European banks try to get around Dodd-Frank

March 22, 2012, 3:40 AM UTC

Updated March 22 11:45 AM

For foreign banks, Dodd-Frank might have an escape hatch.

Federal Reserve

FORTUNE — Foreign banks may have come up with a way to remain eligible for U.S. bailouts without having to follow some of the pesky rules that came out of the financial crisis, rules that were meant to prevent future taxpayer rescues.

Last month, German financial giant Deutsche Bank altered the legal structure of its U.S. operations so that it’s no longer officially a “bank-holding” company. As such, Deutsche, even though it’s one of the nation’s largest banking operations with over $350 billion in assets and over 8,500 U.S. employees, may no longer be required to hold the same amount of capital as its American rivals.

For the time being it appears Deutsche’s U.S. operations would still be subject to the Volcker rule – the part of Dodd-Frank banking reform that bars banks from making risky trades and investing in hedge funds and has been one of the most contested portions of bank reform by Wall Street – and other soon to be passed regulations. But a further legal maneuver might allow the bank to get around those as well. Worse, because Deutsche still has a U.S. subsidiary it will be able to borrow from the Fed when it gets into trouble, potentially setting up a repeat of the financial crisis when the Fed was forced to extended billions of dollars in cheap loans to Deutsche and other foreign banks in order to stave off a worsening of the credit crunch.

British bank Barclays, which bought the U.S. investment banking operations of Lehman Brothers when that bank collapsed, appears to be making moves to ease it’s U.S. capital requirements as well.

“These moves ought to be severely scrutinized by the Fed,” says Michael Barr, a former Treasury Department official who helped write the Dodd-Frank legislation and is now a law professor at the University of Michigan. “The Fed needs to fully understand these foreign banks’ U.S. operations and the risks they pose to our system.”

Deutsche spokesman Dunkin King says, “We always had and will continue to have appropriate capital levels in all our U.S. regulated entities. This action, which does not diminish any of our regulatory oversight allows us to streamline our organizational structure, strengthening an already strong institution.”

Getting around Dodd-Frank won’t lower the overall capital the foreign banks have to hold. New banking rules require banks in the U.S. and Europe to hold the same amount of money to cover bad loans and other losses. But it may save Deutsche from raising the amount of capital it keeps at its U.S. subsidiary by $20 billion. Some fear that in times of financial stress foreign banks might not be able or willing to bailout their U.S. subsidiaries. Foreign regulators, worried about their local economies, might not let banks move capital overseas.

Barr says regulators knew foreign banks would have the ability to wiggle out of some of Dodd-Frank’s rules. As a result, the legislation gives the Fed the ability to impose capital requirements on foreign banks even if they are not U.S. bank holding companies. Financial firms deemed “systemically important,” meaning their failure could cause problems for other banks, would have to hold more capital in the U.S. whether they are classified as a bank or not. Still, the capital rules aren’t automatic and would have to be approved by the Fed. Fed officials could not be reached for comment.