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. 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. 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 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. 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 framework known as the Basel Capital Accord (Basel I). 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. 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. 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. 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. 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. 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. 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 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. 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. 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. Basel III: A Global Regulatory Framework for More Resilient Bank and Banking Systems, December 2010. 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. 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. 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. In 1991, Congress passed the Foreign Bank Supervision Enhancement This Act, which amended IBA, authorizes the Federal Act (FBSEA). Reserve to oversee all foreign bank operations in the United States. Foreign banking organizations seeking to establish subsidiaries, branches, or agencies in the United States must apply for an operating 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.