Weakening Bank Capital Rules Puts Us All at Risk
By: Oscar Valdés Viera
This summer, federal bank regulators proposed a rule to massively weaken the key post-2008 financial crisis banking regulation designed to make the mega banks more resilient and reduce the risk of their failure. The Trump regulators proposed reducing the enhanced supplementary leverage ratio (eSLR) by over $200 billion. The proposed rule would allow the eight biggest banks to use more borrowed money—or leverage—which would increase the likelihood and severity of another financial crisis.
This is an attack on the post-crisis reforms that were designed to make the financial system more robust and resilient during times of economic stress. The Trump administration and Republican Congress are removing this and many other guardrails that have served us well over the past fifteen years and helped prevent economic stressors—like the pandemic and the 2023 bank failures—from becoming full-blown financial crises.
Letting the biggest banks gamble with borrowed money was one of the key drivers of the 2008 crash. Banks win big when their bets pay off. They repay the lenders that provided the money they invested and pocket the profits. When their investments fail—as they did with subprime mortgage securities and credit default swaps—and they do not have enough equity capital they can stumble or fail.
Economic downturns that are driven by financial crises are deeper and more protracted. The banks bounced back pretty quickly from the 2008 crisis, but the economic pain lingered for years longer for the millions of families that lost their life savings, homes, and jobs during the financial crisis.
That is what makes the supplementary leverage ratio so important. It is very straightforward and difficult for banks to game. It is simply the share of the bank’s own equity—as opposed to borrowed money—invested in its assets. Bank capital requirements essentially direct the banks to have their own skin in the game and rely less on borrowed funds. It reduces excessive risk-taking and helps make sure banks have enough resources to absorb losses and avoid bank failures. Weakening this standard would mean thinner shock absorbers for megabanks and greater risks for the rest of us. But instead of building on the lessons of 2008 and the 2023 bank failures and bailouts, regulators are considering yet another dangerous rollback.
Regulators regurgitate banking industry’s talking points: The proposal reinforces the industry’s long-standing mischaracterization of capital requirements as a mandatory reserve or rainy day fund that prevents banks from making investments. This is an intentional misdirection. As Professors Steven Cecchetti and Kim Schoenholtz noted in the Washington Post:
The primary debate is over regulators’ call to raise capital requirements — that is, increase the fraction of banks’ funding that comes from shareholders (equity) rather than from depositors or bondholders (borrowing). Bank advocates argue that this equity is somehow idle, so any increase in required capital wastes resources and depresses lending, reducing the ability of households and businesses to finance essential activities…. This is wrong. The truth is that capital is never a wasted resource. It is a source of funds that the bank uses to provide loans. A well-capitalized bank has more resources to supply credit, not fewer.
Capital rules merely require that a certain share of a bank’s assets be financed with its own equity—like requiring a homebuyer to make a cash down payment rather than financing the entire purchase with debt. Because equity doesn’t carry fixed repayment obligations, having more of it gives banks a stronger cushion to absorb losses when things go wrong.
However, this is where the public debate often goes off the rails. Too many policymakers repeat the fallacy—sometimes explicitly, sometimes implicitly—that requiring banks to have more capital means locking money away and choking off lending. As Senate Banking Committee Chairman Tim Sott (R-SC) said in a hearing, capital requirements are “simply requiring more capital on the sidelines, which then means fewer dollars to lend to small businesses, first-time homebuyers, car loans. So the actual impact of a higher regulatory standard is fewer dollars to lend to Americans.” These are straight up banking industry talking points and extortion tactics to avoid regulation; basically big banks CEOs saying that if regulators crack down on them they will hurt families and the economy.
Contrary to bank lobbyists talking points, strong capital requirements aren’t a drag on lending. Well-capitalized banks face less funding stress because investors and creditors see them as safer and they can raise money more cheaply. Better capitalized banks also lend more, even when funding conditions are tight. And strong capital buffers help reduce systemic risk and the probability of crises. Furthermore, bank lending is not inherently limited by reserve or capital requirement. Banks can always make loans first and obtain reserves afterward if needed, with the Federal Reserve constantly ensuring sufficient reserves in the system to meet its interest rate target.
Industry claims that “capital is too expensive” ignore that the long-term benefits to the economy far outweigh any short-term costs. As Stanford’s Anat Admati and others have shown, the private costs to banks of having to use more equity are far smaller than the social benefits, which include greater financial stability and fewer and less severe crises.
The rollback agenda: The weakening of the supplementary leverage ratio is not happening in a vacuum. The administration and Republicans in Congress are advancing a broad deregulatory agenda, including rolling back prudential safeguards and weakening tools for monitoring and responding to systemic risks. They’ve already gutted stress tests, undermined regulatory bodies like the Financial Stability Oversight Council, are coming for the leverage ratio, and also are planning to weaken the risk-based Basel capital standards. The combination of these deregulatory moves is much more dangerous than the sum of its parts. The administration is setting the stage for the next financial crisis by making banks more fragile and more susceptible to collapse.
The bottom line is that when megabanks run thin on capital, the risks don’t just impact their shareholders. When a giant, interconnected institution fails, policymakers face a grim choice: allow a collapse that devastates the economy, or step in with public support. That’s the essence of “too big to fail.” Strong capital rules reduce that moral hazard by forcing banks to absorb more of their own risks. Weakening those rules does the opposite—it increases the likelihood of big bailouts and preserves the subsidies megabanks enjoy simply by being too large and systemically important.
A resilient financial system depends on strong capital standards and other guardrails that put financial stability and the resiliency of the real economy above the interests of Wall Street banks and their investors. Weakening capital standards now would make the system shakier, the economy more fragile, and the public more exposed—just like the deregulation that led to the 2008 financial crisis.