollar value of loans on its balance sheet as 

a percentage of the total dollar value of loans on the balance sheets of all 

the bank holding companies in the market.

We also calculated the HHI for 2010 for each loan market in alternative 

scenarios in which exempt holding companies cease making loans and 

transfer the loans on their balance sheets to bank holding companies that 

remain in the market. In the first scenario, exempt foreign-owned 

intermediate holding companies’ loans are distributed proportionally 

among remaining bank holding companies. In the second scenario, 

exempt foreign-owned intermediate holding companies’ loans are 

acquired by the largest remaining bank holding company in the market.

A limitation of defining the market as the collection of top-tier bank holding 

companies that filed FR Y-9Cs with the Federal Reserve is that we 

exclude organizations that provide credit. For example, small bank 

holding companies—those with consolidated assets of less than $500 

million—generally are not required to file form FR Y-9C. However, they do 

make loans. Other credit market participants include savings and loan 

holding companies, stand alone banks, savings and loan associations, 

credit unions, and finance companies not owned by bank holding 

companies. Capital markets are another source of funds for some 

borrowers. As a result, our estimates of market shares are likely 

overstated. Furthermore, our estimates of market concentration may be 

either understated or overstated, depending on the number and market 

shares of other credit providers. 

 

7

The HHI is one of the market concentration measures that government agencies, 

including the Department of Justice (DOJ) and the Federal Trade Commission (FTC), use 

when assessing concentration to enforce U.S. antitrust laws. DOJ and FTC often calculate 

the HHI as the first step in providing insight into potentially anticompetitive conditions in an 

industry. However, the HHI is a function of firms’ market shares, and market shares may 

not fully reflect the competitive significance of firms in the market. Thus, DOJ and FTC use 

the HHI with other evidence of competitive effects when evaluating market concentration.
Appendix I: Objectives, Scope, and 

Methodology

Page 45 GAO-12-235 Bank Capital Requirements 

Another limitation of our analysis is that we implicitly assume that all loan 

markets are national in scope; that is, that credit provided by a bank 

holding company is available to any potential borrower, regardless of his 

or her respective geographic location. If loan markets are not national in 

scope, then our market share and market concentration estimates are 

unlikely to represent those that we would estimate for a specific 

subnational region, such as a state or metropolitan area. The market 

share and market concentration estimates for some regions likely would 

be greater than our national estimates, while others likely would be lower.

For this analysis, we relied on the Federal Reserve’s FY-9C data that we 

obtained through SNL Financial and on information from the Federal 

Reserve on foreign banking organizations’ top-tier intermediate holding 

companies in the United States. We conducted reliability assessment on 

these data by reviewing factors such as timeliness, accuracy, and 

completeness. We also conducted electronic testing to identify missing and 

out-of-range data. Where applicable, we contacted officials from the Federal 

Reserve to address questions about the reliability of the information. We 

found the data to be sufficiently reliable for our purposes. 

To estimate the effect of capital ratios on the cost and availability of 

credit, we estimated a modified version of a vector autoregression (VAR) 

model commonly used in the macroeconomics and monetary literature. 

Our model closely follows Berrospide and Edge (2010) and Lown and 

Morgan (2006). The VAR consists of eight variables. The core variables 

that represent the macroeconomy are (1) real gross domestic product 

(GDP) growth, (2) GDP price inflation, (3) federal funds rate, and (4) 

commodity price index growth. As is pointed out in Lown and Morgan 

(2006), these four variables potentially make up a complete economy, 

with output, price, demand, and supply all represented. We capture the 

banking sector with four variables: (1) loan volume growth, (2) changes in

lending spreads—commercial and industrial loan rates relative to a 

benchmark, (3) lending standards as measured by the net fraction of loan 

officers at commercial banks reporting a tightening of credit standards for 

commercial and industrial loans in the Federal Reserve’s Senior Loan 

Officer Opinion Survey, and (4) the aggregate capital-to-assets ratio for 

the commercial bank sector. The addition of the latter four variables 

allows us to investigate the dynamic interaction between banks and the 

macroeconomy. The data were assembled from Thomson-Reuters 

Datastream and the Federal Reserve. We have relied on these data in 

our past reports and consider them to be reliable for our purposes here.
Appendix I: Objectives, Scope, and 

Methodology

Page 46 GAO-12-235 Bank Capital Requirements 

Using the estimated VAR system for the third quarter of 1990 to the

second quarter of 2010, we trace the dynamic responses of loan 

volumes, lending spreads, and other macroeconomic variables to shocks 

to the bank capital ratio. As a result, we can obtain quantitative estimates 

of how bank “innovations” or “shocks” affect the cost and availability of 

credit. Our base results rely on impulse response functions using the 

following causal ordering of the variables: GDP, inflation, federal funds 

rate, commodity spot prices, loan volumes, capital ratio, loan spreads, 

and lending standards. However, our final estimates use the average of 

the outcomes for the two different orderings of the variables: (1) where 

the macro variables are given causal priority and (2) where the bank 

variables are given causal priority. The VAR model, and the innovation 

accounting framework, is laid out in greater detail in another GAO report.8

The VAR methodology, while containing some advantages over other 

modeling techniques, has particular limitations, and therefore the results 

should be interpreted with caution. First, the methodology potentially 

overstates the quantitative effects of shocks on the economy and can be 

difficult to interpret. Second, because the technique relies on past data, it 

is subject to the criticism that past information may not be useful for 

gauging future response due to policy changes. Third, to conduct 

meaningful assessments of the impacts of shocks to the system, causal 

priority is given to some variables over others. However, our results are 

not particularly sensitive to this ordering, although we do obtain smaller 

impacts of bank capital on lending activity with some alternative 

orderings. To minimize this limitation, our estimates are an average of a 

model where causal priority is given to the macroeconomic variables and 

a model where causal priority is given to the bank variables. Last, in our 

particular case the impulse response functions have wide confidence 

intervals, suggesting considerable uncertainty in the results. Despite 

these limitations, the VAR approach is considered to be a reasonable 

alternative to other types of models. However, it is prudent to evaluate our 

results in the context of the wider body of research on the effects of bank 

capital on lending activity.

The studies we relied on for comparison are useful in that they represent 

a variety of different modeling techniques ranging from VAR and crosssectional regression methodologies to more sophisticated dynamic 

 

8

See GAO-12-237. 
Appendix I: Objectives, Scope, and 

Methodology

Page 47 GAO-12-235 Bank Capital Requirements 

stochastic general equilibrium (DSGE) modeling. None of these 

approaches are without limitations. For example DSGE models, although 

among the best for conducting counterfactual experiments and easy to 

interpret, are difficult to estimate and the techniques used to facilitate 

estimation can result in questionable results that are at odds with 

empirical observations. Nevertheless, by considering the body of 

evidence from different studies, we are able to provide some assessment 

of the reliability of our findings. However, the studies discussed in the 

report are included solely for research purposes and our reference to 

them does not imply we find them definitive.

To describe U.S. banks operating abroad and their services, major 

customers, and competitors, we used information obtained from interviews 

with some of the largest internationally active U.S. banks. We also 

analyzed audited financial statements in the annual reports for relevant 

companies. We selected the six largest internationally active U.S. banks 

based on their level of foreign business activity.9

We conducted this performance audit from December 2010 to January 

2012 in accordance with generally accepted government auditing 

standards. Those standards require that we plan and perform the audit to 

obtain sufficient, appropriate evidence to provide a reasonable basis for 

our findings and conclusions based on our audit objectives. We believe 

that the evidence obtained provides a reasonable basis for our findings 

and conclusions based on our audit objectives. 

To identify banks’ views 

on the potential risks from changes in capital requirements on U.S. banks 

operating abroad, we interviewed officials from the three U.S. bank holding 

companies that engaged in significant international operations. We also 

interviewed officials from the European Commission—a European Union 

entity that, among other things, through capital directives sets out general 

capital rules to be transferred into national law by each of the 27 European 

Union countries as they deem appropriate. We summarized relevant 

academic literature and regulatory studies and congressional testimonies 

on the potential effects on U.S. banks’ funding costs, product pricing, and 

lending activity abroad. We also obtained the views of federal banking 

officials from the Federal Reserve, FDIC, OCC, and OTS, and officials from 

the Department of the Treasury.

 

9

The bank holding companies are: Bank of America Corporation, The Bank of New Mellon 

Corporation, Citigroup Inc., The Goldman Sachs Group, Inc., JPMorgan Chase & Co., and 

Morgan Stanley.
Appendix II: Impact of Reducing the RiskWeighted Assets of Exempt Holding 

Companies to Comply with New Requirements

Page 48 GAO-12-235 Bank Capital Requirements 

Bank holding companies can take different approaches to comply with the 

new capital requirement in the Dodd-Frank Wall Street Reform and

Consumer Protection Act. From 2001 to 2010, the Board of Governors of 

the Federal Reserve System granted capital requirement exemptions to 

six foreign-owned intermediate holding companies provided that the 

companies satisfied certain conditions, including having well-capitalized 

foreign parent banks.1 As of the end of 2010, four foreign-owned 

intermediate holding companies continued to rely on a capital exemption 

from the Federal Reserve. The Dodd-Frank Act eliminated this 

exemption, and these exempt holding companies must now meet new 

capital requirements. Some of these exempt holding companies may 

choose to raise capital, while others may choose to deleverage by 

decreasing the risk-weighted assets on their balance sheets (or a 

combination thereof).2 Although predicting the responses of the exempt 

holding companies to the higher U.S. bank capital requirements is a 

complex proposition, this appendix illustrates the potential effect on the 

availability of credit if the three exempt holding companies respond by 

reducing their balance sheets.3

If the exempt holding companies chose to reduce their balance sheets to 

meet new capital regulations, we estimate that the decrease would be 

small relative to the aggregate assets for the U.S. banking sector. As 

table 6 illustrates, the three exempt holding companies would need to 

decrease their risk-weighted assets by amounts ranging from $12.2 billion 

to as much as $15.3 billion to meet the minimum capital requirements 

 

1

Supervision and Regulation Letter 01-1 (January 5, 2001). 

2

Risk-weighted assets are the total assets and off-balance-sheet items held by an 

institution that are weighted for risks according to the federal banking agencies’ regulatory 

capital standards. 

3

We excluded one exempt holding company from this analysis because of various factors. 

For example, the exempt holding company likely will restructure its U.S. operations. 

Officials from the bank did not respond to our request for a meeting to discuss potential 

actions.

Appendix II: Impact of Reducing the Risk-Weighted 

Assets of Exempt Holding Companies to Comply 

with New Requirements 
Appendix II: Impact of Reducing the RiskWeighted Assets of Exempt Holding 

Companies to Comply with New Requirements

Page 49 GAO-12-235 Bank Capital Requirements 

under the Dodd-Frank Act.4

Table 6: Decrease in Risk-Weighted Assets Necessary to Meet Certain Capital Levels

While the scale of this deleveraging is large 

at the individual holding company level, it is small as a percentage of the 

total risk-weighted assets of the U.S. banking sector (see table 6). For 

example, although the exempt holding companies would have to reduce 

their balance sheets by 20 percent on average, the total decline in assets 

amounts to 0.44 percent of the $9.1 trillion in total risk-weighted assets for 

the aggregate U.S. banking sector. To meet the equivalent of the wellcapitalized standards that apply to banks and thrifts, the exempt holding 

companies would need to reduce their risk-weighted assets by $65.8 

billion, or roughly 0.7 percent of the total risk-weighted assets for the 

aggregate U.S. banking sector. This would require two of the exempt 

holding companies to decrease risk-weighted assets by roughly 38 

percent and 34 percent, respectively.

Decline in risk-weighted 

assets to meet minimum 

capital requirements under 

the Dodd-Frank Act

Percentage of total 

U.S. banking sector 

assets

Decline in risk-weighted 

assets to meet well 

capitalized level

Percentage of 

total U.S. 

banking sector 

assets

Company 1 $12,313,113,000 0.13% $26,516,093,000 0.29%

Company 2 $15,316,751,000 0.17 $23,175,154,000 0.25

Company 3 $12,176,820,000 0.13 $16,143,270,000 0.18

Total decline $39,806,684,500 0.44% $65,834,517,000 0.72%

Total risk-weighted assets for banking sector $9,141,452,000,000

Sources: GAO analysis of Federal Reserve and SNL Financial data.

Note: The foreign parent of company 4 is considering plans to restructure its operations to eliminate 

the need to raise capital. 

While the reduction in assets could entail the canceling of lines of credit 

and reduced lending by these institutions, our market share analysis 

detailed above suggests that other banks would service affected 

creditworthy borrowers at competitive rates. This shrinkage in risk-

 

4

To meet the minimum capital requirements under the Dodd-Frank Act, a bank holding 

company would be required to maintain at a minimum a tier 1 risk-based capital ratio of 4 

percent, a total risk-based capital ratio of 8 percent, and a leverage capital ratio of 4 

percent, except that of a bank holding company that holds the highest supervisory rating is 

subject to a 3 percent minimum leverage ratio. The total risk-based capital ratio equals the 

sum of tier 1 and tier 2 capital divided by risk-weighted assets. Tier 2 capital includes 

limited amounts of subordinated debt, loan loss reserves, and certain other instruments. 

The tier 1 leverage capital ratio is tier 1 capital divided by average total assets. 
Appendix II: Impact of Reducing the RiskWeighted Assets of Exempt Holding 

Companies to Comply with New Requirements

Page 50 GAO-12-235 Bank Capital Requirements 

weighted assets still could have implications for less-creditworthy 

borrowers, especially if a reduction in assets included lines of credit to 

customers who benefited from lower rates than they otherwise could 

receive at other institutions. However, rather than simply reducing the 

overall size of their portfolios, exempt holding companies also could shift 

the composition of their portfolios toward less-risky assets. For example, 

if the exempt holding companies were to sell assets with a 100 percent 

risk weighting and purchase an equivalent amount of assets with a 50 

percent risk weighting, one would exceed the minimum capital 

requirements while the others would need to reduce their assets by an 

additional $1.2 billion and $1.8 billion. An adjustment of this type would 

imply a shift from commercial loans and commercial mortgages, which 

appear to be a significant portion of book of business for the three holding 

companies under consideration.
Appendix III: GAO Contact and Staff 

Acknowledgments

Page 51 GAO-12-235 Bank Capital Requirements 

Thomas J. McCool, (202) 512-2642 or mccoolt@gao.gov

In addition to the contact listed above, Daniel Garcia-Diaz (Acting 

Director), Rachel DeMarcus, M’Baye Diagne, Lawrance Evans Jr., Colin 

Gray, Joe Hunter, Elizabeth Jimenez, Courtney LaFountain, Akiko 

Ohnuma, Marc Molino, Timothy Mooney, Patricia Moye, Michael Pahr, 

and Barbara Roesmann made key contributions to this report.

Appendix III: GAO Contact and Staff 

Acknowledgments 

GAO Contact

Staff 

Acknowledgments

(250582)
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