Bank Regulators lower required capital increase to 9%, a win for banks

The recent changes to U.S. banking capital regulations, unveiled by Federal Reserve Vice Chair for Supervision Michael Barr, represent a significant shift in the regulatory landscape for the largest banks. Originally introduced in July 2023, the Basel Endgame proposal aimed to raise capital requirements for the world’s largest banks by approximately 19%. However, following extensive feedback from the banking industry, lawmakers, and business groups, regulators have revised the proposal, cutting the required capital increase by half. The new plan now requires only a 9% increase in capital for big banks, significantly lower than expected.

The original proposal was designed to address vulnerabilities in the banking system that had lingered since the 2008 financial crisis. By requiring banks to hold more capital as a cushion against potential losses, the plan sought to improve the safety and stability of the financial sector. However, concerns arose that such an increase could stifle lending, particularly in areas like mortgages and small business loans, and push financial activity toward nonbank institutions. The revised rules reflect an attempt to balance these concerns by tempering the capital requirements while maintaining some of the protective measures.

One of the most notable aspects of the updated regulations is the exclusion of regional banks with assets between $100 billion and $250 billion from the new capital rules. These institutions, which had been caught up in the regulatory net of the original proposal, will now only be subject to a requirement to recognize unrealized gains and losses on their securities portfolios. This change comes in response to the failures of midsized banks like Silicon Valley Bank, which collapsed in part due to mismanagement of interest rate risks. By focusing on this specific issue, regulators hope to prevent similar failures without imposing unnecessary capital burdens on smaller banks.

The reduction in capital requirements has been viewed as a win for Wall Street’s largest banks, who had lobbied heavily against the initial proposal. Industry executives, including JPMorgan Chase CEO Jamie Dimon, argued that the original 19% increase would have made lending more expensive and harder to access, potentially slowing economic growth. The 9% increase is seen as more manageable, although some critics, such as Senator Elizabeth Warren, have called it a “Wall Street giveaway,” arguing that it could increase the risk of future financial crises and put taxpayers on the hook for potential bailouts.

In addition to the revisions for big banks, the new proposal also brings some of the measures for mortgages and retail loans more in line with international standards. The initial draft of the Basel Endgame was seen as particularly onerous for these areas, which are crucial for consumers and businesses. The updated rules, however, lower the risk weightings for tax credit equity funding structures, often used to finance green energy projects, and reduce surcharges for banks with histories of operational failures. These changes aim to make the capital rules more equitable while supporting key sectors of the economy.

While the revisions represent a significant concession to the banking industry, the changes are far from final. Barr has stated that the proposal will undergo another public review process before being finalized, with the next step likely delayed until after the November 2024 election. This opens the possibility that, if a Republican candidate wins the presidency, the rules could be further weakened or even abandoned altogether. The delay has left some uncertainty regarding the long-term impact of the regulations on the banking sector.

Overall, the revised capital requirements are expected to have a mixed impact on the banking sector. While the new rules are less stringent than originally proposed, they still represent a tightening of regulations that could affect bank lending practices and profitability. Banks are already well-capitalized, as noted by the American Bankers Association, but any increase in capital requirements will still carry costs for the broader economy. Analysts expect banks to adjust their strategies, including stock buybacks and dividend growth, based on the new capital rules, making this an important consideration in future earnings calls.

In conclusion, the revised Basel Endgame rules represent a significant regulatory shift aimed at balancing the need for financial stability with concerns about economic growth. While the lower-than-expected capital requirements are seen as a win for banks, critics argue that the changes may increase financial risks. The next phase of public review will be crucial in determining the final shape of the regulations and their impact on the banking sector.