KBRA Financial Intelligence

Election Results to Play Critical Role in Shifting Bank Capital Requirements

With the 2024 U.S. presidential election just days away, stakes are high for the future of banking regulation. Less than two years on from the March 2023 banking turmoil, which kicked off three of the four largest bank failures in U.S. history, lawmakers and regulators remain focused on banks’ capital requirements.

The 2022-23 Fed rate hikes played an unintended role in creating banking sector panic throughout 1H 2023, as they saddled banks with an unprecedented level of unrealized losses on held-to-maturity (HTM) and available-for-sale (AFS) securities. Some banks were more affected than others, specifically those carrying unrealized losses greater than the capital available to absorb the losses if they had to be realized. In response, depositors at these institutions began pulling their funds. Persistent withdrawals triggered a collapse of investor confidence and a subsequent evaporation of equity value, which doomed Silicon Valley Bank, Signature Bank, and First Republic Bank to receivership. Fed and FDIC intervention stemmed the trepidation before it spread further through the banking system, but the damage done was enough to trigger involvement from Washington.

These events remain pertinent to the upcoming election, as President Joe Biden’s administration has backed assertions that stricter and wider-reaching capital requirements should be enacted under existing law. The White House largely foisted blame for the 2023 bank failures onto the Trump administration, claiming that the 2018 Economic Growth, Regulatory Relief, and Consumer Protection Act signed by then-President Trump initiated a “harmful weakening of bank safeguards and supervision.” Though the bill was given final legislative authority by Trump, it passed the House of Representatives and Senate with significant bipartisan majorities exceeding 60% of all voting members.

The Biden administration’s primary assertion was that, by amending the Financial Stability Act of 2010, Trump-era deregulation rolled back prudent standards and requirements on bank holding companies (BHC) and their subsidiaries with at least $50 billion in total assets. They argue that the 2018 Economic Growth, Regulatory Relief, and Consumer Protection Act, signed by President Trump, weakened safeguards and supervision. The act, which passed with bipartisan support, raised the threshold for designating systemically important financial institutions (SIFI) from $50 billion to $250 billion in assets, loosening oversight for many banks. These SIFI-designated institutions must adhere to enhanced liquidity standards and hold high-quality liquid assets (HQLA) to manage risks under the Dodd-Frank Act.

With the SIFI threshold raised to $250 billion, banks like SVB Financial Group (the parent of Silicon Valley Bank), Signature Bank, and First Republic Bank, which held assets between $110 billion and $213 billion by Q4 2022, were exempt from the stricter regulatory framework in place before 2019. By 4Q 2022, the final quarter before the 2023 bank failures, 56 U.S. financial institutions carried more than $50 billion in assets, but only 14 exceeded the elevated $250 billion SIFI threshold. As such, only the latter group faced the more stringent regulatory framework the entire group would have faced prior to 2019.

A post-mortem analysis authored by the Fed in the wake of the 2023 bank failures found that comparing SVB Financial Group’s “capital and liquidity levels against the pre-2019 requirements suggests that [the bank] would have had to hold more high-quality liquid assets (HQLA) under the prior set of requirements.” Further, Silicon Valley Bank would have been required to recognize unrealized gains or losses on its AFS securities portfolio in its regulatory capital, reducing its reported regulatory capital by $1.9 billion. Though the Fed claimed that “increased capital and liquidity would have bolstered the resilience” of Silicon Valley Bank, theoretically leaving it in a better state to manage the circumstances that ultimately led to the institution’s collapse, the report stopped short of claiming the pre-2019 regulatory framework would have prevented the bank’s failure. It should be noted that the Fed could have used its own discretion to impose the same restrictions that larger banks face upon selected institutions with total assets as low as $100 billion, but it failed to identify the severity of risks facing the banks that ended up failing in 2023.

Adjustments to capital requirements are under discussion, with the final stage of Basel 3 Endgame implementation to be finalized in the U.S. by 2025. Endgame seeks to update global capital standards among financial institutions, based on agreements within the Basel Committee on Banking Supervision. Though U.S. regulators remain deadlocked with no final proposal yet agreed upon, the most recent Fed guidance suggested banks above the $250 billion threshold may face an aggregate common equity tier (CET) 1 capital requirement increase of 9%, down from a more aggressive 19% bump that was previously proposed. Banks with $100 billion-$250 billion in assets would have to include unrealized gains and losses on their securities in regulatory capital going forward, likely resulting in a smaller increase of up to 4% in capital requirements for banks with significant trading activities. Each of these figures remains subject to ongoing negotiations between the Fed and its counterparts at the FDIC and the Office of the Comptroller of the Currency (OCC), two federal agencies that are headed by presidential appointees but conditional upon Senate confirmation. This means that either candidate’s eventual administration could have meaningful influence over the finalization of new regulatory capital rules, which could become stricter or looser.

The executive offices of both the FDIC and OCC carry five-year terms but have fallen into states of limbo. Biden appointee Martin Gruenberg has been chairman of the FDIC since January 2023 and could have remained so all the way until 2028, but Gruenberg announced earlier this year that he plans to tender his resignation once a chosen successor achieves Senate confirmation. Though President Biden nominated Christy Goldsmith Romero, commissioner of the Commodity Futures Trading Commission (CFTC), to take on the role in June, the Senate has yet to call a vote to confirm her for the role. At the OCC, Michael Hsu has been serving as acting comptroller of the currency for more than three years, an unprecedented tenure for a comptroller who has not even received an official nomination for the job. If the White House and Congress do not move to solidify control of these offices before the end of Biden’s term, it could leave both positions wide open to be formally filled by the next president’s administration. Additionally, if officials remain deadlocked on Basel 3 Endgame negotiations beyond next year, Fed Chair Jerome Powell’s term of office is set to expire in May 2026, granting the president the right to nominate a successor who might be able to tip the balance toward their desired outcome.

Given that Kamala Harris has served as vice president for the past four years, this suggests an administration with Harris at the helm may continue along a similar path that regulators have carved out during Biden’s tenure. Throughout the latter portion of that period, the White House and congressional Democrats have often lobbied in favor of stronger capital requirements for banks with assets in excess of $100 billion. Several lawmakers have openly advocated for the Fed to work toward “strong” new capital rules as part of Basel 3 endgame, including Senator Elizabeth Warren (D-MA), who has explicitly called on Chair Powell to convene regulators for a vote on a double-digit percentage increase in aggregate capital requirements.

Though the Fed adopted a rule that required it to enshrine some form of Basel 3’s capital rules into its regulatory framework all the way back in 2013, there is no deadline mandating that the U.S. finish implementation by a certain date. Further, U.S. institutions maintain discretion regarding how much of Basel 3, and to what degree, will ultimately be integrated into the American financial system. If a second Trump presidency were to retain the same deregulatory fervor as the first, it is possible that a more comprehensive Basel 3 implementation could be deferred in favor of more permissive re-proposals that give U.S. banks a competitive edge over their international counterparts that will not be able to lend as freely. The most obvious opportunity cost of allowing American financial institutions to lever up their capital more extensively is the risk that banks will be more easily pushed to the edge in the event of yet another unforeseen crisis within the sector.

KFI will continue to monitor the election’s impact on U.S. banks. Our Excel Add-in Screener Ratio templates, available for BHCs, commercial banks, and credit unions, can be utilized to detail the capital adequacy of individual institutions’ CET1 capital ratios, tangible common equity ratios, and more. Request a demo with KFI to access our full library of tables and templates.