Fox Rothschild | Federal Reserve and Banking Agencies Announce Sweeping Overhaul of Bank Capital Rules

Key Points

• The Federal Reserve, FDIC and OCC jointly propose overhauling U.S. bank capital rules, replacing the 2023 Basel III Endgame proposal with a reduced-stringency framework estimated to provide $87.7 billion in system-wide CET1 relief.
• CET1 reductions by category: ~4.8% for GSIBs (Category I & II); ~5.2% for large regional banks (Category III & IV); ~7.8% for smaller banking organizations.
• Key structural reforms: AOCI inclusion mandated for Category III/IV banks (five-year phase-in from 2027); MSA capital deductions eliminated (250% risk weight substituted); market risk methodology shifts from VaR to expected shortfall; CVA capital requirements introduced.
• Comment deadline: June 18, 2026; over 200 specific questions posed; final rules effective two calendar quarters after adoption.

A Complete Reset

Federal banking regulators this week unveiled a comprehensive package of proposals that will reshape how America’s banks manage capital for years to come.

If you’ve been following the saga of “Basel III Endgame” since its contentious 2023 debut, you’ll find this new iteration dramatically different — and for most banks and their clients, considerably more favorable.

The agencies — the Federal Reserve, FDIC, and OCC — have abandoned their controversial 2023 proposal and replaced it with a streamlined framework that the regulators characterize as “modernizing” rather than tightening capital requirements. The bottom line is significant: the largest banks (GSIBs) will see their common equity tier 1 capital requirements decrease by approximately 4.8%, while smaller regional banks and community banks will see reductions of 5.2% and 7.8%, respectively.

This represents a stark reversal from the 2023 proposal, which would have increased capital requirements by 19% for the largest institutions. The agencies now frame the reductions as “reasonable given the evolution of large bank capital requirements over the last decade.”

Whether this balance proves durable — and whether the capital reductions prove wise in hindsight — will depend on economic conditions that no one can predict with certainty. For now, the regulatory winds have clearly shifted toward a more accommodating stance for America’s banks.

The package consists of three interconnected proposals. Each has a distinct focus.

Proposal 1. The “Expanded Risk-Based Approach” for Large Banks

This proposal applies primarily to Category I and II banking organizations, the nation’s largest, most internationally active banks with $700 billion or more in assets or significant cross-jurisdictional activity.

The most significant simplification is the move from two separate capital calculations to one. Currently, large banks must calculate capital ratios under both the “standardized approach” and the “advanced approaches” and comply with whichever produces the higher requirement. Under the new framework, these banks will use only the new “expanded risk-based approach,” eliminating the advanced approaches entirely.

Key changes include better alignment of capital with actual risk through metrics like loan-to-value ratios for real estate exposures and improved recognition of credit risk factors. The proposal also introduces an explicit operational risk capital requirement based on a firm’s income and expenses, replacing the current reliance on complex internal models.

For market risk, the proposal substantially overhauls how banks measure trading book exposures, replacing the current value-at-risk methodology with an expected shortfall-based measure that better captures tail risk.

Proposal 2: The “Standardized Approach” for Regional and Community Banks

This proposal affects virtually every other banking organization in the country, from large regional banks to community institutions. The changes focus on better calibrating capital requirements for traditional lending activities — the bread-and-butter business of most American banks.

The proposal would reduce the risk weight for corporate exposures from 100% to 95% and lower the weight for miscellaneous assets from 100% to 90%. Mortgage lending receives particularly favorable treatment through a new loan-to-value based approach for residential real estate exposures.

Perhaps most significantly for the regional banking sector, Category III and IV banks (generally those with $100 billion to $700 billion in assets) would be required to include accumulated other comprehensive income (AOCI) in their regulatory capital. This change directly responds to lessons from the 2023 regional banking stress, when unrealized losses on securities portfolios contributed to the failures of Silicon Valley Bank and Signature Bank.

The agencies recognize this will increase capital volatility for affected institutions and have proposed a five-year phase-in period to ease the transition.

Proposal 3: The G-SIB Surcharge Framework

The Federal Reserve’s solo proposal addresses the additional capital buffer required of the eight U.S. global systemically important bank holding companies — the largest, most complex institutions including JPMorgan Chase, Bank of America, Citigroup, and others.

The current framework has produced surcharges that regulators now view as “not commensurate with risk” due to outdated calculation methodologies. The proposal makes several technical but consequential changes:

• Coefficient adjustments: The proposal would apply a one-time 20% downward adjustment to the “method 2” coefficients used to calculate surcharges, reflecting that economic and financial system changes have caused these scores to drift higher without corresponding increases in actual systemic risk.
• Automatic indexing: Going forward, the coefficients would be annually indexed to nominal U.S. GDP growth, so banks can grow with the economy without automatically seeing their surcharges increase.
• Short-term wholesale funding recalibration: The proposal would recalibrate the weight of short-term wholesale funding to 20% of the overall score, as originally intended, down from approximately 30% currently.
• Data averaging: To reduce incentives for year-end “window dressing,” certain systemic indicators would be calculated as annual averages rather than point-in-time year-end values.
• Narrower score bands: Surcharges would increase in 10 basis point increments rather than 50 basis points, reducing “cliff effects” when a bank’s score crosses a threshold.

The Numbers That Matter

The cumulative impact across all three proposals is a compelling story of regulatory recalibration:

Institution Category	CET1 Requirement Change
Category I & II (Largest Banks)	-4.8%
Category III & IV (Large Regional)	-5.2%
Smaller Banking Organizations	-7.8%

 

For the largest banks, the Basel III proposal alone would modestly increase capital requirements by 1.4%, but this is more than offset by the 3.8% reduction from the G-SIB surcharge proposal. When combined with previously proposed stress testing changes, the overall package delivers material capital relief.

In dollar terms, the proposals would lower common equity tier 1 capital requirements across the entire U.S. banking system by approximately $87.7 billion.

Fed Achieves Consensus, Not Unanimity

The proposals have generated an unusual degree of consensus among Federal Reserve Board members, though not unanimity.

Chair Jerome Powell emphasized that “financial regulators should always strive to improve” and characterized the proposals as ensuring rules “still effectively and efficiently mitigate the risks they were designed to address.” He specifically noted his interest in hearing whether the Basel III proposal “successfully achieves the objectives of the international accord while tailoring to the unique characteristics of the U.S. banking system.”

Vice Chair for Supervision Michelle Bowman, who led development of the proposals, described them as arising from a “bottom-up review of each element of the framework,” evaluating “whether it aligns with risk, achieves its intended purpose, and avoids creating unintended outcomes.” She emphasized that “over-calibration can harm bank competitiveness and the ability to serve customers, limit the availability of credit, and stifle economic growth.”

Governor Michael Barr dissented from all three proposals, warning they would “harm the resilience of banks and the U.S. financial system.” He particularly criticized the G-SIB surcharge changes as lacking adequate justification and expressed concern that the market risk deviations from Basel standards could “trigger a ‘race to the bottom’ on standards, harming the global financial system.”

Governor Christopher Waller offered strong support, particularly endorsing the GDP-based indexing mechanism. “What matters for assessing the systemic importance of a bank is its nominal size relative to the nominal size of the U.S. economy,” he explained. “The absolute nominal size of a bank is not relevant.”

Practical Implications For Companies That Borrow from Banks

Lower capital requirements generally translate to greater lending capacity and potentially more competitive pricing. The agencies explicitly designed these proposals to “reduce incentives for traditional lending activities — like mortgage origination, mortgage servicing, and lending to businesses — to migrate outside of the regulated banking sector.”

The improved treatment of corporate exposures (reduced from 100% to 95% risk weight) should modestly improve economics on commercial loans. For real estate borrowers, the loan-to-value based approach creates more granular risk assessment that could benefit creditworthy borrowers with lower leverage.

For Mortgage Market Participants

The proposals represent a significant policy shift toward encouraging bank participation in mortgage markets. The elimination of capital deductions for mortgage servicing assets is particularly notable — previously, banks had to deduct MSAs exceeding certain thresholds from their capital, creating a direct disincentive for mortgage servicing. Under the proposals, all MSAs would instead be subject to a 250% risk weight, which is considerably more favorable for most institutions.

This change responds to the dramatic migration of mortgage activity to nonbank servicers over the past decade. The agencies note that “nonbank mortgage companies originated approximately two-thirds of mortgages in the United States and owned the servicing rights on 54 percent of mortgage balances in 2022,” compared to just 39% of originations and 4% of servicing in 2008.

For Capital Markets Participants

The market risk framework changes will affect trading operations at larger banks. While the overall market risk-weighted assets would increase under the proposal, the simultaneous changes to stress testing are designed to offset this impact. The new framework introduces an expected shortfall-based measure that better captures tail risk, along with more granular treatment of liquidity horizons for different risk factors.

For derivatives users, the proposal introduces explicit credit valuation adjustment (CVA) capital requirements, though client-facing derivative transactions would be exempt.

For Regional Bank Customers and Investors

The AOCI inclusion requirement for Category III and IV banks deserves careful attention. While the five-year phase-in provides breathing room, institutions with significant unrealized losses on securities portfolios will need to manage the transition carefully.

The agencies estimate the long-run average impact of AOCI inclusion would be equivalent to a 4.5% increase in common equity tier 1 requirements for affected depository institutions, partially offsetting the benefits from risk-weight reductions. The net effect remains favorable, with an estimated cumulative decrease in requirements of 4.7% for these institutions.

What Happens Next

Comments on all three proposals are due by June 18, 2026. The agencies have emphasized their interest in public feedback across a wide range of issues, and the notice includes over 200 specific questions for commenters.

Implementation timing remains to be determined pending review of comments. The proposals would take effect two calendar quarters after adoption of any final rule, giving institutions time to modify systems and processes.

The AOCI requirement for Category III and IV banks would include a five-year transition period, phasing in at 20% per year beginning January 1, 2027.

The Bigger Context

These proposals represent more than technical regulatory adjustments. They reflect a fundamental reassessment of post-financial crisis capital requirements in light of fourteen years of experience. The agencies acknowledge that “certain elements of the framework have resulted in excessive requirements for traditional banking activities,” and that “some elements of the framework, such as the advanced approaches, have added complexity and burden without commensurate benefits.”

At the same time, the agencies emphasize that “capital levels would still be substantially higher than they were before the financial crisis” and that “the overall calibration of the core capital requirements for our largest banks” would be preserved.

The proposals also demonstrate the continuing influence of international standards while acknowledging the need for U.S.-specific adaptations. As Vice Chair Bowman noted, “the Basel Committee recognizes that jurisdictions must have the flexibility to adjust its recommendations to meet their legal frameworks and their unique banking markets.”

 

 

Compliments of Fox Rothschild – a member of the EACCNY