Back in July 2017, when we observed that a shocking 40% of the Fed's interest on excess reserves had been paid, inexplicably, to foreign banks and implicitly represent a subsidy to foreign banks to the tune of tens of billions each year, we said that "we wonder if this is the main reason why the Fed is so desperate to trim its balance sheet as it hikes rates, as sooner or later, someone in Congress will figure this out."

As a tangent we said that "considering that cash at US banks, most of which is parked at the Fed as reserves, amounts to just under $1.5 trillion, we wonder why the Fed does not simply cut off foreign banks' eligibility for its generous IOER subsidy, and make its balance sheet eligible only to US banks. It would slash its bloated balance sheet by over $800 billion overnight. Oh yes, that may actually test the widely accepted theory that banks outside the US are "safe."

Almost two years later, while the Fed has yet to move on curbing foreign bank subsidies courtesy of IOER, the US central bank is finally considering stricter rules on foreign bank branches to tighten what critics say is a loophole that has allowed overseas lenders to shield assets from the toughest U.S. bank rules, while collecting billions in annual hand outs courtesy of reserves parked with the Fed.

The proposed changes would be a blow for such banks as Deutsche Bank, Credit Suisse and UBS and which have for years held billions of dollars in assets, such as corporate loans, at their New York branches. Additionally, as Reuters notes the rule changes, which have yet to be passed, could also inflame tensions with European regulators who have long-complained that their lenders are held to higher standards in the United States than domestic rivals.

The Fed proposal would seek to impose tougher liquidity requirements on foreign bank branches, which could involve holding higher-quality liquid assets to ensure the branch could meet its short-term obligations, almost as if the Fed is proactively concerned what would happen to foreign bank deposits in case there were a bank run in either the lender's host country, or the US. Indicatively, foreign branches held more than $1.6 trillion in assets as of June last year.

The specific treatment of foreign branches, which typically focus on corporate business and are just one part of a foreign bank’s overall U.S. operations, has long been a dilemma for the Fed.

The paradox is that legally foreign branches are part of the overseas parent which would be on the hook to shore-up the branch if it were to fail. But, because foreign bank branches do large amounts of dollar-denominated business, they can also access the Fed’s discount lending window which they used heavily during the 2008 financial crisis.

After the crisis, the Fed tightened rules on foreign banks, requiring them to put their non-branch assets into a new holding company which would be subject to the same heightened post-crisis rules as domestic U.S. banks, including tough stress tests, leverage and capital standards. Following the transition, many banks were allowed to continue using branches, subject to some additional but less onerous requirements, fearing a crackdown would lead overseas regulators to retaliate against U.S. bank branches in their markets.

This critics claim, allows foreign banks to continue using their branches to shield assets from the tougher holding company rules, and point to the fact a larger percentage of overall foreign bank assets are being held in branches.

The Fed data shows that of foreign banks with combined assets of more than $50 billion, around 40% of all their U.S. assets were held in branches as of June. That is compared to around 37 percent in Dec. 2014 when the new regulatory regime was finalized.

While the Fed can decree how much cash should be held at a branch versus the holdco, what is more important is that the proposed additional liquidity requirements would aim to reduce the reliance foreign branches would have on the Fed’s discount window during a future crisis, even as current costs for those firms would increase... which is only fair considering the tens of billions in US taxpayer subsidies that foreign banks have received courtesy of the interest the Fed pays on excess reserves.

As one would expect, foreign banks and regulators claim that additional requirements are unnecessary, since foreign branches are limited in their activities, rarely hold federally insured deposits, and are subject to their home country rules.

And now, we wait for AOC, Elizabeth Warren and an entire generation of wealth redistributing democrats to realize that whereas the Fed has paid hundreds of billions in "interest" to banks merely for the "privilege" of creating reserves out of thin air and handing them out to the banks, approximately half of this amount has been paid to foreign banks most of which are one rumor of a bank run away from insolvency anyway.