Building quickly on the risk conclusions in its recent report to Congress on non-traditional activities, the FRB has proposed stringent new prudential standards not only for the type of merchant-banking previously highlighted in its advance notice of proposed rulemaking, but also for a wider range of long-approved holdings and activities in this sector.  These changes would not only impose more stringent overall limits for FHCs, but also introduce punitive risk-based capital requirements posited not so much on credit risk, but rather on the legal and reputational ones the FRB fears result from environmental liability.  This approach to risk-based capital departs from the usual U.S. regulatory policy of setting risk-weighted assets (RWAs) in relation to empirical loss estimates.  Although the NPR directly addresses only merchant banking related to physical commodities, it seeks comment on the RWA that should generally apply to this activity, laying the groundwork for new standards that could also prove punitive if Congress does not quickly act on the Board’s request that FHCs be simply banned from merchant banking.

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