It is a known fact that if you keep those low-rise/high-waist/baggy/skinny/bell-bottom/bootcut/wide-leg jeans in your closet long enough, they are bound to be fashionable again. It is even better if you had forgotten about them and then find them just at the right time.
The same principle seems to apply to US bank regulation.
Team Regulator—the Federal Reserve, FDIC, and the Office of the Comptroller of the Currency—just put forth a(nother) proposal for how to adapt the Basel III guidelines into federal regulation and kindly requests the banks’ feedback on this by June.
I don’t know if you remember how the previous proposal, which was a 1,000-page brick of a summer beach read in 2023, lit the bank comment section on fire, but I am sure some people on Team Regulator still have singed eyebrows.
Let me just recap that Team Bank did not find an estimated 19% increase in capital requirements amusing or fair. But even if they pushed back hard and succeeded in getting Team Regulator to do it over, the banks did not totally let down their hair and go all out on capital spending. They just kept a bit in the closet and waited for it to come around again.
And that is what happened this week.
The new proposal simplifies the rules and, together with the streamlining of stress testing, lowers the capital requirements between 4.8% and 7.8%. The smallest banks, those with less than $100BN in assets, get the biggest reprieve (source: Financial Times).
Michelle Bowman, Vice Chair for Supervision at the Fed, said that excessive capital requirements without a specific purpose impair the banks’ ability to provide credit to the real economy, leading to foregone economic growth, reduced job creation, and lower standards of living. My best bet is that Team Bank will not be inclined to argue too much with that sentiment.
Bloomberg estimates that the banks just had around $200BN slide back into style, and that is quite a chunk of capital. So, what are they going to spend it on? As Bloomberg sees it, they have several options:
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They can buy back stock from shareholders, but because the banks are already doing great, their stock is expensive, and they will not get as much return for their buck.
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They can invest or trade the extra money. That might look like a better option, but not necessarily with a higher return, since it is still TBD if we are en route to an economic rut, and also because the new proposal standardizes rules on market risk by disallowing the banks’ use of internal models.
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They can grow their existing loan books, but that could lead to over-excitement in the economy, looser underwriting standards, and more losses down the line.
Probably it will be a combination of all the options, and no choice fits all. In all cases, it is a choice of luxury, not unlike finding a pair of renaissance jeans in the back of your closet.
FRG and The Risk Report find bank regulation interesting because we help financial institutions navigate the regulatory environment in which they exist.
Regitze Ladekarl, FRM, is FRG’s Director of Company Intelligence. She has 25-plus years of experience where finance meets technology.
This article is part of the FRG Risk Report, published weekly on the FRG blog. To read other entries of the Risk Report, visit frgrisk.com/category/risk-report/.