Imagine that your town introduces new building inspection rules that make your house look unsafe. Do you question the rules, or the soundness of your house?
Similar questions are hanging over the banking sector, following the proposal of new rules that stem from the Dodd-Frank financial overhaul. Under one new regulation, banks now face a limit on how exposed they may be to other banks or companies. In particular, the largest banks won’t be allowed to have exposure – through things like loans, bonds or derivatives — to a single institution that exceeds 10 percent of their loss buffers, defined as capital plus bad-loan reserve. At smaller banks, the exposure limit to a single company would be 25 percent.
How would this look in practice? Citigroup, with a $210 billion buffer, is unlikely to have made loans to, say, General Electric that exceed 10 percent of that amount, or $21 billion.