	Overview of Bank Prudential Regulation

Lending is inherently risky. As part of safety and soundness regulation, banks are required to maintain sufficient capital reserves to buffer against losses associated with default (credit), funding (liquidity), and systemic-risk events. The Basel Capital Accords

The Basel Committee on Banking Supervision's (BCBS's) work on the first Basel Capital Accord, Basel I, provided an international consensus framework for bank safety and soundness regulation. In other words, international regulators were concerned that banks might prefer to domicile in countries with the most relaxed safety and soundness requirements. Unless capital reserve requirements are internationally harmonized, variation in standards may also lead to competitive disadvantages for some banks with competitors in other countries. Pillar 1 of Basel III modifies the regulatory capital and liquidity requirements established in Basel I and Basel II, requiring more and higher quality capital. On September 12, 2010, the 27 member jurisdictions and 44 central banks and supervisory authorities approved the requirements and phase-in schedules for Basel III. Banks must comply with the Basel III enhanced requirements by 2019. On July 9, 2013, federal banking regulators issued a final rule (the Regulatory Capital Rule) to implement most of the Basel III recommendations. Regulators have since adopted additional requirements on larger U.S. banking firms, discussed in Appendix B , Appendix C , and Appendix D .

		Enhanced Safety and Soundness Requirements Under Dodd-Frank

The Regulatory Capital Rule also implements some provisions from the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act; P.L. 111-203 ) that addressed capital reserve requirements for banks. Section 171: The Collins Amendment

The Collins Amendment of the Dodd-Frank Act provides for the development of consistent capital requirements for all insured depository institutions, depository institution holding companies, and systemically important nonbank financial companies. The Regulatory Capital Rule applies to all banks and bank holding companies domiciled in the United States. The leverage-ratio requirements for U.S. banks appear below. On April 8, 2014, the federal banking regulators issued a final rule (the Enhanced Supplemental Leverage Ratio) that would add an additional capital buffer of at least 2% to the current supplementary leverage ratio of 3% for bank holding (parent) companies with more than $700 billion in total consolidated assets or $10 trillion in total assets, thus raising the total supplementary leverage ratio requirement to a 5% minimum. On October 10, 2014, the federal banking agencies announced a final rule to implement the BCBS's LCR, calling for depository banking institutions with $50 billion or more in assets to hold more HQLA in their portfolios. Some Implications of Greater Prudential Capital and Liquidity Standards

Higher capital requirements and stress testing requirements (discussed in Appendix C ) may result in a larger cushion to absorb unexpected losses and reduce the vulnerability of banking institutions to insolvency (i.e., failure). Higher liquidity requirements may reduce vulnerability to sudden reversals in cash flow. By comparison, a systemic-risk event typically involves multiple financial institutions that simultaneously experience financial distress. Prudential requirements for the banking system may become less effective at mitigating financial risks when a significant amount of lending occurs outside the regulated banking system. When large amounts of lending activity occur in parts of the financial system that are not regulated for safety and soundness, raising prudential requirements for depository institutions would not necessarily address the rise in the various types of financial risks in the economy. Legislative Developments

The 114 th Congress is considering bills that would affect the prudential regulation of the banking system. S. 1484 , the Financial Regulatory Improvement Act of 2015, was reported without amendment to the Senate on June 2, 2015. In October 2012, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and the Federal Reserve separately announced final rules requiring national banks and federal savings associations with total consolidated assets of $10 billion or more to conduct annual stress tests. These stress tests are referred to as the Dodd-Frank Act Stress Tests (DFAST).
The Basel III international regulatory framework, which was produced in 2010 by the Basel Committee on Banking Supervision (BCBS) at the Bank for International Settlements, is the latest in a series of evolving agreements among central banks and bank supervisory authorities to promote standardized bank prudential regulation (e.g., capital and liquidity requirements, transparency, risk management) to improve resiliency during episodes of financial distress. Because prudential regulators are concerned that banks might domicile in countries with the most relaxed safety and soundness requirements, capital reserve requirements are internationally harmonized, which also reduces competitive disadvantages for some banks with competitors in other countries.
Capital serves as a cushion against unanticipated financial shocks (such as a sudden, unusually high occurrence of loan defaults), which can otherwise lead to insolvency. Holding sufficient amounts of liquid assets serves as a buffer against sudden reversals of cash flow. Hence, the Basel III regulatory reform package revises the definition of regulatory capital, increases capital requirements, and introduces new liquidity requirements for banking organizations. The quantitative requirements and phase-in schedules for Basel III were approved by the 27 member jurisdictions and 44 central banks and supervisory authorities on September 12, 2010, and endorsed by the G20 leaders on November 12, 2010. Basel III recommends that banks fully satisfy these enhanced requirements by 2019. The Basel agreements are not treaties; individual countries can make modifications to suit their specific needs and priorities when implementing national bank capital requirements.
In the United States, Congress mandated higher bank capital requirements as part of financial-sector reform in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act; P.L. 111-203, 124 Stat.1376). Specifically, the Collins Amendment to the Dodd-Frank Act amends the definition of capital and establishes minimum capital and leverage requirements for banking subsidiaries, bank holding companies, and systemically important non-bank financial companies. In addition, the Dodd-Frank Act requires greater prudential requirements on larger banking institutions.
This report summarizes the higher capital and liquidity requirements for U.S. banks regulated for safety and soundness. Federal banking regulators announced the final rules for implementation of Basel II.5 on June 7, 2012, and for the implementation of Basel III on July 9, 2013. On April 8, 2014, federal regulators adopted the enhanced supplementary leverage ratio for bank holding companies with more than $700 billion of consolidated assets or $10 trillion in assets under custody as a covered bank holding company. On October 10, 2014, the federal banking agencies (i.e., Board of Governors of the Federal Reserve System, Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation) announced a final rule to strengthen liquidity regulations for banks with $50 billion or more in assets. Additional requirements that have since been proposed or finalized particularly for the larger and more complex financial institutions are described in various appendices of this report. In addition, the 114th Congress is considering bills that would affect the banking system's prudential regulation, including S. 1484, the Financial Regulatory Improvement Act of 2015, which would affect bank capital regulation.
Greater prudential requirements for most U.S. banking firms may reduce the insolvency risk of the deposit insurance fund, which is maintained by the Federal Deposit Insurance Corporation (FDIC), because more bank equity shareholders would absorb financial losses. A systemic-risk event, however, refers to multiple institutions simultaneously experiencing financial distress. For example, higher bank capital reserves may absorb greater losses associated with the financial distress of an individual institution, but a systemic-risk event exhausts the capital reserves of the industry, thus threatening the level of financial intermediation conducted by the banking system as a whole. Higher capital reserves in the banking industry are also incapable of buffering losses associated with financial activity that occurs outside of the banking system.