The US is deregulating banks. Will the rest of the world follow?
New rules will boost lending and profits and entrench American dominance. But critics say they could lead to another crash
Martin Arnold in London
A picture of the Farmers & Drovers Bank has pride of place on the shelf next to Michelle Bowman’s desk at the US Federal Reserve in Washington — a prominent reminder of her family ties to one of the oldest lenders in Kansas.
Bowman’s great-great-grandfather was the first president of the 143-year-old bank her family still owns in the rural Midwest and she spent seven years as its vice-president before joining the Fed’s board in 2018.
Her roots in banking made her an obvious choice for US President Donald Trump to pick as the Fed’s vice-chair of supervision in June, and she is also one of the contenders to succeed Fed chair Jerome Powell.
The fact that banking is in Bowman’s blood also helps to explain the gusto with which she has launched one of the most significant reversals of US financial regulation for decades following her appointment as the top cop for the sector.
The effort, accompanied by a 30 per cent reduction in staff numbers at the Fed’s supervisory and regulatory unit, is in line with the Trump administration’s broader aims of shrinking the state and rolling back regulation.
Researchers have forecast the reforms of US banking regulation she is leading will free up almost $2.6tn in lending capacity and boost profitability at the country’s lenders by reducing the amount of loss-absorbing capital they are required to hold.
Many on Wall Street and among Trump’s supporters have applauded Bowman — widely known as Miki — as she has promised to remove what they see as excessive restrictions on US banks to encourage more lending, financial innovation and economic growth.
They say the clampdown on the sector that followed the 2008 crash went too far in driving risk-taking out of the banks while pushing large swaths of lending and trading into more lightly supervised private credit markets and hedge funds.
“The world is watching and the US is moving ahead at a rapid pace,” says Tim Adams, head of the Institute of International Finance, which lobbies for many of the world’s biggest banks.
“We had 15 years of constantly adding on capital and liquidity and focusing on operational risk.
The time has come to rethink this.”
Foreign rivals of big Wall Street banks worry that an easing of US rules will hand the country’s lenders a powerful advantage, enabling them to extend their already dominant position in many parts of international capital markets.
Bowman’s critics warn that watering down much of the US financial rule book, just over two years since several mid-sized US banks collapsed, will encourage excessive risk-taking by banks, expose their customers to more wrongdoing and losses, and even plant the seeds of the next financial meltdown.
Some fear a regulatory race to the bottom, as bankers around the world lobby their own regulators to ease restrictions.
Robert Mazzuoli, at credit rating agency Fitch, says that the shift to looser regulation is “likely to reduce the resilience of the banking sector to systemic market shocks”.
Michael Barr, Bowman’s predecessor as vice-chair of supervision, said in a speech this month that “periods of relative financial calm” had repeatedly led to efforts to weaken regulation and supervision.
“This has often had dire consequences, as we saw prominently during the global financial crisis.”
Bowman’s initial reforms are mostly aimed at freeing up lending capacity at US banks, by loosening many of the constraints that determine how much capital they need to allocate to those loans and other assets on their balance sheets.
One of the key lessons from the 2008 crisis was that heavily indebted banks lacked the equity capital to absorb large losses, leaving regulators with an unpleasant choice between letting banks fail or bailing them out to protect depositors.
In the years that followed, lenders were forced to drastically increase their capital levels.
The amount of common equity tier one — the main yardstick of bank capital — at major US banks has more than doubled since 2011 to over $1.1tn, according to JPMorgan Chase.
Speaking at an event in Madrid this month, Bowman praised these post-crisis reforms as “very important”.
But she went on to say: “Things that we may have created or calibrated in the post-financial crisis years may or may not still be fit for purpose.
“In 15 years the economy has changed tremendously,” she said.
“We have seen a number of different innovations and different engagements that I think our banks in particular would like to be part of, but they are inhibited from doing so by the regulatory environment.”
This seemed to be music to the ears of many bankers in the audience that day, even though Bowman went on to say that she preferred to describe the process as “modernisation” rather than deregulation.
The Fed has already approved some of her planned reforms, such as an easing of the so-called enhanced supplementary leverage ratio, which sets out how much non-risk-adjusted capital the biggest US banks need in proportion to their overall assets.
The plan will lower the ratio from at least 5 per cent to between 3.5 and 4.25 per cent.
Officials estimate this will free up $13bn capital at the holding company level of the eight biggest US lenders, and $210bn at their deposit-taking subsidiaries.
Bowman has said this will lift a barrier that deters banks from being more active in the $29tn US Treasury market, bolstering US government debt sales.
Officials also point out that it merely brings US rules in line with international norms by removing additional protections — so-called “gold-plating” — added earlier by Washington.
But Barr, who is still a Fed board member, voted against the plan, warning it would “significantly increase” the risk of a big bank failing and adding that he was “sceptical that it will achieve the stated objective of strengthening the resiliency of the Treasury market”.
The central bank has also presented plans for a major overhaul of its annual stress test exercise following an unprecedented legal challenge last year, which argued the tests were illegal because they lacked transparency.
“The stress tests have been the strongest driver of capital requirements for the biggest US banks,” says Douglas Elliott, a partner at consultants Oliver Wyman.
“The changes are likely, in practice, to loosen this constraint to some extent.”
The Fed estimated its proposals to disclose and seek feedback on the hitherto secret models it uses to test the resilience of the sector would reduce capital requirements for the biggest US lenders by a “negligible” 0.25 percentage points on average compared with the past two years.
Barr voted against these changes too, warning they would “make the stress test weaker and less credible” by leading to “overly optimistic projections” and opening the process up to “gaming by banks”.
But other reforms are yet to be presented in detail by the Fed, such as easing the extra capital buffer it requires of the largest US banks.
The US is expected to cut this to bring it in line with the lower global standard imposed on other banks considered systemically important.
One of the most eagerly awaited parts of Bowman’s agenda is her plan to complete the implementation of the so-called Basel III rules, the capital standards agreed by a committee of global regulators based in the Swiss city.
Expected early next year, these changes will implement reforms to bank capital requirements first agreed a decade ago in response to the 2008 crisis.
A stricter “gold-plated” version of the rules was proposed a couple of years ago by Barr that would have put almost 20 per cent extra capital requirements on the biggest US banks.
But after heavy lobbying by the sector against what it dubbed “Basel Endgame”, including TV adverts during the Super Bowl warning of higher borrowing costs, this version was ditched.
Bowman hopes to present her plans to implement a looser form of the Basel III rules, which is likely to be more acceptable to Wall Street, early next year.
Observers expect these to be broadly capital-neutral for most US lenders.
“Every bank in the US, particularly the big banks, wants to get Basel III implemented and to move on,” said Daniel Pinto, vice-chair of JPMorgan.
The revised US proposal is expected to keep bank capital “more or less flat to what it was”, Pinto told an event in Frankfurt this month.
He added that this “creates a situation where we have $50bn-$60bn of excess capital because we were prepared for the worst scenario of Michael Barr’s interpretation”.
That sum is equivalent to the entire market capitalisation of France’s Société Générale, underlining the difference in scale between US and European lenders.
The top 13 US banks already have about $200bn of excess capital above their regulatory minimums, according to Rebecca Boeve, an investment specialist at JPMorgan’s private bank.
“Deregulation should enable banks to allocate this excess capital towards loan growth, share buybacks and dividends, and mergers and acquisitions,” she says.
However, some US bank executives still have concerns about duplication of capital to cover operational and market risks they think could occur between the Basel rules and the buffers imposed by the Fed based on its stress test results.
Members of the Senate banking committee wrote to Bowman and Fed chair Powell this month, calling on them to avoid “overcapitalisation of risks” that have already been accounted for by US rules.
This has prompted worries among European regulators about whether the US will fully adhere to the original Basel agreement, even though Bowman has reassured them it will.
The UK and EU have already delayed implementing their versions of the Basel III rules, while they wait to see what the US does.
A senior EU central banker said that if the US backed away from the market or operational risk parts of Basel “that would be a big deal”.
Randal Quarles, who was the Fed’s vice-chair for supervision in Trump’s first term, is confident the US can implement Basel fully while still going easy on its banks.
“The US has gold plated a lot of elements of banking regulations, so this is the right time to make some changes to that,” he says.
The Fed this month also announced a significant softening of its “large financial institution” rating system — a supervisory tool that imposes restrictions on riskier activities at banks rated as not “well managed”.
“Since the financial crisis we have really been focusing on things that are procedural in nature, box-checking,” said Bowman.
“While they are important, they are not as important as things that actually lead to a bank’s failure, like material financial risk.”
What is already clear is that Wall Street banks are likely to be the biggest winners from Bowman’s reforms.
Alvarez & Marsal, a consultancy, estimated in a recent report that deregulation would free up almost $140bn of capital for US lenders, boosting their return on equity by almost 6 per cent.
Fernando de la Mora, co-head of financial services at Alvarez & Marsal, predicts UK banks would do well too, with a drop of about 8 per cent in their capital requirements thanks to expected regulatory changes and less onerous stress tests.
But he says EU lenders would mostly miss out as their overall capital requirements are expected to inch up 1 per cent.
Switzerland’s regulators are heading in the other direction, he forecast, raising capital levels by 33 per cent in response to the 2023 crisis at Credit Suisse, which necessitated its rescue by domestic rival UBS.
“Our view is the UK will quickly follow the US on deregulation and probably achieve about half of the reduction in capital requirements,” says de la Mora.
“But in the EU we are only talking about simplification and not about reduction.”
Spurred by the prospect of US deregulation, British and EU bankers are already calling on regulators to ease restrictions.
UBS, frustrated by a planned $26bn increase in its capital requirements, is discussing whether to move its headquarters to the US.
“There is a discussion to be had,” said Richard Haythornthwaite, chair of UK lender NatWest, at a financial conference in Washington last month.
“It comes back to the bigger regulatory issues, one of which is the capital stack and really the extent to which we are forced to retain capital on our balance sheets, which just crowds out lending.”
In the UK, where the government is also pushing for more growth-friendly regulation, the Bank of England will next week present the results of its latest assessment of UK bank capital requirements.
Executives hope this will ease some rules; Sarah Breeden, deputy BoE governor for financial stability, recently hinted it was considering a cut to leverage ratio requirements for banks.
She told the event in Madrid attended by Bowman that she had not expected the leverage ratio to be “routinely binding on firms” when it was introduced.
“When we look at the UK banks right now, we can see that it is binding for quite a few of them,” she added, questioning whether the system was “operating as we expected”.
The European Central Bank, which regulates larger banks in the EU, is also preparing to present the conclusions of a task force looking at simplifying rules.
But the ECB’s top supervisor, Claudia Buch, has downplayed the idea it could significantly lower bank capital requirements.
“Banks that are better capitalised are better able to lend, particularly in times of stress,” she said.
European bank executives are fretting they will lose even more market share to US rivals as a result of the apparent divergence on capital rules.
“This is really bad news,” says one top EU bank executive.
George Bridges, senior adviser to Ana Botín, executive chair of Spain’s Banco Santander, says the US authorities are “going to pull every lever they can to make the US very much more attractive to capital and to strengthen US banks and financial institutions”.
“How are we going to respond to this?
I think in London, in Brussels and in Frankfurt we are going to have to have an urgent conversation about the mindset we have towards regulation and supervision and about our risk appetite.”
As Bowman transforms the US regulatory landscape in favour of its banks, other regulators fear it will raise the pressure to follow suit and risk eroding the guardrails put in place to avoid another financial crash.
Ashley Alder, the veteran regulator who chairs the UK’s Financial Conduct Authority, flagged this week how there seem to be “successive cycles of regulatory tightening — usually in response to a financial crisis — which were then followed by periods of relaxation as memories fade and economic priorities change . . . until the next crisis”.
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