Banks Find Loophole on Capital Rule

By DAVID ENRICH in London

Some foreign banks are moving to restructure their U.S. operations to avoid one of the most-burdensome requirements of the new Dodd-Frank law.

In November, Barclays PLC quietly changed the legal classification of the U.K. bank's main subsidiary in the U.S. so that the unit would no longer be subject to federal bank-capital requirements. Several other banks based outside the U.S. are considering similar moves, according to people familiar with the matter.

View Full Image

Bloomberg News

Barclays office in New York. The lender has changed the legal classification of its main U.S. subsidiary.

The maneuver allows them to escape a provision of the financial-overhaul law that forces the pumping of billions of dollars of new capital into the U.S. entities, known as bank-holding companies.

"It's just not worth it to have all that capital trapped" in the holding company, said a New York lawyer who is advising banks on how to restructure.

The moves are the latest example of how banks are scrambling to cushion the impact of new laws and rules around the world.

Policy makers are demanding banks hold more capital and cash to help prevent a repeat of the financial crisis. But bank executives are worried that all the changes will crimp profits without making the financial system safer.

Last summer's Dodd-Frank law beefed up rules governing the quantity and types of capital banks must keep to protect themselves from potential losses. The provision also closed a loophole that allowed foreign banks to run their U.S. subsidiaries with thinner capital buffers than those of their local rivals.

For example, Barclays Group US Inc., the U.K. bank's Delaware-based holding company, had a Tier 1 leverage ratio of just 1.37% as of Sept. 30. That put the holding company below almost all its peers of similar size, which had an average ratio of 9.13%, according to Federal Reserve data.

U.S. bank-holding companies generally must have Tier 1 ratios of at least 4% to be considered well-capitalized by federal regulators.

View Full Image

But the Federal Reserve, which is responsible for overseeing bank-holding companies, granted an exemption in 2001 to bank-holding companies that are owned by foreign banks.

Instead, their parent companies have to adhere to the capital requirements imposed by national regulators in their home countries.

The Dodd-Frank law upends the exemption. Starting in July 2015, all bank-holding companies must comply with the minimum federal capital requirements, regardless of where their parent is based. The provision came in an amendment to the law sponsored by Sen. Susan Collins (R., Maine).

To clear the 4% hurdle, Barclays likely would have needed to pump more than $12 billion in new capital into its U.S. holding company, or sharply reduce the holding company's assets.

Instead, Barclays simply deregistered Barclays Group US as a bank-holding company, moving a credit-card operation into a new U.S. entity that is a direct subsidiary of the British parent company. The credit-card bank is regulated by the Federal Deposit Insurance Corp. and needs no additional injection of capital.

The second business that was part of the U.S.-based bank-holding company, investment bank Barclays Capital Inc., is now regulated by the Securities and Exchange Commission instead of federal banking regulators.

Barclays disclosed the move this week in a footnote on Page 91 of its annual financial statements.

"The purpose of the restructuring was to better align the businesses with the appropriate capital regimes," a Barclays spokesman said. People familiar with the matter said the move was a direct response to Dodd-Frank.

In a statement Thursday, Sen. Collins said she hopes the Fed "will look closely at the economic substance of these transactions to ensure that the new entity is not straining the resources of the insured bank."

The non-U.S. banks seen as most likely to follow the lead of Barclays are those with retail operations housed under the same roof as businesses that normally wouldn't have to meet federal bank-capital requirements.

For example, Dutch bank Rabobank Groep NV's U.S. unit, Utrecht-America Holdings Inc., has a Tier 1 ratio of 3.39%, slightly less than the 4% threshold. The unit's businesses include a 123-branch retail bank in California, some capital-markets businesses and a St. Louis-based farm-finance company.

A Rabobank spokeswoman declined to comment on whether the company is considering restructuring its U.S. operations to avoid the Dodd-Frank provision.

Deutsche Bank AG officials examined the possibility of making such a change but opted against it, according to people familiar with the matter. The German bank was deterred partly by potential tax consequences.

HSBC Holdings PLC declined to comment beyond saying the U.K. bank is reviewing the implications of Dodd-Frank.

The move to remove large swaths of foreign-bank operations in the U.S. from the purview of the Fed comes just as the Fed has been intensifying its supervision of those banks.

In October, the Fed issued a "cease and desist" order against the U.S. arm of HSBC, forcing it to take dozens of steps to strengthen compliance and audit functions. The requirements included hiring a new compliance officer who was acceptable to the Fed.

Write to David Enrich at david.enrich@wsj.com