A Shift in Banking Regulations: Capital Rules Eased for Big Banks

The Federal Reserve, in a major shift in banking regulations, has unveiled revised plans that significantly reduce the amount of capital the largest US banks will be required to hold. These changes, originally proposed as part of the Basel III Endgame initiative, aim to bring capital requirements more in line with international standards, but have drawn criticism for potentially weakening financial stability.

The Basel III Endgame: A Long Journey to Tighten Banking Regulations

The Basel III Endgame, first introduced in July 2023, initially aimed to enhance capital requirements for global banks by roughly 19%. This ambitious plan, a response to the 2008 global financial crisis, sought to bolster the financial resilience of banks and strengthen oversight of risky lending and trading activities. However, the stringent nature of the initial proposal faced significant pushback from the banking industry.

• The proposal was perceived as potentially increasing the cost of loans and making credit harder to obtain, potentially shifting activity towards nonbank providers.
• Industry executives, including JPMorgan Chase CEO Jamie Dimon, spearheaded efforts to argue against the proposed regulations.

Fed Backs Down: Reduced Capital Requirements for Big Banks

In response to the industry pressure, the Federal Reserve, in collaboration with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation, has agreed to resubmit the Basel III Endgame proposal with significantly reduced capital requirements. The revised proposal will now see a more modest 9% increase in capital requirements for big banks.

• This move comes after extensive feedback from banks, business groups, lawmakers, and other stakeholders who voiced concerns about the potential negative impact of the original proposal.
• The Fed's Vice Chair for Supervision, Michael Barr, stated that the revised proposal aims to achieve a better balance between the benefits and costs of increasing capital requirements.

Regional Banks Excluded: Focused on Unrealized Gains and Losses

While big banks are seeing a significant reduction in capital requirements, regional banks with assets between $100 billion and $250 billion have been excluded from the revised proposal. However, these banks will still be subject to a requirement to recognize unrealized gains and losses on securities in their regulatory capital.

• This change is likely a direct response to the failures of midsized banks last year due to deposit runs triggered by unrealized losses on bonds and loans amidst rising interest rates.
• The new requirement could lead to a 3% to 4% increase in capital requirements for these regional banks over time.

A More Balanced Approach: Risk Weighting and Surcharges

The revised proposal for big banks incorporates several measures to align risk weighting with international standards. Key areas of change include:

• More balanced risk weighting for mortgages and retail loans.
• Reduced risk weighting for tax credit equity funding structures, often used for green energy projects.
• A tempered surcharge for firms with a history of operational failures.
• Recognition of the lower-risk nature of investment management operations.

Political Implications: Potential Delay and Uncertainty

The revised Basel III Endgame proposal, along with separate capital surcharge rules for the biggest global institutions, will be subject to a public review process, which is expected to take at least a year. This means the finalization of the regulations will likely extend beyond the November election.

• The delay raises concerns that if Republican candidate Donald Trump wins the election, the regulations could be further weakened or even abandoned.
• Some regulators and lawmakers had hoped to avoid this scenario, fearing a weakening of financial stability.

Uncertain Outcomes: Industry Reactions and Potential Litigation

The impact of the revised proposal on the banking industry and its constituents remains uncertain. While some may welcome the easing of regulations, others may still view them as overly burdensome.

• Banks and their trade groups had previously threatened legal action to prevent the implementation of the original proposal.
• It remains to be seen whether the revised proposals will appease these concerns or lead to further legal challenges.

The Balancing Act: Benefits and Costs of Capital Requirements

The Federal Reserve's decision to significantly modify the Basel III Endgame proposal reflects the ongoing debate surrounding the balance between the benefits and costs of capital requirements in the banking industry. While higher capital requirements can bolster financial stability, they can also lead to increased lending costs and a reduction in credit availability.

• The revised proposal aims to strike a more balanced approach, potentially mitigating some of the negative economic impacts of the original regulations.
• However, the extent to which these revised regulations will effectively address the concerns of both the banking industry and regulators remains to be seen.