The Revisit: Our Take on the U.S. Banking Agencies' Regulatory Capital Revamp

On July 27, 2023, the Board of Governors of the Federal Reserve System (FRB), the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation (collectively, FBAs) issued their long-awaited proposal amending the regulatory capital rules (proposal) for large banking organizations and banking organizations with significant trading activity. The FBAs maintain that the proposal is "generally consistent" with recent changes to international capital standards issued by the Basel Committee on Banking Supervision (Basel). It includes a three-year transition period beginning July 1, 2025, with a full phase-in on July 1, 2028. Comments on the proposal are due November 30, 2023. In the interim, the FBAs will collect data to refine their understanding of the proposal's impacts.

At over 1,000 pages, there is a lot to synthesize in terms of scope, technical application, and potential impact. There is also the FRB's accompanying 65 page G-SIB surcharge proposal (with the same comment period), which would amend the Systemic Risk Report (FR Y-15) and seek to make the GSIB surcharge approach more reflective of a GSIB's systemic risk profile. Using our interactive tool, readers are invited to consider the most relevant detail and potential impacts of these proposals as applied to their category, including U.S. firms in Category I-IV, and certain foreign banking organizations (FBOs). 

Overall, the proposals reflect a revamp of the existing U.S. bank capital framework and foreshadow the FBAs potential direction on other upcoming enhanced prudential regulation. If finalized in current form, the proposal is expected to result in a substantial increase in risk weighted assets across the board. For now, three observations:

1. The proposal is a broad-based "alignment" in the application of various capital rules to all Category I – IV institutions and, therefore, appears to be a pivot away from the regulatory tailoring of enhanced prudential standards under the bipartisan Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA). Should the proposal be finalized in its current form, the unwinding of a tailored capital framework for large banks means that Category III and Category IV firms would be brought fully within international standards through the Basel capital framework;
2. While not altogether surprising — especially following issuance of the White House Fact Sheet[1] one week after the failure of Silicon Valley Bank — the FBAs shift away from a tailored capital framework could portend broader "alignments" in future regulatory proposals, including for total loss-absorbing capacity (TLAC), resolution plans, and liquidity (e.g., liquidity coverage ratio and net stable funding ratio); and
3. Under the G-SIB Surcharge proposal, because of the FBAs' perceived "material" understatement of risk in the current cross-jurisdictional activity risk-based indicator, a meaningful number of FBOs would potentially move from Categories III and IV to Category II, subjecting a subset of these firms to a variety of more stringent capital and liquidity requirements than they are currently subject to.

There has been notable debate about the proposal, including the extent to which it strikes the right balance between strengthening supervision and regulation for Category IV firms, whether it threatens a decline in liquidity in capital markets and a movement of certain activities to the non-bank sector, and whether its "gold-plated" capital structure — resulting in a capital increase of 16 percent for all large banks — will ultimately improve the resiliency of the financial system. While the proposal is intended to better align capital requirements with risk, and may ultimately ensure that banks have the ability to absorb losses and continue to lend during stress, it remains unclear whether it meets the statutory bar set by Section 165 of the Dodd-Frank Act, as amended by Congress under EGRRCPA.

Across each Category in our interactive tool, there is a summary of relevant topics, key variables, and unresolved questions. Although the proposals would not be effective for several years, U.S. bank capital regulations are at the cusp of a significant revamp, with broader consequences likely beyond just updated regulatory capital rules.