WASHINGTON — Federal Reserve Board Gov. David Tarullo Friday made clear the central bank will unlikely be swayed from its push to require that U.S.-based subsidiaries of foreign banking organizations also face capital requirements separate from their parent firm.

Given the financial stability mandate conferred on the Fed by the 2010 Dodd-Frank Act, "we need to do something, and change the circumstance in which a huge banking operation in the United States can have zero capital," Tarullo said, taking questions following a speech at the Peterson Institute for International Economics.

"It is just not a safe and sound situation to be in," he added. "Somebody is going to have to face up to the problems created when a very large broker-dealer comes under severe stress."

Citing the different banking environment, Tarullo said the Fed is changing the rules "because so much has changed in the world."

He noted that today, half of the assets of foreign banking organizations operating in the U.S. are capital market-related. In addition, half of the broker-dealers operating within these shores are FBOs, he added, as are nine of the 20 largest banking organizations.

As a result during the 2008 financial crisis, foreign banks "were a substantially disproportionate user of both the Fed discount window and all the liquidity facilities which the Fed created," Tarullo said.

"Under these circumstances, I think it's only prudent to make sure that the largest ones have minimum capital and liquidity obligations here," he argued.

Tarullo said it is "way more efficient" to plan in advance for what might happen by having requirements in place, than to let past events occur again and then host countries have to implement ad-hoc ring fencing activities "just at the moment when the firm can least deal with it."

The rules are currently out for comment, and Tarullo said that as responses come in and are reviewed, "I'm sure as always we will make some adjustments."

Still, "I certainly ... do not expect to be convinced that somehow we were misguided in thinking in these terms," he added.

Tarullo's speech highlighted the continued risks posed by the short-term wholesale funding to the financial system, and he said shadow banking is another area that has been "least addressed" by regulators.

Tarullo was appointed chairman of the Financial Stability Board's standing committee on supervisory and regulatory cooperation, succeeding the UK's Adair Turner, and he said the above issues will be on his radar. "The central focus for that committee going forward is very likely to be shadow banking," he said.

On the subject of the Volcker Rule, Tarullo noted that there has been "a good bit of progress" by regulators, although banking regulators have been quicker to reach an agreement the securities agencies - the CFTC and SEC - still have a bit more work to do.

Still, Tarullo said there is no reason not to expect that the rule will be completed in the next few months.

Market News International is a real-time global news service for fixed-income and foreign exchange market professionals. See www.marketnews.com.

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