Explainer-What is basel and why has it been so contentious?

Basel III Endgame: Why New U.S. Bank Capital Rules Are So Contentious

Understanding the Basel III Endgame and Its Impact on U.S. Banking Regulation

By Pete Schroeder

WASHINGTON, March 12 (Reuters) - U.S. President Donald Trump's bank regulators will unveil this month a new draft of sweeping capital rules that would overhaul how big banks gauge their risks and in turn the funds they must put aside to absorb potential losses. 

The "Basel Endgame" rule has been mired in controversy since it was first unveiled in 2023 under the Democratic Biden administration, sparking a massive pushback from Wall Street banks who said it would hurt lending and the economy.

Critics, meanwhile, say banks are flush with cash and that the changes will weaken critical rules introduced as a result of the 2007-09 crisis at a time when geopolitical shocks sparked by the Iran conflict and deteriorating private credit conditions are rattling markets. 

The new draft, combined with changes to other capital rules, will modestly reduce capital requirements for many lenders, Federal Reserve Vice Chair for Supervision Michelle Bowman said on Thursday.

What is 'Basel III Endgame'?

The Basel Committee on Banking Supervision is a panel convened by the Bank for International Settlements (BIS) in Basel, Switzerland, which aims to ensure regulators globally apply similar minimum capital standards so that banks can survive loan losses during tough times.

The committee's "Basel III" standard was agreed after the 2007-09 global financial crisis. It includes numerous capital, leverage and liquidity requirements for banks. Regulators across the world have worked for years to implement many of those standards, and the so-called "endgame," agreed in 2017, is the final iteration.

The Fed is leading the project in the United States, along with the Federal Deposit Insurance Corporation and Office of the Comptroller of the Currency.  

Why Are Trump's Regulators Putting Out a New Draft?

The original 2023 Basel draft led by Bowman's Democratic predecessor Michael Barr proposed raising capital by 16%. Big banks said it could hike their levels by as much as 20%. That came as a shock to the industry, which had expected the rule would shift capital around but keep overall levels mostly flat. 

In response, banks launched an unprecedented lobbying effort and public campaign - which included running attack adverts during football games - arguing the rules were unnecessary because banks were already well-capitalized, and that they would hurt lending, small businesses and the economy. Banks also threatened to sue.

Barr pledged to rewrite the rule, but the three regulators could not agree a path forward, and the effort slipped into the Trump administration, which has generally sided with the industry. 

What Are the Proposal's Goals and What Impact Will It Have?

Overhauling Risk Assessment for Large Banks

The U.S. proposal would overhaul how large banks gauge their risk, and in turn, how much capital they should set aside as a cushion against potential losses. The main areas of focus are credit risk, market risk and operational risk. 

Regulatory Adjustments and Relief for Banks

On Thursday, Bowman said the new proposal would "right-size" requirements to better capture risks, while minimizing overlaps. The changes would also give banks relief for activities regulators see as less risky and which they want to promote, such as mortgage lending.

Impact on Smaller Banks

For smaller banks, the plan would create a new standardized measurement of risk which would "moderately reduce" their requirements and incentivize lending.

Expected Outcomes for Largest Banks

Overall, Basel is still expected to raise capital slightly for the largest, riskiest banks. But when combined with changes to a surcharge levied on risky global or "GSIB" U.S. banks, capital at the biggest Wall Street banks would shrink "a small amount," she said.

What's the 'GSIB Surcharge'?

Definition and Rationale

The GSIB surcharge requires eight big U.S. banks deemed to be globally risky to hold even more capital. Those big banks have argued for years the surcharge calculation needs to be updated.

Proposed Updates to the Surcharge

Bowman said on Thursday that the Fed plans to update some calculation inputs, which were fixed in 2015, to adjust for economic growth and in turn more accurately reflect the size of the banks relative to the global economy. The Fed had previously considered that change, but the effort stalled amid the broader Basel fight.

Short-Term Funding Risks

The Fed also plans to tweak how much banks must set aside due to short-term funding risks, as Bowman argued it had become more costly over the years than originally intended.

What Do Critics Say?

Concerns Over Financial System Safeguards

While regulatory experts agree it's reasonable to question how capital is allocated, many have argued that the overall amount in the system is broadly right and that chipping away at capital and liquidity levers will ultimately weaken financial system safeguards. On Thursday, Democratic Senator Elizabeth Warren - who helped shape the rules introduced following the 2007-09 crisis - said the changes put the economy at risk.

Research on Lending and Capital Requirements

Research by Stephen Cecchetti, a professor at the Brandeis International Business School who has analyzed aggregate Fed loan data going back more than a decade, found there is no clear evidence that higher bank capital requirements have resulted in U.S. banks lending less, Reuters reported in 2024. Cecchetti also helped shape the Basel rules post-crisis.

What Happens Next?

Regulatory Process and Timeline

Bowman said the Fed will vote on the proposals soon and the public will be able to provide feedback. Regulators have said they want to move quickly, but the proposals are lengthy and complex, and finalizing the drafts could take many months. 

(Reporting by Pete Schroeder; editing by Michelle Price and Nick Zieminski)