On February 27, the U.S. House of Representatives passed H.R. 4296, which aims to reduce the operational capital requirements imposed on financial institutions. The bill passed with a vote of 245-169. As is typical with deregulatory legislation, only 19 Democrats supported the bill, while only three Republicans voted against it.
Currently, most U.S. financial institutions are subject to Basel III’s stringent minimum capital requirements in order to counterbalance their exposure to various operational risks. Under Basel III, a bank must maintain more than 50 percent of high-quality Tier 1 capital in its reserves—mostly comprised of common stock and retained earnings—in order to absorb unexpected losses on a “going concern” basis (i.e., while the bank remains solvent). Higher minimum capital requirements result in less money available for consumer and commercial lending.
H.R. 4296 tightens the circumstances under which federal banking agencies can establish such operational capital requirements. They may only do so if the requirement “(1) is based primarily on the risks posed by a banking organization’s current activities; (2) is appropriately sensitive to the risks posed by such current activities and businesses; (3) is determined under a forward-looking assessment of potential losses that may arise out of a banking organization’s current activities, businesses, and exposures, which is not solely based on a banking organization’s historical losses; and (4) permits adjustments based on qualifying operational risk mitigants.” H.R. 4296, 115th Cong. § 1(a).
Proponents of the bill argue Basel III’s requirements are outdated because they require banks to hold billions of dollars in reserve to account for activities they no longer practice and risks they no longer have. This money, they argue, could be used to fund a wide array of consumer and commercial loans and further invigorate the bullish American economy. According to proponents, the bill simply amends the way in which reserve capital is calculated by making capital requirements more accurate and tailored to a bank’s current risk profile. Opponents of the bill, however, view the bill as a giveaway to Wall Street that prematurely prevents regulators from promulgating capital requirements.
The bill is significant because if it is signed into law, banking regulators will have fewer grounds upon which to substantiate an increase the reserve funds banks must maintain, leaving more funds available for banks to conduct lending activities. Moreover, in light of the recent 25 percent reduction in the maximum amount of surplus funds Federal Reserve Banks can maintain, the bill signals the coming of further deregulation in the banking industry, including perhaps a relaxing of Basel III’s capital requirements to Basel II levels. If this should occur, we may see an uptick in capital access and lending activity, which could cause the market to remain bullish for longer than previously anticipated.