VALLETTA (Reuters) - The European Central Bank has proposed that large branches of foreign banks in the European Union be subject to tighter regulation and capital requirements, a move that would increase U.S. and Asian lenders’ costs and also hit British banks after Brexit.

FILE PHOTO: The headquarters of the European Central Bank (ECB) are illuminated with a giant euro sign at the start of the "Luminale, light and building" event in Frankfurt, Germany, March 12, 2016. REUTERS/Kai Pfaffenbach/File Photo

The ECB proposal to European Union states, seen by Reuters, says that a draft piece of legislation on foreign bank regulation already under discussion among the 28 EU members should be toughened further.

The draft rules, proposed by the EU executive commission in November, require foreign lenders with a major presence in the EU to combine their businesses in the region into a separately capitalized holding company.

The proposal is aimed at ensuring that foreign banks classed as globally systemic lenders or those with at least 30 billion euros of assets in the EU are able to sustain significant losses without support from their headquarters.

It has already been met with strong opposition from non-EU banks who say it would significantly raise the cost and bureaucracy of operating in the EU.

But now the ECB is proposing the law goes further and requires branches of foreign banks to be included in the EU holding company, a move that would likely raise foreign lenders’ capital requirements. The draft law had exempted branches.

The ECB said it was making the proposal more comprehensive as it was concerned that the draft law could lead to “regulatory arbitrage” where banks booked important transactions in branches in order to reduce the level of assets that would be subject to the holding company’s capital requirements.

The changes it proposes would also bring the draft EU law in line with similar rules faced by large foreign banks in the U.S, it said.

Currently, big lenders such as Goldman Sachs GS.N, JP Morgan Chase JPM.N, Bank of America BAC.N or the Industrial and Commercial Bank of China 601398.SS, carry out significant operations through branches in the EU rather than subsidiaries, the paper said, meaning the capital reserves they keep inside the bloc are lower, posing a higher risk to financial stability.

The ECB is also proposing that the holding companies be regulated by whoever supervises the largest individual entity within the group, which in practice would most often be the ECB.

This would mark a broadening of the central bank’s supervisory reach, partly at the expense of national securities watchdogs inside the EU.

The proposal, that was drafted together with the EU’s banking liquidation body, the Single Resolution Board, is also aimed at facilitating the SRB task of preparing resolution plans for banks operating in the EU, so that in case they fail, their creditors’ funds can be used to prop them up, instead of taxpayers’ money.

CLASH OF VIEWS

EU envoys last week had a first exchange of views on the paper, dated March 28. The issue may be discussed at a regular meeting of the bloc’s finance ministers in Malta on Friday and Saturday although it is not formally on the agenda.

The ECB move was welcomed by France, whose large banks have been lately hit by U.S. competitors, and also pleased smaller EU countries where branches of foreign banks operate, because it would reduce lenders’ risks by stepping up controls and the transparency of their operations, officials briefed on the envoys’ meeting said.

But the legislative change would hit EU’s larger financial centers making them likely less attractive to foreign banks as headquarters for their continent-wide operations. Britain “strongly disagreed” with the ECB proposal, the source said.

Britain and Luxembourg, which host Europe’s biggest financial hubs, have already protested against the original proposals made by the European Commission.

In a joint paper, sent to EU countries and seen by Reuters, they said the requirement to set up a holding company in the EU would increase costs for foreign banks, “risking significant disruption” to economic functions provided by these companies to EU businesses and households. They cited in particular risks posed to asset management activities of U.S. banks in the EU.

British banks are also likely to see the costs of their EU activities soaring after Brexit as they would be treated as foreign lenders.