Session 6 · Bank Regulation
History → Core framework → 2008 reforms → 2018 tailoring → recent updates. Lots of click-to-reveal explainers for FIN310.
🔎 Self-Check: How Safe Is Your Bank? Start here
Your Quick Triage
Flagged Weak Spots
Suggested Fixes
How to read this
Green = stronger cushions/diversification. Yellow = okay but tight in stress. Red = fix these first (raise CET1, add HQLA, term out funding, reduce duration, diversify deposit base, implement hedges).
📖 Regulation Jargon Buster
Quick reference for common terms in this session.
| Term | Meaning | Why It Matters |
|---|---|---|
| CET1 | Common Equity Tier 1 Capital — core shareholder equity & retained earnings | Absorbs losses first — key safety cushion |
| RWA | Risk-Weighted Assets — loans & assets weighted by riskiness | Used as the denominator for capital ratios |
| CET1 Ratio | CET1 ÷ RWA | Measures solvency strength — higher = safer |
| LCR | Liquidity Coverage Ratio — HQLA ÷ 30-day outflows | Shows if bank has enough liquid assets to survive a 30-day stress run |
| NSFR | Net Stable Funding Ratio — Available ÷ Required Stable Funding | Focuses on 1-year funding stability |
| OCI | Other Comprehensive Income (unrealized gains/losses) | Impacts equity when bonds drop in value — a big deal in 2023 failures |
| TLAC | Total Loss-Absorbing Capacity | Extra buffer for the biggest banks — used if they fail |
| CTI | Cost-to-Income Ratio (efficiency ratio) | Shows how much cost per $1 revenue — lower = more efficient |
1) Why Regulate? What problem are we solving?
Safety & Soundness
Prevent failures that harm depositors and the economy.
Consumer Protection
Fair treatment: disclosures, fees, and lending practices.
Financial Stability
Avoid systemic crises and contagion.
Plain-English examples
- Capital is like a cushion: more losses you can absorb before failing.
- Liquidity is like your cash-on-hand for emergencies.
- Stress tests are fire drills: can the bank handle bad scenarios?
2) U.S. Regulation Timeline (very short)
Click to expand the mini-timeline
- 1863–64: National Bank Acts → OCC supervision.
- 1913: Federal Reserve Act → Fed created (lender of last resort, payments).
- 1933: Banking Act of 1933 — FDIC deposit insurance; Glass-Steagall separation of commercial vs. investment banking.
- 1980–82: DIDMCA & Garn-St Germain → interest-rate deregulation, S&L era changes.
- 1994: Riegle-Neal → interstate branching.
- 1999: Gramm-Leach-Bliley → removed Glass-Steagall separation (affiliations allowed).
- 2010: Dodd-Frank Act (post-2008) → systemic risk council, stress tests, Volcker Rule, CFPB.
- 2018: EGRRCPA (S.2155) → tailoring thresholds and relief for some banks.
- 2023+: Post-regional-bank stress → proposals to strengthen capital, liquidity, and resolution.
2a) Banking History Video — Exploring the Basel Core Principles
🎥 Exploring the Basel Core Principles – The Evolution of Banking Regulations
A short explainer video on how global banking standards (Basel I → III) evolved over time and why they matter.
Source: YouTube – “Exploring the Basel Core Principles – The Evolution of Banking Regulations”
2a) Outcomes: Short vs Long Term
For each milestone, expand to see typical short-run effects vs. longer-run outcomes. Simplified teaching notes.
1933 Banking Act (FDIC; Glass-Steagall)
Short-term
- Confidence boost; deposit runs abate.
- Insured small depositors return; funding stabilizes.
- Stricter separation reduces immediate risk taking.
Long-term
- Lower run frequency; “safety-net” expectations form.
- Industry structure shaped by separation rules (until 1999).
- Potential moral hazard offset by supervision & premiums.
1999 Gramm-Leach-Bliley (affiliations allowed)
Short-term
- Consolidation; new cross-selling and scale economies.
- Complexity rises; risk-management integration needed.
Long-term
- Universal-bank model gains; supervisory coordination vital.
- Benefits from diversification vs. complexity costs trade-off.
2010 Dodd-Frank (post-2008 reforms)
Short-term
- Higher capital/liquidity buffers; stress tests constrain payouts.
- Risky trading curtailed (Volcker) at banks.
Long-term
- Greater resilience of large firms in severe scenarios.
- Activities migrate to non-banks; perimeter risk becomes key.
2018 EGRRCPA (tailoring)
Short-term
- Reporting relief for some banks; cost of compliance falls.
- Supervisory focus re-scaled by size/complexity.
Long-term
- Risk that some mid-size firms run with thinner cushions.
- Debate: proportionality vs. potential gaps in oversight.
2023+ Post-regional-bank stress (IRR + deposits)
Short-term
- Heightened monitoring of duration risk & uninsured deposits.
- Liquidity playbooks and communication tightened.
Long-term
- Possible higher capital/liquidity & funding-stability rules.
- Faster digital run dynamics embedded in supervisory design.
2b) Watch: Dodd-Frank, Volcker & Stress Tests
Short explainers to run in class.
What is Dodd-Frank? | CNBC Explains
The Volcker Rule Explained | The New York Times
Stress Test: What Is Bank Capital?
Bank Stress Tests, Explained
3) Who Regulates Whom? U.S. overview
Federal Reserve (Fed)
- Holding companies (BHC/LHC) & state member banks
- Capital & liquidity rules (Basel framework), stress tests
OCC
- National banks & federal savings associations
- Chartering, supervision, enforcement
FDIC
- Deposit insurance & resolution of insured banks
- Supervises state non-member banks
Also relevant
- CFPB (consumer financial protection)
- State regulators (state-chartered banks, non-banks)
4) Capital & Risk-Weighted Assets (Basel III intuition)
Capital ratios compare loss-absorbing equity to risk-weighted assets (RWA). Higher = safer (all else equal).
CET1 Ratio Calculator (toy)
What is CET1?
Common equity, retained earnings, minus deductions (e.g., intangibles). Basel III sets minimums plus buffers.
Risk Weight Toy
Reality check
Actual risk weights vary (mortgages, corporates, commitments). We use simple examples for intuition.
5) Liquidity: LCR & NSFR (intuition)
LCR Toy
Why it matters
LCR ≥ 100% aims to ensure enough liquid assets for a 30-day stress window.
NSFR Toy
Plain words
Stable funding for one-year horizon; ≥100% is the idea.
6) Post-2008: Dodd-Frank Act (2010) — Big Themes
Systemic Risk
FSOC created; enhanced prudential standards for larger firms.
Stress Tests
Supervisory scenarios to test resilience; public disclosures.
Volcker Rule
Limits proprietary trading at banking entities (with exemptions).
Resolution
Orderly liquidation authority; living wills for large firms.
Consumer
CFPB established for consumer financial protection.
Derivatives
Central clearing and margining for many swaps.
Click for student notes
- Goal: lower failure probability and reduce damage if failure happens.
- Capital & liquidity raised vs. pre-2008; more data and transparency.
7) 2018 Tailoring (EGRRCPA / S.2155)
Regulatory requirements were tailored based on size and risk profile.
Click to see simple category intuition
- Category I: Largest GSIBs — toughest standards.
- Category II–IV: Large banks with varying complexity — standards scaled (capital, liquidity, stress).
- Smaller banks: Some relief in certain rules (e.g., reporting/threshold adjustments).
What students should remember
Bigger/complex = more rules; smaller/simpler = relatively lighter. Thresholds and tests vary over time.
8) Recent Updates (Post-2023 regional-bank stress)
- Supervisors emphasized interest-rate risk management and uninsured-deposit concentrations.
- Proposals to strengthen capital and long-term funding for larger banks (often called “Basel III endgame” and related measures).
- Focus on resolution readiness (e.g., pre-positioning collateral, liquidity in resolution, and communication).
Student takeaway
- Duration risk + fast digital outflows can be dangerous together.
- Stronger cushions (capital/liquidity) and planning help stability.
8a) GENIUS Act (2025) — U.S. Stablecoin Framework
Guiding and Establishing National Innovation for U.S. Stablecoins (GENIUS) Act — enacted July 18, 2025 — creates the first comprehensive federal framework for U.S. payment stablecoins. Direction of travel: higher oversight, reserves, transparency, and consumer protection. Beginning July 2028, only permitted issuers (PPSIs) may issue covered payment stablecoins in the U.S.
What the law covers (plain English)
- Scope: “Payment stablecoins” intended for payments/settlement and designed to maintain stable value.
- Federal perimeter: Clarifies primary federal oversight and coordination with state regulators for issuers and key service providers.
- Permitted issuers only (PPSIs): Beginning July 2028, only permitted payment stablecoin issuers may issue covered stablecoins in the U.S.
Key Provisions (outline)
Authorization
- PPSI charter/approval with ongoing prudential standards.
- Fit-and-proper management and governance requirements.
- Critical vendors subject to supervisory expectations.
Reserves & Risk
- High-quality liquid reserves (cash/T-bills/other HQLA) in prescribed proportions.
- Daily reconciliation; liquidity and concentration limits.
- Independent attestations/audits at set intervals.
Consumer Protection
- Par-value redemption within stated timelines.
- Clear disclosures on risks, reserves, and fees.
- Error resolution, complaints, and fraud safeguards.
Operations
- Wallet/transfer controls; AML/CFT compliance.
- Cybersecurity, business continuity, incident reporting.
- Chain/bridge policies for interoperability.
Activities & Limits
- Restrictions on proprietary risk-taking with reserves.
- Affiliation/related-party and concentration limits.
- Marketing standards to avoid “bank-like” misrepresentation.
Supervision & Enforcement
- Ongoing exams; data/reporting to supervisors.
- Corrective actions, penalties, off-ramp and wind-down plans.
- Coordination with state regimes for licensure where relevant.
Implementation Timeline (simplified)
- July 2025: Law enacted; agencies begin rulemaking and guidance.
- 2026–2027: Phased standards for reserves, disclosures, audits, and reporting; PPSI applications open.
- July 2028: PPSI-only issuance goes live; non-permitted issuance prohibited.
- Beyond 2028: Ongoing supervision, periodic updates, cross-border coordination.
Outcomes: Short vs Long Term
Short-term
- Greater transparency (attestations, disclosures).
- Issuers align reserves and redemption ops to new rules.
- Market consolidation toward compliant PPSIs.
Long-term
- Higher trust and broader payments use cases.
- Closer integration with banks/treasuries and payment rails.
- More level playing field; risks migrate to regulated perimeter.
Class Notes: Compare to banks
- Like banks: prudential oversight, liquidity, governance, exams.
- Unlike banks: no fractional lending with reserves; strict investment limits.
- Policy aim: payments stability without importing bank run dynamics.
8b) GENIUS Act Explainer Video
Source: YouTube – “What are stablecoins and how does the GENIUS Act regulate them?”
9) Stress Tests & Living Wills
Stress Loss Toy
Living Will (Resolution Plan)
- How to be resolved safely if the firm fails
- Critical operations, liquidity, and separability
- Reducing complexity ahead of time
🎲 Stress Test Challenge — Can Your Bank Survive?
Use the fields above to set Pre-stress CET1, Losses, and Distributions. Then click the button to see if your bank passes the test.
10) Deposit Insurance (FDIC)
Helps prevent runs and protects small depositors up to insured limits.
Coverage Primer
Click for common categories
- Single accounts, joint accounts (limits apply per depositor per bank)
- Trust/retirement categories have special rules
Run Dynamics
Uninsured balances can move quickly; communication and access to liquidity are key.
11) Mini Tools
12) Quick Quiz
Q1. Capital ratios mostly protect against:
Q2. LCR ≥ 100% means the bank has enough:
Q3. The 2018 tailoring idea was to:
📄
Open Full 20-Question True/False Quiz
(Opens in a new tab — practice the full set of regulation questions)
13) Homework — Bank Risk & Safety Brief (≈300–400 words)
Imagine you are explaining to a friend why banks need capital and liquidity rules. Pick one type of bank (a “big diversified bank” like JPMorgan, or a “regional bank” like Silicon Valley Bank).
- Identify 2 big risks your chosen bank type faces.
- Example: "Interest-rate risk: if rates rise, bond values drop."
- Example: "Liquidity risk: if depositors pull out money too fast, cash runs low."
- Describe 2 simple scenarios and what might happen:
- Scenario 1: Interest rates rise fast (loan costs, bond losses?)
- Scenario 2: 20% of deposits leave in a week (need to find cash?)
You don’t need exact CET1/LCR/NSFR math — just explain in words what goes up, down, or gets tighter.
- Suggest 2 “fixes” the bank could do to stay safe.
- Example: raise more capital, keep extra cash, buy hedges, talk to depositors.
- For each, give one sentence on the trade-off (e.g. “More capital is safer but lowers ROE.”)
Goal: Write like you are briefing a smart classmate. Focus on why each step matters.
📌 Model Bank — One-page Snapshot (use for comparison)
Balance Sheet & Mix (toy)
- Assets: Loans $400; Securities $200; Cash/HQLA $180
- Liabilities: Deposits $560 (65% insured / 35% uninsured); LT debt $40; Short-term wholesale funding $120
- Equity (CET1): $60
Key Ratios
- CET1 / RWA: 10% (60 / 600)
- LCR: ~120% (HQLA 180 ÷ 30-day outflows 150)
- NSFR: ~107% (ASF 600 ÷ RSF 560)
Risk Posture
- Avg. securities duration: ~4.0 years
- Deposits: 35% uninsured; some industry concentration
ALT: words-only summary (no numbers)
- Plain-vanilla bank: mostly loans, some bonds, healthy cash cushion.
- About a third of deposits are uninsured, so a fast run is possible.
- Capital and liquidity look fine in normal times; rate shocks or deposit runs tighten cushions.
How students should compare (use this in your brief)
- Two risks: Is your bank higher or lower risk than the Model Bank? Why?
- Two scenarios (words only): e.g., “If uninsured share > 35%, a fast run bites harder than the Model Bank.”
- Two fixes + trade-offs: e.g., “More CET1 is safer but lowers ROE.”
- Tie to ratios: Say how fixes would move CET1/LCR/NSFR directionally.
🧾 Bank Types & Key Risks — Quick Student Guide
Use this as a cheat sheet for your homework.
🏦 Big Diversified Bank (e.g., JPMorgan)
- Main Danger: Systemic risk — losses can shake the whole system.
- Biggest Risks: Market swings (trading), global credit losses.
- Stay Safe: Strong capital buffers (CET1 > regulatory minimum), stress tests, tight liquidity coverage.
🏢 Regional Bank (e.g., SVB, First Republic)
- Main Danger: Fast deposit runs (esp. uninsured deposits).
- Biggest Risks: Interest-rate risk on bond portfolios, concentrated customers.
- Stay Safe: Diversify deposits, hedge interest-rate risk, hold more cash-like assets.
🤝 Credit Union
- Main Danger: Local economic downturns (jobs, housing).
- Biggest Risks: Loan defaults in the community, smaller capital base.
- Stay Safe: Conservative lending, member loyalty, NCUA insurance.
📱 Fintech / Neobank
- Main Danger: Tech outages, fraud, and funding risk (rely on partner banks).
- Biggest Risks: Don’t hold their own deposits; third-party dependencies.
- Stay Safe: Strong cybersecurity, good compliance, multiple partner banks.
Regulators care most about systemic safety. Consolidation is a long-term trend; the goal is a stable system overall.