Basel III Endgame 1682938205

1
Table of Contents
Introduction 4
Section 1: Post-Global Financial Crisis Regulatory Reforms 6
1.1 Overview 6
1.2 Background on Standard Setting 11
1.3 Financial Resources 14
1.3.1 Capital ratios and financial buffers 16
1.3.1.1 Minimum capital requirements 20
1.3.1.2 Stress Capital Buffer (SCB) and Capital Conservation Buffer (CCB) 24
1.3.1.3 G-SIB Surcharge 25
1.3.1.4 Countercyclical Buffer 26
1.3.1.5 Collins Amendment 26
1.3.1.6 Gone concern financial requirements 27
1.3.2 Liquidity ratios 31
1.3.2.1 Liquidity Coverage Ratio 32
1.3.2.2 Net Stable Funding Ratio (NSFR) 35
1.4 Stress Testing and Loss Estimation 36
1.4.1 Background on Forecasting 37
1.4.2 Stress-Testing for capital adequacy 40
1.4.3 Stress-Testing for liquidity coverage 43
1.4.4 Loss estimation for reserves 45
1.5 Trading and Counterparty Risk Management 48
1.5.1 Central Clearing and Margin 49
1.5.2 Single-Counterparty Credit Limits (SCCL) 54
1.5.3 Volcker Rule 56
1.5.4 SA-CCR 57
1.6 Supervisory Programming 57
1.6.1 Capital planning 59
1.6.2 Liquidity 61
1.6.3 Recovery and Resolution Planning 61
1.7 Supplemental Enhancements to Risk Management 64
1.7.1 Leveraged Lending 65
1.7.2 Corporate governance and the role of the board of directors 66
1.8 Conclusion 66
Section 2: Literature Review 67
2.1 Overview 67
2.2 Literature Review Scope 77
2 Basel III Endgame | The next generation of capital requirements

2.3 Overview of Select Papers - Methodology, Conclusions, and Limitations 80
2.3.1 An Analysis of the Impact of “Substantially Heightened” Capital Requirements on Large
Financial Institutions (2010)
Anil Kashyap, Jeremy C. Stein, and Samuel Hanson 81
2.3.2 Basel Committee on Banking Supervision - An assessment of the long-term economic
impact of stronger capital and liquidity requirements (2010)
Multiple Authors 85
2.3.3 Bank of England - Measuring the Macroeconomic Costs and Benefits of Higher UK Bank
Capital Requirements (2015)
Martin Brooke, Oliver Bush, Robert Edwards, Jas Ellis, Bill Francis, Rashmi Harimohan,
Katherine Neiss, and Casper Siegert 94
2.3.4 Federal Reserve Bank of St. Louis (FRB) - Empirical Economic Assessment of the Costs
and Benefits of Bank Capital in the United States (2019)
Simon Firestone, Amy Lorenc, and Ben Ranish 101
2.3.5 Capital Requirements, Risk Choice, and Liquidity Provision in a Business-Cycle Model
(2020)
Juliane Begenau 107
2.3.6 A Macroeconomic Model with Financially Constrained Producers and Intermediaries
(2021)
Vadim Elenev, Tim Landvoigt, Stijn Van Nieuwerburgh 110
2.3.7 European Central Bank - The Growth-at-risk Perspective on the System-wide Impact of
Basel III Finalisation in the Euro Area (2021)
Katarzyna Budnik, Ivan Dimitrov, Carla Giglio, Johannes Groß, Max Lampe, Andrei Sarychev,
Matthieu Tarbé, Gianluca Vagliano, and Matjaž Volk 115
2.3.8 Financial Regulation in a Quantitative Model of the Modern Banking System (2022)
Juliane Begenau and Tim Landvoigt 121
2.3.9 Federal Reserve Board - The Welfare Effects of Bank Liquidity and Capital Requirements
(2022)
Skander J. Van den Heuvel 125
2.3.10 Bank of England - Implementation of the Basel 3.1 Standards (2022)
Multiple Authors 131
2.3.11 Basel Committee on Banking Supervision - Evaluation of the Impact and Efficacy of the
Basel III Reforms (2022)
Multiple Authors 137
2.4 Conclusion 144
Section 3: Recent Turmoil in the Banking Sector 145

Introduction
US bank regulators are expected to issue a notice of proposed rulemaking (NPR) updating US capital rules, known as
Basel III Endgame, this spring, with the final rule likely to come later in the year with an expected effective date of January
1, 2025. Industry participants are preparing for this to be the most consequential change to US banking regulation since
the 2010 passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, as it will have far reaching
implications for economic growth, credit availability, market liquidity and financial stability.
Basel III Endgame is a suite of rules that will change how much capital firms need to hold against credit, market and
operational risk exposures. It is designed to make capital requirements more risk-sensitive while reducing variability of
risk-weighted assets (RWA).
While US regulators have stated in the past that a more risk-sensitive approach can be capital neutral, Basel III Endgame
is expected to raise aggregate capital requirements substantially, potentially increasing the required level of capital by “up
to 20%” for the largest US banks.1, 2 The key driver of the increase is the revised capital requirements for capital markets
activities (e.g., trading and market activities). The Basel Committee on Banking Supervision (BCBS) estimates that Basel
III Endgame will increase market risk capital requirements by 57% on average for Global Systemically Important Banks
(G-SIBs).3
The primary objective of higher capital requirements is to bolster financial stability by reducing the likelihood of individual
bank failures and their subsequent effects on the banking system, broader economy and markets. However, such
measures do not come without costs.4 Increased capital requirements can negatively impact economic growth by raising
the cost of lending and reducing the availability of financing for corporations and consumers.
Since the Global Financial Crisis (GFC), the level of capital in the system has quadrupled and key capital ratios roughly
doubled due to significant increases in capital requirements. Numerous measures beyond capital requirements have also
been implemented to reduce risk in the financial system, such as new requirements for liquidity and total loss absorbing
capital requirements, limits on counterparty exposures and restrictions on trading activity.
As US bank regulators consider how to implement Basel III Endgame, they should consider two key questions: (1) are the
increases in capital and other regulatory reforms that have occurred to date enough to prevent taxpayer-funded bailouts in
an economic downturn or period of market turmoil and, (2) if the banking system needs more capital, how much is
required?
In order to inform this debate, this article evaluates the literature by regulators, international standard setting bodies and
academics that seeks to identify an optimal level of capital. This literature generally evaluates the marginal cost of a
reduction in economic growth against the marginal benefit of greater financial stability. Although the estimates across
papers vary widely, the average optimal capital level that the papers suggest is near current levels at firms expected to be
subject to Basel III Endgame capital requirements.5
A critical aspect of evaluating these papers and their conclusions regarding optimal capital levels is understanding how
they incorporate post-financial crisis reforms – which have been aimed at reducing risk in the financial system – and the
complex interactions between bank capital requirements, the size of the non-bank financing sector, and the cost of credit
and financial stability. If an analysis does not incorporate risk-reducing reforms beyond capital requirements, it might
1
US Government Publishing Office: Serial No. 116-70, House Hearing, 116 Congress (2019-2021), “Oversight of
Prudential Regulators: Ensuring the Safety, Soundness, Diversity, and Accountability of Depository Institutions: Statement
of the Honorable Randal K. Quarles, Vice Chairman of Supervision, Board of Governors of the Federal Reserve System
(Fed)” Committee on Financial Services, December 4, 2010, pg 17.
2
In his December 2, 2021 speech at the American Enterprise Institute, “Between the Hither and the Farther Shore:
Thoughts on Unfinished Business,” Randal Quarles, then Vice-chair for Supervision of the Board of Governors of the
Federal Reserve, noted his view that Basel III could result in a material increase in capital levels, “perhaps up to 20
percent for our largest holding companies.”
3
The Basel Monitoring Report (February 2023) estimates an increase of 5650 basis points to existing market risk capital
requirements for G-SIBs. See Basel III Monitoring Report (BCBS), February 2023, page 80.
4
Mark Carney, Bank of England, “Letter to Rt. Hon. Andrew Tyrie MP, Chairman of the Treasury Select Committee.” April
5, 2016.
5
The average tier 1 capital ratio across the 33 firms that participated in the 2022 CCAR submission is 15.2%. This value
is computed as a simple average across the 33 participating firms, which equates to Category I - IV firms. Whether the
NPR or final rule will include all Category I - IV banks is not certain at this time. These results are as-of 4Q2022 and were
sourced from 4Q2022 FR Y-9C submissions.
overestimate the marginal benefit of higher capital requirements, leading to a potentially overestimated optimal capital
level. While more recent papers attempt to account for the effects of post-financial crisis regulatory reforms and their
interaction with the non-bank financing sector, no study to date has fully addressed the entire spectrum of regulatory
reforms designed to reduce both the probability and impact of a financial crisis.
The remainder of the paper is organized as follows:
• Section 1 provides an overview of the post-GFC regulatory reforms and discusses how those reforms were designed
to reduce risk in the financial system, and includes metrics, where available, describing the impact.
• Section 2 reviews the literature authored by regulators, international standard-setting bodies and academics that
examine the marginal costs and benefits of raising capital levels. The analysis covers over twenty papers and sheds
light on the implications of Basel III Endgame for economic growth and financial stability. Section 2 also provides a
detailed review of the methodologies, conclusions and limitations of the selected literature.
• Section 3 summarizes recent events that caused stress in the banking sector and analyzes how the regulatory capital
requirements and supervisory structure relate to those events.

Section 1: Post-Global Financial Crisis Regulatory Reforms
1.1 Overview
Since the GFC, there has been considerable effort to analyze and examine sources of vulnerability in the financial system
and to design regulations that mitigate specific risks. The result of this work has been numerous new regulations and
supervisory actions seeking to not only to make the financial system resilient in periods of economic and market stress but
also to help safeguard large financial firms so they can continue to provide credit and perform their role as financial
intermediaries in periods of pronounced market turmoil.6 The regulations are also intended to reduce the probability of
collapse of a large bank and, if one were to fail, limit contagion.These bank regulatory reforms focus primarily on:
1. Increasing the amount and quality of banks’ financial resources;
2. Introducing stress testing of financial resources and other forward-looking loss estimation techniques;
3. Reducing counterparty exposures and risk in trading activities;
4. Creating new supervisory programs to complement new regulatory requirements and enforce compliance with the
heightened expectations; and
5. Requiring supplemental enhancements to risk management.
A brief review of the effect of these five reforms is provided below.

1. Increasing financial resources at banks has come primarily in the form of requirements for higher levels and quality
of capital and liquidity to strengthen resiliency. Capital and liquid assets provide a cushion against unexpected losses
and cash outflows, reducing a firm’s risk of failure. Capital requirements for large firms have been increased primarily
through the introduction of new capital buffers, such as the G-SIB surcharge and Stress Capital Buffer (SCB), as well
as the implementation of the standard and enhanced supplementary leverage ratio. In addition, the introduction of
Total Loss Absorbing Capital (TLAC) sought to support the operations of a failing institution and allow for an orderly
resolution, if needed. The GFC made clear that the level of both capital and liquidity in the banking sector was
insufficient, as firms failed due to a combination of losses eroding capital and the closing of critical funding avenues.
For US G-SIBs, the average G-SIB surcharge is 2.3%, which is equivalent to 58% of the average SCB, implying that
estimated capital depletion in capital stress testing would need to be materially underestimated for both buffers to be
fully consumed. Liquidity requirements for large firms have been increased primarily through the introduction of new
quantitative liquidity standards in the form of the Liquidity Coverage Ratio (LCR), designed to ensure banks have
sufficient liquid assets to weather liquidity stress, the Net Stable Funding Ratio (NSFR), designed to ensure banks
maintain a stable funding profile, and internal liquidity stress testing requirements, discussed further below.
2. Stress Testing and Forecasting of capital and liquidity is a lynchpin of the post-financial crisis regulatory framework.
Stress testing involves assessing capital and liquidity levels by evaluating whether there are sufficient resources to
withstand a pronounced stressed macroeconomic environment defined by regulators and the banks themselves.
Stress tests are now ingrained into the supervisory framework through prescribed requirements governing the
evaluation of a bank’s consolidated operations, including:
– Supervisory capital stress tests that assess capital adequacy through different scenarios under conservative
assumptions and determine stressed capital needs;
– Company-run capital stress tests that accompany capital plan submissions and demonstrate capital adequacy
through idiosyncratic scenarios that stress a bank’s risk profile; and
– Internal liquidity stress tests that model near-term funding needs and inform the buffer required to meet net
stressed cash flows across a 30-day time horizon.
Each of these components has necessitated significant investment by banks in model development as well as an
extensive set of processes for identifying and measuring the material risks stemming from their strategy and
operations.
6
Board of Governors of the Federal Reserve System, “Stress Tests.” Last update: June 22, 2022.

3. Reducing counterparty and trading risks is an important focus of post-crisis reforms to limit systemic risk and
financial contagion. To reduce the extent of risk transmission, regulatory guardrails place limits on aggregate
exposures to counterparties. In order to limit risk stemming from trading activities, the Volcker Rule banned proprietary
trading for certain products.
– Central clearing of and margin requirements for non-cleared derivatives aim to reduce risk by addressing
the operational complexity created by a lack of standardization for swap contracts and lack of standard
approaches for raising margin. Regulators have mandated the clearing of swaps through centralized
counterparties (CCPs), and implemented standardized margin requirements for non-cleared OTC derivatives.7
These structural changes to the OTC derivative market provide greater transparency for the market overall, while
confirming that financial resources could be available to support contract performance.
– Single counterparty credit limits (SCCL) reduce the risk of contagion between financial institutions by
establishing limits on the amount of credit exposure a US or foreign holding company can have to an unaffiliated
entity. The rule requires firms to manage limits on net credit exposures relative to tier 1 capital. Exposures greater
than 5% of tier 1 trigger an economic interdependence assessment.
– The Volcker Rule prohibits banking entities from engaging in proprietary trading or investing in or sponsoring
hedge funds or private equity funds. Large firms are required to employ an extensive compliance program to
demonstrate the separation of banking and trading activities.
4. Supervisory programs have complemented the implementation of new capital requirements with two explicit goals –:
(1) enhance the resiliency of a firm to lower the probability of its failure and (2) reduce the impact on the financial
system and the broader economy in the event of a firm’s failure or material weakness. Post-GFC legislation and
supervision uses several factors when assessing the risk posed by a bank to the financial system and, in turn, the
level of supervisory scrutiny that is appropriate. Among these factors are asset size, reliance on short-term wholesale
funding, and cross-jurisdictional business activities. Size and the nature of exposures determines the scope of a
bank’s participation in horizontal examinations such as the Dodd-Frank Act Stress Test (DFAST), the Comprehensive
Capital Analysis and Review (CCAR), the Comprehensive Liquidity Assessment and Review (CLAR) and Title
I-related Resolution Planning examinations.
– DFAST and CCAR evaluate large firms’ capabilities in capital planning, including an evaluation of their ability to
identify risks, incorporate those risks into a nine-quarter forecasting scenario, and measure those risks by
modeling revenue, loss and capital levels in those scenarios, net of capital actions.8 In addition, regulators
evaluate the quality of board and management oversight of this capital planning process. Regulators have broad
authority to restrict dividends and share repurchases, as the Federal Reserve did during COVID-19.9
– CLAR is a firm-specific liquidity evaluation that analyzes liquidity risk management practices and resiliency under
normal and stressed conditions. CLAR includes an evaluation of a firm’s internal liquidity stress testing
capabilities, liquidity position and liquidity risk management practices.
7
Rule 17Ad-22 establishes minimum requirements regarding how registered clearing agencies must maintain effective
risk management procedures and controls as well as meet the statutory requirements under the Exchange Act on an
ongoing basis.
8
For company-run stress tests (12 CFR 252.56(b)) and supervisory-run stress tests (12 CFR 252.44(c)) required
assumptions on capital actions include: (1) The covered company will not pay any dividends on any instruments that
qualify as common equity tier 1 capital; (2) The covered company will make payments on instruments that qualify as
additional tier 1 capital or tier 2 capital equal to the stated dividend, interest, or principal due on such instrument; (3) The
covered company will not make a redemption or repurchase of any capital instrument that is eligible for inclusion in the
numerator of a regulatory capital ratio; and (4) The covered company will not make any issuances of common stock or
preferred stock.
9
Board of Governors of the Federal Reserve System, “Federal Reserve Board releases results of stress tests for 2020
and additional sensitivity analyses conducted in light of the coronavirus event.” (Press Release), June 25, 2020.
– Title I Resolution Planning exams are joint assessments by the Federal Reserve and Federal Deposit Insurance
Corporation (FDIC) that assess how an institution can be unwound in an orderly manner without undermining
financial stability. These plans must incorporate consideration of various areas of enterprise risk management
such as capital and liquidity allocation, in addition to other considerations that relate to the firm’s governance,
operations and legal structure. The Federal Reserve also requires G-SIBs to produce recovery plans that include
a set of actions that can be taken in a timely manner to reduce the probability of bankruptcy and insolvency.
In addition to supervisory feedback, these exams often include a publication or disclosure of planning strategies,
methodologies and relevant metrics for the benefit of the public. The transparency of post-GFC supervision, and
its associated disclosure requirements, have a role in reducing financial system risk by bolstering confidence in
US G-SIBs.
5. Supplemental enhancements to risk management include areas where additional requirements and supervisory
guidance have sought to enhance risk management, governance, identification, and measurement. In some
instances, supervisory guidance has sought to limit the level of risk taking related to certain products, such as
restrictions on underwriting criteria. Supervisory expectations have reinforced the importance of maintaining effective
credit risk management policies and procedures.
Other enhancements include heightened requirements and expectations that the board of directors is effective in
overseeing the risk management capabilities of the bank. As approvers of a bank’s risk appetite and business
strategy, regulation requires large bank boards to have a dedicated risk committee to directly and deliberately support
the effectiveness and independence of risk management. These enhancements reinforce the importance of having an
effective risk management culture throughout individual banks.
To meet the requirements of stress testing, enhanced prudential standards and the new supervisory programs, banks
raised substantial amounts of higher quality financial resources, and made large investments to enhance their risk
management and measurement capabilities. Both capital amounts and liquid assets rose materially across the largest
banks within the financial system.
• Capital levels increased significantly, with CET1 ratios roughly doubling, and CET1 levels increasing over three-fold
(3x) since the financial crisis. The emphasis on common equity tier 1 (CET1) capital in Basel III also led to an
improvement in the quality of bank regulatory capital. The 2007–09 GFC revealed several weaknesses in the capital
bases of internationally active banks: definitions of capital varied widely between jurisdictions, regulatory adjustments
were generally not applied to the appropriate level of capital and disclosures were either deficient or non-comparable.
Basel III established a common definition for common equity tier 1 capital (CET1), and identifies these resources as the
highest quality of regulatory capital, and most capable of absorbing losses immediately when they occur.10
• Similarly, high quality liquid assets total almost $3 trillion, an increase of nearly 11x when compared to pre-crisis
levels
10
Bank for International Settlements, “Definition of capital in Basel III – Executive Summary,”
https://www.bis.org/fsi/fsisummaries/defcap_b3.pdf.

Figure 1: CET1 Amounts and Ratios for US G-SIBs11
Figure 2: HQLA Amounts for US G-SIBs12
11
Data Source: S&P Capital IQ. Common equity tier 1 is the sum across US G-SIBs. US G-SIBs include JPMorgan Chase
& Co., Bank of America Corporation, Citigroup, Wells Fargo & Company, The Goldman Sachs Group, Morgan Stanley,
The Bank of New York Mellon Corporation, and State Street Corporation.
12
High-quality liquid assets (HQLA) are estimated by adding excess reserves to an estimate of securities that qualify for
HQLA. Data only include US GSIBs (Category I) firms. Data source: FR Y-9C, FR 2900, Federal Reserve accounting
system. Board of Governors of the Federal Reserve, “Supervisory Developments,” Supervision and Regulation Report,
May 14, 2019; S&P Capital IQ.

• Additional loss-absorbing capacity to support a firm’s resolution also raised total regulatory capital levels, now well
above 20% of risk-weighted assets (Figure 3). This significant increase in financial resources illustrates the
effectiveness of higher regulatory standards on capital ratios.
Figure 3: Increase in Total Usable TLAC13
In addition to the observable increase in financial resources, banks invested in their stress testing and other
risk-management information systems in order to meet increased regulatory expectations for managing and aggregating
exposures across a banking organization. This included large investments in risk modeling and financial performance
forecasting capabilities, including investment in supporting infrastructure to meet control requirements and to produce
forecasts in a more timely manner. For larger banks subject to resolution requirements, planning necessitated the
establishment of a process for identifying critical operations, which must consider size, complexity, scope and the role of a
bank in markets that are critical to US financial stability. A full resolution plan must consider both domestic and
foreign-based covered entities, including strategic analysis, corporate governance, organizational structure, an inventory
of management information systems and specific information pertaining to the jurisdictions where the bank operates. As a
new post-crisis requirement, resolution planning is both resource and personnel intensive, often requiring dedicated staff
and offices responsible for aggregating information and responding to any deficiencies identified by the Federal Reserve
and FDIC.
This section reviews each of these mechanisms for reducing financial system risks and describes their evolution and
impact on banking organizations, from the enactment of the Dodd-Frank Act (2010) and later reforms in the Economic
Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) (2018), to the adoption of various components of
the Basel Committee on Banking Supervision’s (BCBS) framework for banking standards (Basel III). Specifically, this
includes an overview of the mechanics and purpose of each requirement and how their design is intended to increase
financial resiliency for banks and mitigate systemic risk.
13
Randall D. Guynn, Head of the Financial Institutions Group, Davis Polk & Wardwell, “Making Banks Safe to Fail: Ten
Years Later”, March 2019.

1.2 Background on Standard Setting
Overview
The current US regulatory and supervisory framework is the product of standards that have been designed by
policy-makers and the enactment of domestic legislation. The relationship between international standard-setting bodies
and domestic regulators balances fairness and competition, which is achieved by applying consistent standards across
jurisdictions with a recognition that requirements, when adopted, must be well-suited to the local banking system.
Knowledge of the international standard-setting process and present framework for bank standards is foundational to a
conceptual understanding of post-crisis reforms, while understanding the scope of their application in the United States
requires a background in recent legislative and supervisory trends that have guided their local adoption.
• International Standard Setting may be organized through several different forums, for example, the Financial Stability
Board (FSB), the Bank of International Settlements (BIS), or the Group of 20 (G20). These groups often consist of
financial and economic ministers, central bankers and other representatives from domestic regulatory and
policy-making institutions. Banking standards specifically are coordinated through the Basel Committee on Banking
Supervision (BCBS) within the BIS. The collection of banking standards, which cover capital, liquidity and global and
systemically important banks (G-SIBs) is referred to as the “Basel Framework.” Basel III is the third iteration of the
Basel Framework and consists of the post-crisis banking standards that have largely been adopted into the US
regulatory framework.
• Regulatory and Supervisory Tailoring: While most post-crisis international standards are now incorporated into US
regulation, the scope and application of these standards evolved to reflect a “tailored approach” that applies the highest
standards to those financial institutions that are global, interconnected and systemically important, with modified
application for community and regional banks. These changes in both regulation and supervision occurred in response
to the passage of the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) in 2018, which
revised key provisions in the Dodd-Frank Act. The law raised the threshold for applying enhanced prudential standards
from $50 billion in total assets to $250 billion, reducing the regulatory burden on smaller banks. To align supervision
with these changes, the Federal Reserve adopted a “tailored” approach using funding and size-based criteria to
establish different categories of bank holding companies that align to full or modified requirements. Category I banks
are US G-SIBs, subject to the most stringent regulatory standards and supervisory expectations. Tailored requirements
for smaller banks may include, for example, fewer or modified regulatory submissions, lower capital and liquidity
requirements and less frequent participation in horizontal supervisory examinations.
International Standard Setting
Since 1975, reforms to banking regulation are coordinated through the Basel Committee on Banking Supervision (BCBS)
and its members within the Bank for International Settlements (BIS). The Basel framework is designed to coordinate
regulatory standards for banks across jurisdictions, mitigate risks from cross-border banking activities and provide a
consistent approach for setting supervisory requirements to prevent competitive inequalities. Initial capital requirements
were introduced in 1988 as part of Basel I: the Basel Capital Accord, which included a single pillar covering minimum
capital requirements.14 By the release of Basel II in 2004, the Basel framework had expanded to include supervisory
review, and market discipline and disclosure. The three pillars of Basel II not only incorporated credit risk, but operations
risk and market risk. The expanded framework also acknowledged the growth and increasing importance of internal
models and other “advanced approaches” that banks were using to measure and manage risk.15
14
“History of the Basel Committee.” Bank for International Settlements. https://www.bis.org/bcbs/history.htm.
15
Board of Governors of the Federal Reserve System, “Board approves final rules to implement Basel II risk-based capital
framework.” (Press Release), November 2, 2007.

In response to the financial crisis, the BCBS published its third and most comprehensive set of standards to-date, which
reinforced and enhanced the three pillars established as part of Basel II. Basel III included, among other enhancements:
• an emphasis on quantity and quality of capital, particularly the importance of common equity
• additional buffers and requirements designed to mitigate leverage and offset credit cycles
• liquidity requirements for short-term and longer-term funding needs
• additional requirements for systemically important banks
Basel III also expanded and revised calculations for risk-based capital requirements across areas of credit risk,
operational risk and market risk to include:16
• Capital requirements for central counterparties (CCPs)
• Margin requirements for non-centrally cleared derivatives
• A standardized approach for counterparty credit risk (SA-CCR)17
• A revised market risk framework (Basel 2.5)
• Enhanced disclosure requirements
Table 1 shows the current Basel Framework, including those components of the framework which have yet to be adopted
within the US jurisdiction as part of Basel III Endgame.
Table 1: Basel Framework
Basel Framework18
Standard Adoption Completed (Basel I, II & III) Adoption Not Started (Basel III “Endgame”)
Capital • Risk-based capital • Equity investments in funds

• Capital conservation buffer (CCB) • Securitization framework
• Countercyclical buffer (CCyB) • Revised standard for credit risk
• Margin for uncleared derivatives • Revised Internal Ratings-Based (IRB) for credit risk
• Capital for Central Clearing Counterparties (CCPs) • Revised Credit Valuation Adjustment (CVA)
• Standardized Approaches for Counterparty Credit (SA-CCR) • Revised minimum requirements for market risk
• Total Loss Absorbing Capacity (TLAC) • Revised operational risk
• Output floor
Leverage • Leverage exposure (2014 definition) • Leverage exposure (2017 definition)

• Supplementary Leverage Ratio (SLR)
Systemic Importance • Global Systemically Important Bank (G-SIB) Surcharge N/A

• Leverage ratio buffer (eSLR)
Interest Rate Risk • Interest Rate Risk in the Banking Book (IRRBB) N/A
16
17
The US GSIBs are required to calculate a number of different risk-weighted capital ratios using both the Standardized
and Advanced Approaches. Standardized Approach refers to prescribed risk weights and exposure methodologies used
to calculate RWAs; and Advanced Approaches refers to an internal ratings-based approach and other methodologies
used to calculate RWAs.
18
Basel Committee on Banking Supervision (BCBS), “RCAP on timeliness: Basel III Implementation dashboard.” As of
September, 30, 2022.

Liquidity • Monitoring tools for intraday liquidity management N/A
• Net Stable Funding Ratio (NSFR)
• Liquidity Coverage Ratio (LCR)
Large Exposure • Large Exposure Framework (Single Counterparty Credit N/A

Limit - SCCL)
Regulatory and Supervisory Tailoring
In response to the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA), the Federal Reserve
tailored its requirements by developing a framework that uses factors such as asset size, cross-jurisdictional activity,
reliance on short-term wholesale funding, nonbank assets and off-balance sheet exposure to categorize banks and tailor
regulatory requirements to the risk a bank poses to financial stability.19 Table 2 illustrates present requirements for banks
based on the existing tailored framework (i.e. Tailoring Rule).
Table 2: Tailored Financial and Supervisory Requirements
Tailored Financial and Supervisory Requirements
Category IV Category III Category II Category I

Other banks with $100b ≥ $250b Total Assets or ≥ $700b Total Assets or G-SIB Framework
to $250b Total Assets ≥ $75b in non-bank ≥ $75b in Cross Method 1 or Method 2
assets, short-term Jurisdictional Activity
wholesale funding, or
off-balance sheet
exposure
G-SIB Surcharge ✓
eSLR ✓
TLAC ✓
GMS/LCD20 ✓ ✓ ✓
Advanced Approaches ✓ ✓
Capital No AOCI Opt-out ✓ ✓
Countercyclical Capital
✓ ✓ ✓
Buffer (CCYB)
SLR ✓ ✓ ✓
Company-run Stress ✓ ✓ ✓
Test (Every 2 years) (annual) (annual)
✓
FED-run Stress Test ✓ ✓ ✓
(Every 2 years)
19
Board of Governors of the Federal Reserve System, “Federal Reserve Board finalizes rules that tailor its regulations for
domestic and foreign banks to more closely match their risk profiles,” (Press Release), October 10, 2019.
20
The global market shock component for the severely adverse scenario applies to a firm that is subject to the stress test
and that has aggregate trading assets and liabilities of $50 billion or more, or aggregate trading assets and liabilities equal
to 10 percent or more of total consolidated assets, and that is not a Category IV firm under the Board's tailoring
framework. See 12 C.F.R. § 252.54(b)(2)(i). For CCAR 2023 the following banks are subject to GMS or LCD: Bank of
America Corporation, Barclays US LLC, Citigroup Inc., DB USA Corporation, The Goldman Sachs Group, Inc., JPMorgan
Chase & Co., Morgan Stanley, State Street Corporation, Wells Fargo & Company. See the Board of Governors of the
Federal Reserve System, “Dodd-Frank Act Stress Test Publications: 2023 Stress Test Scenarios,” February 2023.

✓ ✓
Liquidity Coverage ✓ ✓
(+70% for selected (+85%; +100% for
Ratio (+100%) (+100%)
banks only) selected banks)
✓ ✓
Net Stable Funding ✓ ✓
(+70% for selected (+85%; +100% for
Ratio (+100%) (+100%)
banks only) selected banks)
Liquidity
✓
Reporting ✓ ✓ ✓
(Monthly; Daily for
Requirements (Monthly) (Daily) (Daily)
selected banks)
Company-run Stress ✓ ✓ ✓ ✓
Test (Quarterly) (Monthly) (Monthly) (Monthly)
✓ ✓ ✓
Resolution Planning
(Every 3 years) (Every 3 years) (Every 2 years)
Finally, it should be recognized that a variety of requirements applied to US GSIBs – including the Collins Floor, Stress
Capital Buffer (SCB), enhanced Supplementary Leverage Ratio (SLR), G-SIB scoring method and TLAC – surpass those
that have been established by the Basel Committee on Banking Supervision, resulting in US firms being subject to more
stringent capital requirements.
1.3 Financial Resources

Overview
Financial resources are a traditional source of resilience for a financial institution and capital requirements, for example,
have existed in various forms throughout the history of the US banking system.21 Since 1975, the Basel Committee on
Banking Supervision (BCBS) and its members within the Bank for International Settlements (BIS) have been the
standard-setters of regulatory reforms for internationally active banks, and many of the rules implemented in the United
States are the domestic application of those regulatory standards agreed amongst BIS members. The Basel Framework
defines regulatory capital by outlining two tiers of financial resources, with a further distinction within tier 1:22
• Common equity tier 1
• Additional tier 123
• Tier 2 Capital24
Each tier is defined by eligibility criteria to include those resources most capable of absorbing losses. As part of the Basel
III reforms, CET1 is defined by the most stringent qualification criteria.
Enhanced standards for financial resources have prioritized increasing capital ratio requirements, including capital quality,
in the form of adding buffers to large banks’ capital stack, increasing the level of capital required for certain types of
exposures, creating new liquidity ratios and associated minimum requirements, and creating requirements for long-term
debt and loss absorbing capacity that can be used in a resolution situation.
21
Joseph G. Haubrich, “A Brief History of Bank Capital Requirements in the United States,” Federal Reserve Bank of
Cleveland: Economic Commentary, February 28, 2020.
22
Basel Committee on Banking Supervision, “CAP - Definition of capital,” The Basel Framework, last modified June 5,
2020.
23
12 CFR 217.20(c).
24
12 CFR 217.20(d).

• Capital Ratios and Buffers: The level of capital required for large banks to hold has increased through the creation of
new ratios and adding buffers to ratios. To improve the quality of capital, the new requirements adopted in 2013
distinguish common equity tier 1 (CET1) from Additional tier 1. The stricter eligibility criteria for CET1 is intended to
ensure that this ratio captures the most loss-absorbing forms of capital and closely approximates tangible common
equity.25, 26 CET1 is now the binding constraint for most large banks, and the basic requirement to have a minimum of
CET1 ratio of 4.5% has been increased for large banks with the addition of surcharges (or buffers) that consider a
bank’s size, complexity and level of risk. For example, these surcharges include the G-SIB surcharge and the Stress
Capital Buffer. These requirements, in aggregate, create a significant increase to CET1 requirements. In addition to
risk-based capital requirements, the supplemental leverage ratio was also created to constrain leverage regardless of
asset composition. Global and systemically important banks (GSIBs) must adhere to no less than 8 ratios when
considering the adequacy of their overall financial resources.27
• RWA Treatment: Risk weighted assets (RWA) are the denominator of a capital ratio. Each type of asset and
off-balance sheet exposure has a risk weight associated with it determined by the level of risk associated with the
exposure.28
• Long-term debt: To reduce the probability that a financial institution’s failure will undermine financial stability, new
standards expect financial resources within specific areas of a bank’s corporate structure. At the consolidated, or
holding company, level, banks are required to use long-term debt instruments to raise capital that can be used to
support its loss absorbing capacity (TLAC) and, if necessary, recapitalize a bank’s material legal entities during
resolution, which is after bankruptcy has taken place (i.e. as a gone-concern). The long-term tenor of this debt is
important, as resolution assumes the bank’s equity has been exhausted.
• Liquidity Ratios: New liquidity ratios increase the level of liquidity banks hold and reduce their reliance on short-term
wholesale funding (STWF) that has the potential to cause a liquidity crisis if short-term funding was to become
unavailable. The Liquidity Coverage Ratio (LCR) measures the level of high quality liquid assets (HQLA) relative to the
amount of net cash outflows in 30 days based on specified net cash flow measures by category of liabilities and
off-balance sheet commitments. HQLA includes cash and assets that can be converted into cash quickly without a
significant loss in value (e.g., US Treasuries).29 The Net Stable Funding Ratio (NSFR) measures the stability of a
bank’s funding profile relative to the composition of its assets and off-balance sheet exposures with the goal of limiting
reliance on STWF and promoting better evaluation of funding risk. NSFR is the ratio of available stable funding over
the required amount of stable funding.
25
As defined in 12 CFR 217.20(b), common equity tier 1 capital is the sum of the common equity tier 1 capital elements
minus regulatory adjustments and deductions, these elements include: 1) Any common stock instruments (plus any
related surplus) issued by the Board-regulated institution, net of treasury stock, and any capital instruments issued by
mutual banking organizations (additional criteria contained in 12 CFR 217.20(b)(1)(i-xiii); 2) Retained earnings; 3)
Accumulated other comprehensive income (AOCI) as reported under GAAP; 4) Any common equity tier 1 minority
interest, subject to the limitations in § 217.21; 5). Notwithstanding the criteria for common stock instruments referenced
above, a Board-regulated institution's common stock issued and held in trust for the benefit of its employees as part of an
employee stock ownership plan does not violate any of the criteria in paragraph (b)(1)(iii), paragraph (b)(1)(iv) or
paragraph (b)(1)(xi) of this section, provided that any repurchase of the stock is required solely by virtue of ERISA for an
instrument of a Board-regulated institution that is not publicly-traded. In addition, an instrument issued by a
Board-regulated institution to its employee stock ownership plan does not violate the criterion in paragraph (b)(1)(x) of this
section.
26
Board of Governors of the Federal Reserve System, “Federal Reserve Board approves final rule to help ensure banks
maintain strong capital positions,” (Press Release), July 2, 2013.
27
These ratios include: 1) CET1, 2) tier 1 capital, 3) total capital, 4) leverage (supplementary or enhanced
supplementary), 5) Liquidity Coverage Ratio (standard or modified), 6) Net Stable Funding Ratio (standard or modified), 7)
Total Loss Absorbing Capacity (G-SIBs), and 8) Long-term Debt (G-SIBs).
28
The Standardized Approaches for Counterparty Credit Risk (SA-CCR) increased the level of RWA associated with
counterparty exposures.
29
Covered banks are required to hold unencumbered and “high quality liquid assets” (HQLA), which is detailed in asset
requirements 12 CFR 252.35(b)(3). Criteria for Level 1, Level 2A and Level 2B HQLA is defined in 12 CFR 249.20.

1.3.1 Capital ratios and financial buffers
Financial resources are an essential part of a banking organization’s resilience as they support a bank’s ability to absorb
unexpected losses and continue operations as a going concern. Capital ratios and financial buffers have been a traditional
regulatory tool for promoting consistent standards across banks. In the simplicity of their application, they support both
international competitive fairness and confidence in the banking system. Initial capital requirements introduced in 1988 as
part of Basel I: the Basel Capital Accord included a single pillar covering minimum capital requirements.30 Under the
current Basel framework (Basel III), capital standards and their calculation expanded significantly to account for both
risk-based and non-risk based exposures at a bank. To strengthen the regulatory framework in the wake of the financial
crisis, Basel III sought to do the following:
• improve the quality of bank regulatory capital by emphasizing common equity tier 1 (CET1) capital;
• increase the level of capital requirements to absorb losses in stress;
• enhance risk screening by revising the risk-weighted capital framework in areas such as market risk, counterparty
credit risk and securitisation;
• add macroprudential elements to the regulatory framework, by: (i) introducing capital buffers to limit procyclicality; (ii)
establishing large exposure limits to mitigate systemic risks arising from interlinkages across financial institutions and
concentrated exposures; and (iii) putting in place a capital buffer to address the externalities created by global and
systemically important banks; and
• specify a minimum leverage ratio requirement to constrain excess leverage in the banking system and complement the
risk-weighted capital requirements.31
Table 3 captures the current US capital requirements designed to achieve the objectives of the Basel III framework. This
post-crisis framework also establishes a new tier of loss-absorbing capital, common equity tier 1, which is defined under
the most stringent eligibility criteria.32 For this reason, CET1 is the preferred financial resource for absorbing losses, as
reflected in the requirements contained in Table 3.
Table 3: Going concern financial resources
Category Requirement Regulation Description33 Ratio
CET1 Minimum Regulation Q (Subpart B) Minimum capital required by regulators that CET1
establish a floor of financial resources
Tier 1 Minimum necessary for supporting a bank’s going Additional Tier 1
Minimum
concern
Capital
Requirements Total Capital Minimum Tier 2
30
31
Basel III: A global regulatory framework for more resilient banks and banking systems - revised version June 2011
https://www.bis.org/publ/bcbs189.htm.
32
12 CFR 217.20(b).
33
The descriptions in the Table are taken from the Basel Framework, with the exception of the stressed capital buffer,
which is detailed in Regulation Y, 12 CFR 225.8(f).

Leverage Ratio
Regulation Q (Subpart B) Non-risk-based "backstop" measure designed Tier 1
to complement risk-based measures
Supplementary Leverage Regulation Q (Subpart B) Non-risk-based "backstop" measure designed Tier 1

Ratio (SLR or eSLR) to complement risk-based measures (applicable
for advanced approaches or Category III banks)
Stress Capital Buffer Regulation Y (Subpart A) Capital required to absorb losses under CET1
severely adverse economic conditions
Capital Conservation Regulation Q (Subpart B) Capital buffer designed to conserve capital CET1
Buffer (CCB) through limitations of capital distributions
Capital Buffer Global Systemically Regulation Q (Subpart B) Methodology for increasing the going-concern CET1
Important Bank (G-SIB) loss absorbency capital requirement for a G-SIB
Surcharge
Countercyclical Capital Regulation Q (Subpart B) Tool for raising capital on large banks during CET1
Buffer (CCyB) periods of elevated risk or deteriorating
economic conditions.
The long-term effect of these new requirements is visible when examining the level of CET1, which as the preferred
source of capital provides a perspective on the growth of loss absorbing resources. Figure 4 illustrates the growth rate in
CET1 and RWA for US G-SIBs. The growth in the level of CET1 since 2008 significantly outpaces the growth in assets,
which reflects the degree to which the most systemically important banks are now maintaining capital reserves. Capital
composed of CET1 has grown nearly 300% since its trough during 2008 as international standards have been
adopted into regulations.

Figure 4: Growth Rate of Common Equity Tier 1 vs. Risk-Weighted Assets of US G-SIBs34
Figure 5 also shows how the amount of CET1 and CET1 ratios increased since the global financial crisis. Prior to the
GFC, aggregate CET1 for GSIBs was approximately $214 billion. But following the GFC, it increased to
approximately $880 billion, which reflects a fourfold increase in loss absorbing capital.35 CET1 ratios roughly
doubled since the GFC. As of 2022, CET1 ratios are near 12% of risk-weighted assets.
34
Data source: Capital IQ. Chart captures the growth rate of CET1 and RWA levels among US-GSIBs (Category I) banks
indexed to 2008 Q1. Covered banks include: Bank of America Corporation, Citigroup Inc., JPMorgan Chase & Co.,
Morgan Stanley, State Street Corporation, The Bank of New York Mellon Corporation, The Goldman Sachs Group, Inc.
Wells Fargo & Company.
35
Data does not include CET1 levels for Morgan Stanley or Goldman Sachs prior to Q1 2009.

Figure 5: Aggregate Level of Common Equity Tier 1 of US G-SIBs36
Figure 6 shows the range of capital requirements (as of 2022) that the US G-SIBs must maintain to be considered
well-capitalized.37 US G-SIBs maintain an average SCB of 4% and an average G-SIB surcharge of 2.3% of CET1, as
a percentage of risk-weighted assets. The average total CET1 capital requirement for the US G-SIBs is 10.8%. As
banks are presently holding approximately 12% of CET1 (Figure 5), current levels of CET1 are 1.2 percentage points
more than required, on average.
36
Data Source: Capital IQ. Common equity tier 1 is the sum across US G-SIBs. US G-SIBs include JPMorgan Chase &
Co., Bank of America Corporation, Citigroup, Wells Fargo & Company, The Goldman Sachs Group, Morgan Stanley, The
Bank of New York Mellon Corporation, and State Street Corporation.
37
Board of Governors of the Federal Reserve System, “Large Bank Capital Requirements,” August 2022.

Figure 6: Capital Requirements for US G-SIBs38, 39
1.3.1.1 Minimum capital requirements
Minimum capital requirements are established in Regulation Q, and are composed of CET1 and Additional tier 1. CET1
and Additional tier 1 capital refer to regulatory capital definitions that get progressively expansive in their criteria of what
qualifies as capital. CET1 is often the binding capital constraint for most banks as it is the most loss-absorbing form of
capital. Adopted in 2013, these requirements are intended to provide adequate financial resources allowing a bank to
continue lending despite an economic downturn and unexpected financial losses.40
The minimum capital ratios are designed to be either risk-based or non-risk based requirements. Risk-based
requirements, such as the CET1, tier 1 and Total minimum capital requirements are designed to ensure a minimum level
of financial resources are maintained that reflect the inherent risk of the bank’s assets (risk-weighted assets or RWA).
Non-risk based requirements, such as the leverage and supplementary leverage ratio, are designed to require an
additional source of minimum financial resources, regardless of the type of asset. Leverage ratios are meant to serve as a
back-stop to reduce the risk that financial deleveraging undermines financial stability.41
38
Ranges for SCB and G-SIB surcharge reflect the most recent capital requirements published by the Federal Reserve as
of October 2022.
39
Heights of each bar are scaled with average SCB of 3.96% and G-SIB surcharge of 2.31% across US G-SIBs as of
2022 Q4.
40
Board of Governors of the Federal Reserve System, “Federal Reserve Board approves final rule to help ensure banks
maintain strong capital positions,” (Press Release), July 2, 2013. Updates to the Regulatory Capital Rules include
amendments to Regulations H, Q, and Y.
41
FSI Connect, “Basel III leverage ratio framework - Executive Summary,” Bank for International Settlements, last
modified October 25, 2017.

Table 4: Minimum Regulatory Capital Requirements
Minimum Regulatory Capital Requirements
Common Equity Tier 1 (CET1) 4.5%
Tier 1 Capital* 6%
Total Capital** 8%
Leverage Ratio*** 4%
Supplementary Leverage Ratio 3%
*Composed of at least 4.5% of CET1 and 1.5% of additional tier I (AT1) capital
**Composed of tier 1 capital and tier 2 capital
***Basel III's leverage ratio is defined as the "capital measure" (the numerator) divided by the "exposure measure" (the denominator) and is
expressed as a percentage. The capital measure is currently defined as tier 1 capital
Adjustments to CET1
When calculating regulatory capital, Regulation Q requires that board-regulated institutions must make certain deductions
and adjustments from the sum of its common equity tier 1 capital. These deductions and adjustments are as follows:
1. Goodwill and other intangible assets, net of associated deferred tax liabilities (DTLs), including goodwill that is
embedded in the valuation of a significant investment in the capital of an unconsolidated financial institution in the
form of common stock.
2. Deferred tax assets (DTAs) that arise from net operating loss and tax credit carryforwards net of any related
valuation allowances and net of DTLs.
3. Defined benefit pension fund net assets, net of any associated DTLs, must be deducted, unless the depository
institution holding company has unrestricted and unfettered access to the assets in the fund, and the holding company
is granted Board approval for its inclusion.
4. Investments in own shares, including treasury stock, must be deducted.
5. Investments in the capital of unconsolidated financial institutions are deducted, based on whether the bank is
an advanced-approach institution or whether the investment is significant or non-significant.
6. Gains and losses due to the changes in the bank’s own credit risk, derived from changes in the fair value of the
bank’s liabilities.
In addition, the largest banks must adjust CET1 levels to account for accumulated other comprehensive income
(AOCI), while smaller, board-regulated entities may opt-out of making an AOCI adjustment.42 This is intended to cover net
unrealized gains or losses on a bank’s securities portfolio or on its cash flow hedges as these positions are
marked-to-market.43 The sensitivity of these assets to changes in interest rates creates a volatile component within CET1
calculations that may require banks to reduce risk, reclassify securities or spend additional resources on hedging.44 As
part of their disclosures, banks must report their CET1 quarterly, including AOCI and any other regulatory adjustments and
deductions that are relevant.45 As opposed to the largest banks, smaller banks (i.e., banks other than Category I & II
banks) can choose to opt-out of this requirement, and therefore avoid reporting the impact on CET1 levels and ratios
42
Advanced approaches banks are required to account for and disclose AOCI as part of Regulation Q requirements.
43
12 CFR 217.22(b).
44
Andreas Fuster and James Vickery, “What happens when regulatory capital is marked to market?” Liberty Street
Economics. October 11, 2018.
45
Disclosure requirements included in Tables accompanying 12 CFR 217.63(a).

caused by fluctuations in the market value of their securities. This means the risk associated with the bank’s securities
remains, and yet the reported level of CET1 does not reflect that risk.
Leverage Ratio
The leverage ratio provides a non-risk based minimum capital requirement. This requirement was intended to reduce the
risk associated with deleveraging, which, during the crisis, created a feedback loop between losses, falling bank capital
and shrinking credit availability.46 The calculation of this requirement is not reflected as a measure relative to risk-weighted
assets, but instead captures a bank’s tier 1 capital relative to the average total consolidated assets as reported.47 While
this ratio may change due to fluctuations in asset levels or tier 1 capital, Figure 7 illustrates the relative consistency of this
ratio, which for the US G-SIBs’ average approximately 7%, nearly 3 percentage points above the required
minimum.
Figure 7: Average Leverage Ratio of US G-SIBs48
Supplementary Leverage Ratio
On September 3, 2014, the Federal Reserve adopted a final rule regarding the Supplementary Leverage Ratio (SLR),
which became effective on January 1, 2018. Similar to the leverage ratio, the SLR is a capital requirement that is risk
neutral and compares a bank’s equity to its assets, taking into account both on-balance sheet and certain off-balance
sheet assets and exposures. This requirement covers advanced-approach banks in addition to Category III
Board-regulated institutions, and applies to their depository institution subsidiaries.49 The SLR is calculated as the tier 1
Capital/Total Leverage Exposure. The Total Leverage Exposure is calculated as the sum of the mean of on-balance sheet
assets and off-balance sheet exposures.50 As a minimum capital requirement, banks must maintain a supplementary ratio
of at least 3%.
46
Bank of International Settlements, “Basel III leverage ratio framework and disclosure requirements,” January 2014.
47
12 CFR 217.10(b)(4).
48
Data Source: Capital IQ. Leverage Ratio for US G-SIBs is calculated as the simple average across banks within
Category I. Category I Banks include JPMorgan Chase & Co., Bank of America Corporation, Citigroup, Wells Fargo &
Company, The Goldman Sachs Group, Morgan Stanley, The Bank of New York Mellon Corporation, and State Street
Corporation.
49
Board of Governors of the Federal Reserve System, “Agencies adopt supplementary leverage ratio final rule,” (Press
Release), September 3, 2014.
50
12 CFR 217.10(c).

In addition, US G-SIBs are subject to the Enhanced Supplementary Leverage Ratio (eSLR). Under eSLR, G-SIBs are
required to maintain an additional tier 1 capital leverage buffer of 2 percentage points above the minimum requirement of
3%, for a total of 5%, whereas the Basel standards set the leverage ratio buffer at 50% of the Basel G-SIB surcharge
(Method 1). As of November 2022, the highest effective leverage ratio buffer under the Basel standards is 1.25%.51 The
eSLR rule also requires insured depository institutions of covered G-SIBs to maintain a 6% supplementary leverage ratio
to be considered well-capitalized.
While the SLR went into effect in 2018, the Federal Reserve’s response to the COVID-19 pandemic in 2020 included an
easing of the SLR requirements by excluding US Treasury securities and deposits as part of the ratio’s calculation.52 This
temporary release, which expired in March 2021, reflects the trade-offs associated with the non risk-based methodology of
the SLR and the equally punitive impact it has across assets that are low-risk.53 Figure 8 illustrates the temporary increase
to the level of the SLR ratio while excluding certain assets from the ratio’s calculation. As the relief measures expired, the
average SLR ratio reverted to pre-pandemic levels at approximately 6-7%. US G-SIBs maintain consistently higher
levels of capital for leverage than the required minimum, and comparatively, leverage has declined from the elevated
levels prior to the GFC.
Figure 8: Average Supplementary Leverage Ratio of US G-SIBs54
51
The Basel G-SIB surcharge is capped at 3.5% which is applicable for G-SIBs in Bucket 5, i.e., the bucket for banks that
are deemed most global systemically important banks and therefore the highest surcharge. And 50% of the 3.5% cap is
1.75%. As of November 2022, Bucket 5 is empty. As a result, the largest G-SIB surcharge is 2.5% that is in effect for
Bucket 4, and 50% of that is 1.25% -- materially lower than the 2.0% in the US capital rules.
52
Board of Governors of the Federal Reserve System, Final Rule for the Temporary Exclusion of US Treasury Securities
and Deposits at Federal Reserve Banks From the Supplementary Leverage Ratio. April 14, 2020.
53
Board of Governors of the Federal Reserve System, “Temporary supplementary leverage ratio changes to expire as
scheduled,” (Press Release), March 19, 2021.
54
Data Source: Capital IQ. Supplementary Leverage Ratio is simple average across banks within each category cohort.
Category I Banks include JPMorgan Chase & Co., Bank of America Corporation, Citigroup, Wells Fargo & Company, The
Goldman Sachs Group, Morgan Stanley, The Bank of New York Mellon Corporation, and State Street Corporation.
Category II Banks include Northern Trust Corporation. Category III Banks include US Bancorp, Truist Financial
Corporation, The PNC Financial Services Group, The Charles Schwab Corporation, Capital One Financial Corporation.
Data for Charles Schwab before 2018Q4 is not included. Data for Truist before 2019Q4 is not included.

1.3.1.2 Stress Capital Buffer (SCB) and Capital Conservation Buffer (CCB)
Stress Capital Buffer (SCB) is calculated as the difference between the bank’s starting and minimum projected CET1
capital ratios under the nine quarter severely adverse scenario in CCAR, inclusive of four quarters of planned common
stock dividends, and floored at 2.5%.55 The SCB aligns stress testing requirements with capital requirements by having
the Federal Reserve calculate the stressed capital needs of a bank using the supervisory stress test results from the
previous year.56 The SCB is applied to banks subject to enhanced prudential standards, whereas for smaller banks with
less than $100 billion in total assets the Capital Conservation Buffer (CCB) of 2.5% is maintained, for the purposes of
the standardized RWA approach.57 Both the SCB and CCB are composed of CET1. The CCB was designed to absorb
losses while requiring banks to limit the amount of eligible retained income that can be paid out (Maximum Payout Ratio in
the Table below) so as to conserve the minimum amount of regulatory required capital (i.e. 4.5% of CET1).58 The penalty
for breaching these limits is applied through a series of haircuts to planned capital distributions.
Table 5: Maximum payout ratio for capital conservation buffers
Capital conservation buffer Maximum payout ratio
Greater than 2.5 percent plus 100 percent of the Board-regulated institution's applicable countercyclical No payout ratio limitation applies.
capital buffer amount
Less than or equal to 2.5 percent plus 100 percent of the Board-regulated institution's applicable 60 percent.
countercyclical capital buffer amount, and greater than 1.875 percent plus 75 percent of the
Board-regulated institution's applicable countercyclical capital buffer amount
countercyclical capital buffer amount, and greater than 1.25 percent plus 50 percent of the
countercyclical capital buffer amount and greater than 0.625 percent plus 25 percent of the
countercyclical capital buffer amount
Unlike the CCB, which is fixed at 2.5%, the SCB maintains this ratio as a minimum and, depending on stressed capital
needs, can result in a much higher CET1 capital requirement, as seen in Figure 9. In the most recent release in August
2022, 34 large US and foreign banks were subject to this requirement, with SCB ranges from 2.5% to 6.3% of RWA for
US G-SIBs. Similar to the CCB, a breach to the SCB has implications for a bank’s ability to make payouts and capital
distributions. Under Regulation Y, if the assumption of four quarters of planned capital distributions results in a breach to
an updated SCB requirement, then banks must adjust their planned capital payout.59 The SCB aligns with other capital
planning requirements contained with Regulation Y as it replaces the quantitative evaluation in the Federal Reserve’s
annual stress-test, the Comprehensive Capital Analysis and Review (CCAR).60 Due to these penalties, banks, as a
55
12 CFR 225.8.
56
To align with the requirements in the Tailoring Rule the Board of Governors of the Federal Reserve calculates the stress
capital buffer requirement annually for Category I-III banks, and biennially for Category IV banks.
57
12 CFR 217.11.
58
12 CFR 217.11(a)(4)(iv).
59
12 CFR 225.8(h)(2)(ii) Within two business days of receipt of notice of a stress capital buffer requirement a bank holding
company must determine whether the planned capital distributions for the fourth through seventh quarters of the planning
horizon under the Internal baseline scenario would be consistent with effective capital distribution limitations assuming the
stress capital buffer requirement provided by the Board of Governors of the Federal Reserve System. If the planned
capital distributions would not be consistent with effective capital distribution limitations, the bank holding company must
adjust its planned capital distributions.
60
Board of Governors of the Federal Reserve System, “Federal Reserve Board announces individual large bank capital
requirements, which will be effective on October 1,” (Press Release), August 10, 2020.

practical matter, often hold additional resources or management buffers beyond the required buffers prescribed by
regulation.
Figure 9: Impact of SCB Adoption on Capital Ratios61
1.3.1.3 G-SIB Surcharge
Published in July 2015 and effective in January 2019, the G-SIB surcharge is a direct charge for global systemically
important banks (G-SIBs) to maintain an additional capital buffer composed of CET1. This buffer is a reflection of a bank’s
systemic importance as determined by various factors, for example, interconnectedness, cross-jurisdictional activity, size
and complexity. The buffer is designed to reduce the systemic risk that these banks pose to financial stability by
increasing their capacity to absorb losses as a going concern and reduce the probability of their failure. For US G-SIBs,
this requirement ranged from a minimum 1% to 3.5% of RWA (Table 6), however the G-SIB surcharge does not have a
ceiling and can increase incrementally based on methodology.62
Table 6: G-SIB Surcharges as of October 1, 2022
G-SIB Surcharges, effective October 1, 202263
Bank of America Corporation 2.5%
The Bank of New York Mellon Corporation 1.5%
Citigroup Inc. 3.0%
The Goldman Sachs Group, Inc. 2.5%
61
Heights of each bar are scaled with average SCB of 3.96% and G-SIB surcharge of 2.31% across US G-SIBs as of
2022 Q4.
62
Board of Governors of the Federal Reserve System, “Federal Reserve Board approves final rule requiring the largest,
most systemically important US bank holding companies to further strengthen their capital positions,” (Press Release),
July 20, 2015.
63
Board of Governors of the Federal Reserve System, “Federal Reserve Board announces the individual capital
requirements for all large banks, effective on October 1,” (Press Release), August 04, 2022.

JPMorgan Chase & Co. 3.5%
Morgan Stanley 3.0%
State Street Corporation 1.0%
Wells Fargo & Company 1.5%
A G-SIB is required to calculate its surcharge on an annual basis by December 31 by using two methods and selecting
the equal or greater of either.64 The first method (Method 1) adopts the BCBS framework by considering size,
interconnectedness, cross-jurisdictional activity, substitutability and complexity. The second method (Method 2) replaces
substitutability with a measure to capture a bank’s reliance on short-term wholesale funding. The scores from Method 1
and 2 align to a range of surcharge rates, which increase as the score increases.65 If a bank is determined to be global
and systemically important, it will be subject to other G-SIB requirements under the Tailoring Rule.
1.3.1.4 Countercyclical Buffer
Countercyclical Buffer (CCyB) is an additional buffer that the Board of Governors of the Federal Reserve system may
set, within a range of zero to 2.5%. This buffer raises CET1 on large banks further during a period of elevated risk and
deteriorating economic conditions to counter procyclicality in the financial system.66 To date, the CCyB remains at zero,
and has not been a tool used in the past.67 An increase to the CCyB would become effective 12 months from the date of
announcement, unless otherwise stated; and a decrease in the CCyB would become effective the day after the date of
announcement.68 The CCyB includes a 12-month expiration period from the effective date, after which it returns to zero
percent.69
1.3.1.5 Collins Amendment
Collins Floor is an amendment to the Dodd-Frank Act sponsored by Senator Susan Collins in 2010 that requires large
US banks to hold minimum risk-based capital that cannot be less than the generally applicable risk-based capital
requirements, which must serve as a floor; nor can this floor be quantitatively lower than the generally applicable
risk-based capital requirements that were in effect for insured depository institutions as of the enactment of the
Dodd-Frank Act. Currently, the Federal Reserve applies the Basel III standardized approach to be the floor for all banks.70
Standardized Approaches refers to the Basel Framework for banking supervision, which is designed to apply a set of
consistent standards for, among other things, capital ratios and methodologies for calculating risk within a bank’s assets.
Banks who choose to use an internal ratings-based (IRB) approach and other internal models to calculate risk-based
capital requirements are using Advanced Approaches. Due to the Collins amendment, the current US requirements are
diverging from the standards as they are applied to other international banks. This is because the current proposed BCBS
64
12 CFR 217.403.
65
12 CFR 217.403(b-c).
66
12 CFR 217.11.
67
Board of Governors of the Federal Reserve System, “Federal Reserve Board votes to affirm the Countercyclical Capital
Buffer (CCyB) at the current level of 0 percent,” (Press Release), December 18, 2020.
68
12 CFR 217.11(b)(2)(v).
69
12 CFR 217.11(b)(2)(vi).
70
The term ‘‘generally applicable risk-based capital requirements’’ means— (A) the risk-based capital requirements, as
established by the appropriate Federal banking agencies to apply to insured depository institutions under the prompt
corrective action regulations implementing section 38 of the Federal Deposit Insurance Act, regardless of total
consolidated asset size or foreign financial exposure; and (B) includes the regulatory capital components in the numerator
of those capital requirements, the risk-weighted assets in the denominator of those capital requirements, and the required
ratio of the numerator to the denominator.

floor would be 72.5% of the new standardized approach, which is lower than the Collins amendment requirement. In
effect, the Collins amendment is becoming a capital constraint rather than serving as a capital floor.71
1.3.1.6 Gone concern financial requirements
The Financial Stability Board (FSB), which is an international body of national financial authorities and standard setters,
also influenced post-crisis regulatory requirements through the issuance of a Total Loss-Absorbing Capacity (TLAC)
standard, specifically for global systemically important banks (G-SIBs).72 Unlike other capital requirements designed to
absorb losses, the TLAC and long-term debt (LTD) requirements are designed to consider a bank’s loss-absorbing
capacity as a gone-concern, which assumes that a bank entering resolution has likely depleted most of its regulatory
capital and equity in the run-up to resolution or bankruptcy. These resources must provide capacity to absorb additional
losses, maintain the continuity of critical functions and support the bail-in or recapitalization of a bank as it exits the
resolution process.73 Adopted in 2017, the TLAC rule is part of the broader set of enhanced prudential standards
contained within Regulation YY.74 Table 7 provides a description of these requirements and the additional guidance
covering the methodology supporting the estimation and positioning of these resources. The final rule includes the
requirements for the calculation and eligibility of resources that can serve as external TLAC and LTD.75
Figure 10: Increase in Total Usable TLAC76
71
Alessandro Aimone, “The Collins flaw: backstop turned binding constraint,” Risk.net, February 14, 2022.
72
Joe Perry, “FSB issues final Total Loss-Absorbing Capacity standard for global systemically important banks,”
November 9, 2015.
73
12 CFR 252.63(c) - TLAC External Buffer is composed solely of CET1.
74
12 CFR 252 (Subpart G).
75
TLAC Rule: External TLAC buffer must be composed of CET1, see 12 CFR 252.63(c)(1). Eligible external LTD is
defined under the final rule as debt that is issued directly by the covered BHC, is unsecured, is “plain vanilla,” and is
governed by US law. Only 50 percent of the amount of eligible external LTD that is due to be paid between one and two
years can be used for purposes of the external LTD requirement (though such debt would count in full for purposes of the
external TLAC requirement). The amount of eligible external LTD due to be paid in less than one year will not count
toward the external TLAC requirement or the external LTD requirement.
76

Figure 11: Total Loss-Absorbing Capital77
Table 7: Gone concern financial resources
Resource Regulation Description78
Total Loss Absorbing Capacity Regulation YY (Subpart G) Loss-absorbing capacity to support the
(TLAC) ongoing operation of material legal entities
while a parent company is in bankruptcy
Long-term Debt (LTD)
As part of TLAC, eligible external long-term
debt is used to recapitalize material entities
and meet operational needs at a consolidated
level
Capital
Resolution Capital Adequacy and Final Guidance (2019) The distribution of capital adequacy resources
Positioning (RCAP) between material legal entities and the
consolidated parent
Resolution Capital Execution Need Final Guidance (2019) Methodology for estimating the capital support
(RCEN) a material legal entity may require to operate
while in bankruptcy
Resolution Liquidity Adequacy and Final Guidance (2019) Methodology for estimating the liquidity needs
Positioning (RLAP) of each material legal entity to ensure the
parent holding company holds sufficient HQLA
to cover the sum of all stand-alone material
entity net liquidity deficits
Liquidity
Resolution Liquidity Execution Final Guidance (2019) Methodology for estimating the liquidity needed
Need (RLEN) after the parent's bankruptcy filing to stabilize
the surviving material entities and to allow
those entities to operate post-filing
77
Data Source: S&P Capital IQ.
78
Board of Governors of the Federal Reserve System and Federal Deposit Insurance Corporation, Final Guidance for the
2019, February 4, 2019.

Table 8 details the methodologies for calculating both TLAC and LTD. For external TLAC, a bank is required to maintain
no less than 18% of the bank’s total risk-weighted assets, inclusive of the G-SIB surcharge and CCyB if applicable; and
7.5% of the bank’s total leverage exposure, with an additional 2% buffer.79 For external LTD requirements, eligible
long-term debt must be maintained in an amount no less than the greater of 6% plus a bank’s G-SIB surcharge and 4.5%
of total leverage exposure.80
Table 8: Methodology for TLAC and Eligible LTD81
Risk-Based Requirements SLR Requirements

Requirement Type
(RWA denominator) (total leverage exposure denominator)
TLAC Minimum 18% 7.5%
Buffer 2.5% + 2.0%

Method 1 GSIB surcharge + countercyclical buffer (if any)
Buffer Composition Buffer must be composed of CET1 capital Buffer must be composed of
tier 1 capital
Eligible LTD Minimum 6% 4.5%

+ Greater of Method 1 and 2 GSIB surcharges
Importantly, eligible external LTD must be issued by the bank at the holding company itself so as to enhance the bank’s
ability to absorb losses incurred across the banking organization, and support a single-point-of- entry (SPOE) strategy
by enabling recapitalization. For an intermediate holding company (IHC), the amount of eligible TLAC and LTD depends
on whether the IHC is expected to enter resolution through a multiple-point-of-entry (MPOE) resolution strategy, or
continue operating outside of resolution while its foreign parent is resolved under a SPOE strategy in its home country.
Figure 12 captures how a bank’s LTD and other eligible Tier 2 can be used to “bail in” a new bridge entity that will be
recapitalized to support the transfer of business activities from the failed bank to the new bank.
79
A covered IHC's eligible TLAC generally is defined to be the sum of (a) the tier 1 regulatory capital issued from the
covered IHC to a foreign parent entity that controls the covered IHC and (b) the covered IHC's eligible LTD.
80
G-SIB surcharge and final ratios will vary across banks based on G-SIB surcharge methodology and size of total
risk-weighted assets.
81

Figure 12: Hypothetical Use of LTD in Resolution
The Fed’s Final Guidance for 2019 provides supervisory expectations for those areas identified as key vulnerabilities
during resolution, including: capital, liquidity, governance mechanisms, operations, legal entity rationalization and
separability, derivative and trading activities, format and structure of the plan, and the plan’s public section. Specifically,
supervisors expect resolution plans to demonstrate that a bank has adequate loss-absorbing capacity to recapitalize
material legal entities and support the holding company, as well as the liquidity to support its preferred resolution strategy
by holding high-quality liquid assets (HQLA).
A bank’s Resolution Capital Adequacy and Positioning (RCAP) should reflect how internal loss absorbing capacity
(internal TLAC) can be deployed and positioned to recapitalize material legal entities and support their ongoing operations
while the parent company is in bankruptcy. Similarly, long-term debt at the consolidated level (external TLAC) should
support the operational needs of the parent company. Additionally, the strategy for recapitalizing or winding down material
legal entities should be supported by a methodology for estimating the capital needs of that strategy, referred to as the
Resolution Capital Execution Need (RCEN). The RCEN methodology needs to ensure, among other considerations,
that a material legal entity’s capital levels will meet or exceed the capital requirements for being “well-capitalized” in
addition to meeting capital needs throughout resolution.82
Similar to estimating capital needs, a bank’s resolution plan should include methodologies for estimating the liquidity
needs of each material entity, its Resolution Liquidity Adequacy and Positioning (RLAP), which is meant to ensure
that HQLA is adequate for supporting net outflows. The RLAP model should use internal liquidity stress test assumptions,
cover a 30-day time horizon, and ensure that the parent holding company holds sufficient HQLA to cover the sum of all
stand-alone material entity net liquidity deficits, while assuming that net liquidity surpluses are non-transferable from one
82
Board of Governors of the Federal Reserve System and Federal Deposit Insurance Corporation, “Section II: Capital,”
Final Guidance for the 2019, February 4, 2019.

material entity to another or to the parent. The Resolution Liquidity Execution Need (RLEN) methodology should be
able to estimate liquidity needs post-bankruptcy and support the timing of filing for bankruptcy so that a bank’s HQLA is
not depleted below RLEN estimates prior to filing. Per guidance, RLEN should: estimate the minimum operating
liquidity (MOL) at each material entity to support operations or wind-down; provide daily cash flow forecasts by material
entity; include a breakout of inter-affiliate transactions that could impact MOL or peak funding estimates; and estimate
minimum and peak liquidity needs for each material entity to inform resolution actions taken by the bank’s board(s) of
directors.83
1.3.2 Liquidity ratios

“Liquidity transformation” or “maturity transformation” - using sources of short-term funding to finance and invest in
long-dated assets - is a fundamental element of the banking business. Banks earn a spread in exchange for accepting
liquidity risk. That is, a bank must be able to fund assets and meet demands for withdrawals of liabilities when they arise
as a consequence of normal operations. Managing the trade-off between financial gains and exposure to liquidity risk is a
challenge for bank managers operating in today’s competitive environment – and it is a post-GFC focal point for
regulators.
In fact, between the mid-1990s and mid-2000s, financial institutions implemented few liquidity management improvements
while supervisors put a spotlight on market risk, credit risk and capital adequacy. It was generally accepted that banks
should maintain a buffer consisting of high quality assets that could be converted into cash during times of stress. Given
the low number of bank failures during this period, and under the assumption of continued access to liquidity, banks
reduced the amount of liquid assets held on the balance sheet. The reversal of market conditions in 2007 and the
subsequent financial crisis revealed weaknesses related to liquidity risk management for both banking organizations and
supervisors, leading to dramatic and rapid progression of liquidity risk management practices throughout the industry.
The BCBS did not completely ignore liquidity prior to the Financial Crisis, despite leaving it out of their first two accords.
BCBS issued a paper in 2000, “Sound Practices for Managing Liquidity in Banking Organizations”, to replace an existing
paper on liquidity issued in 1992, “A Framework for Measuring and Managing Liquidity”. The 2000 paper introduced
fourteen principles that have been revisited and built upon in subsequent guidelines, standards and regulations. The
principles were organized into the following key areas:
• Developing a structure for managing liquidity
• Measuring and monitoring net funding requirements
• Managing market access
• Contingency planning
• Foreign currency liquidity management
• Internal controls for liquidity risk management
• Role of public disclosure in improving liquidity
• Role of supervisors
In direct response to the GFC, the BCBS issued “Principles for Sound Liquidity Risk Management and Supervision” in
December 2008. The paper aimed to emphasize the role of supervisors and address banks that failed to account for a
number of basic principles of liquidity risk management while liquidity was plentiful. Expanded guidance included:
• The importance of establishing a liquidity risk tolerance
83
Board of Governors of the Federal Reserve System and Federal Deposit Insurance Corporation, “Section III: Liquidity,”
Final Guidance for the 2019, February 4, 2019.

• The maintenance of an adequate level of liquidity, including through a cushion of liquid assets
• The necessity of allocating liquidity costs, benefits and risks to all significant business activities
• The identification and measurement of the full range of liquidity risks, including contingent liquidity risks
• The design and use of severe stress test scenarios
• The need for a robust and operational contingency funding plan
• The management of intraday liquidity risk and collateral
• Public disclosure in promoting market discipline
Still lacking was an internationally harmonized set of liquidity standards and metrics. The BCBS sought to strengthen
previous recommendations through its Basel III liquidity risk framework and development of two quantitative measures,
which were first announced in December 2010. These ratios are the Liquidity Coverage Ratio (LCR) and Net Stable
Funding Ratio (NSFR), as described in Table 9.
Table 9: Liquidity Ratios
Category Requirement Regulation Description84 Ratio
Liquidity Coverage Regulation WW (Subpart B) Promotes the short-term resilience of a bank's Liquidity Coverage
liquidity risk profile Ratio (LCR)
Liquidity
Net Stable Funding Regulation WW (Subpart K) Requires banks to maintain a stable funding Net Stable Funding
profile in relation to the composition of their Ratio (NSFR)
assets and off-balance-sheet activities
1.3.2.1 Liquidity Coverage Ratio
The Federal Reserve approved the LCR final rule on December 9, 2014. This requirement is designed to promote
short-term resilience by ensuring that a financial institution has sufficient, unencumbered, high-quality liquid resources to
survive a severe liquidity stress scenario. As a tool for management of short-term liquidity needs, LCR supplements and
mitigates reliance on other types of liquidity support provided by the central bank, such as a special facility or the Discount
Window.85 Specifically, a banking organization’s stock of unencumbered, high-quality liquid assets (HQLAs) is required to
be at least 100% of total net outflows over a period of stress lasting one month.86 The ratio is calculated as:
84
The descriptions in the Table are taken from the Basel Framework, with the exception of the stressed capital buffer,
which is detailed in Regulation Y, 12 CFR 225.8(f).
85
The Federal Reserve operates the Discount Window to provide ready access to funding to support depository
institutions manage their liquidity risks. For more information on the Discount Window see “The Discount Window -
Payment System Risk,” The Federal Reserve.
86
Under the Tailoring Rule and in alignment with EGRRCPA, some banks follow a reduced requirement for LCR of 85
percent or 70 percent. This is reflected in the final LCR rule adopted in 2019. Categories of bank holding companies
subject to tailored requirements are included in Table 2 in the Background section.

𝐻𝑄𝐿𝐴
𝑁𝑒𝑡 𝑐𝑎𝑠ℎ 𝑜𝑢𝑡𝑓𝑙𝑜𝑤𝑠 𝑜𝑣𝑒𝑟 𝑎 30−𝑑𝑎𝑦 𝑠𝑡𝑟𝑒𝑠𝑠 𝑝𝑒𝑟𝑖𝑜𝑑
≥ 100%
Banks apply regulator defined stress scenario assumptions for haircuts to liquid assets, runoff rates for liabilities due in the
next 30 calendar days, and expected cash inflows for maturing assets to determine LCR. Liquid assets eligible for
inclusion in the calculation are separated into three categories by the BCBS:
• Level 1 Assets (e.g., cash, central bank deposits and high-quality government bonds) receive liquidity credit for the full
market value
• Level 2A Assets (e.g., investment grade securities issued or guaranteed by US GSEs) are subject to a 15% haircut and
must not exceed 40% of total HQLA
• Level 2B Assets (e.g., certain publicly traded equities and investment-grade corporate debt) are subject to a 25%-50%
haircut and must not exceed 15% of total HQLA
High-quality liquid assets (HQLA) are assets that can be easily liquidated, even in times of stress, and ideally should be
eligible at central banks for overnight liquidity facilities. However, central bank eligibility alone does not prevent the
categorisation of an asset as HQLA. The BCBS describes fundamental and market-related qualifiers as part of the
standard:
Fundamental characteristics of HQLA:
• Low risk - Assets that are less risky tend to have higher liquidity. (e.g., high issuer rating, low degree of subordination,
low sensitivity to interest rate and market risk, low legal risk, low inflation risk and denominated in a convertible
currency with low FX risk)
• Ease and certainty of valuation - An asset’s liquidity increases if market participants are more likely to agree on its
valuation. Assets with more standardized, homogenous and simple structures tend to be more fungible, promoting
liquidity. The pricing formula of a liquid asset must be easy to calculate and not depend on strong assumptions and
inputs should be publicly available. (i.e., no exotic products)
• Low correlation with risky assets - The stock of HQLA should not be subject to wrong-way (highly correlated) risk.
Assets issued by financial institutions are more likely to be illiquid in times of liquidity stress.
• Listed on a developed and recognised exchange - Being listed increases an asset’s transparency.
Market related characteristics of HQLA:
• Active and sizable market - The asset should have active outright sale or repo markets at all times. This means that
there should be (1) historical evidence of market breadth and market depth (e.g., low bid-ask spreads, high trading
volumes and a large and diverse number of market participants) and (2) robust market infrastructure in place (e.g.,
multiple committed market makers).
• Low volatility - Assets whose prices remain relatively stable will have a lower probability of triggering forced sales to
meet liquidity requirements. There should be historical evidence of stable market terms (e.g., prices, haircuts) and
volumes during stressed periods.
• Flight to quality - Historically, the market has shown tendencies to move into these types of assets in a systemic crisis.
Implementing these standards has had a visible impact on the resources held by the largest banks in the US and their
capacity to address unexpected losses and funding risks. A Federal Reserve study finds the rise in HQLA levels in the
runup to and through the adoption of the LCR (Figure 13).87 Steeper increases in these assets reflect the progress made
87
Vladimir Yankov, “The Liquidity Coverage Ratio and Corporate Liquidity Management.” FEDS Notes, December 3,
2021.

by banks ahead of the Basel III proposal on the Liquidity Coverage Ratio (LCR) in 2010 and the US regulatory proposal
for LCR’s adoption in 2013. While various factors, such as weak loan growth and deposit inflows may influence levels of
HQLA, the adoption and transition to both standard and modified LCR has significantly increased the level of eligible
assets held by banks overall. Levels of HQLA, which include assets such as central bank balances and US government
debt, increased from approximately $246 billion to approximately $1.95 trillion, nearly 8x pre-crisis levels.
Figure 13: Aggregate Level of High-Quality Liquid Assets (HQLA) of US G-SIBs88
Figure 14 illustrates the levels of liquidity coverage across US G-SIBs.89 While the standardized, full daily LCR is required
to be 100%, banks have consistently maintained resources well above this threshold. Since reporting LCR, US G-SIBs
have been 16% - 24% above the required threshold for liquidity coverage.
88
High-quality liquid assets (HQLA) are estimated by adding excess reserves to an estimate of securities that qualify for
HQLA. Data only include US GSIBs (Category I) banks. Data source: FR Y-9C, FR 2900, Federal Reserve accounting
system. Board of Governors of the Federal Reserve, “Supervisory Developments,” Supervision and Regulation Report,
May 14, 2019.
89
Consistent with tailored requirements for LCR (see Table 2:Tailored Financial and Supervisory Requirements), Category
IV banks with less than $50 billion in short-term wholesale funding are not subject to the LCR requirement.

Figure 14: Average Liquidity Coverage Ratio of US G-SIBs90
1.3.2.2 Net Stable Funding Ratio (NSFR)
The BCBS proposed a second liquidity risk metric, the Net Stable Funding Ratio (NSFR), in October 2014, which was
adopted by US regulators in 2021 and will be disclosed after the second quarter of 2023. Unlike other post-GFC reforms
that seek to boost near-term liquidity, NSFR is a longer-term structural liquidity ratio that aims to address liquidity
mismatches and promote the use of stable funding sources. It does so by measuring various assets, off-balance sheet
commitments and contingent liabilities relative to the proportion of stable funding required to support them.
A bank’s available stable funding (ASF) and required stable fundinding (RSF) is calibrated using a prescribed set of
factors that reflect the presumed degree of stability of liabilities and liquidity of assets:
𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑠𝑡𝑎𝑏𝑙𝑒 𝑓𝑢𝑛𝑑𝑖𝑛𝑔 (𝐴𝑆𝐹)

𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑠𝑡𝑎𝑏𝑙𝑒 𝑓𝑢𝑛𝑑𝑖𝑛𝑔 (𝑅𝑆𝐹)
≥ 100%
The balance sheet value of liabilities is multiplied by the below ASF factors and aggregated into total ASF:
ASF Factor
Capital and liabilities ≥ 1-year maturity 100%
Fully insured retail and sweep deposits 95%
Uninsured retail and sweep deposits, stable brokered deposits 90%
Less stable deposits, unsecured wholesale funding < 1-year maturity, wholesale
funding provided by non financials and securities issued by financials > 6-months 50%
but < 1-year maturity
All other funding 0%
90
Data Source: Capital IQ. Liquidity Coverage Ratio is simple average across banks within Category I, which includes
JPMorgan Chase & Co., Bank of America Corporation, Citigroup, Wells Fargo & Company, The Goldman Sachs Group,
Morgan Stanley, The Bank of New York Mellon Corporation, and State Street Corporation.

Similarly, the value of on- and off-balance sheet assets are multiplied by the below RSF factors and aggregated into total
RSF:
RSF Factor
Cash, securities, FI loans < 1 year 0%
Undrawn commitments 5%
Unencumbered securities 15-50%
Retail client loans ≥ 1-year maturity and assigned risk weight < 50% 65%
Retail client loans ≥ 1-year maturity and assigned risk weight > 50% 85%
All other assets 100%
1.4 Stress Testing and Loss Estimation

Overview
Forecasting processes and loss estimation methodologies are foundational to how a bank determines capital and liquidity
adequacy, as well as the size of allowances for credit losses. Since the output of these approaches inform the amounts of
financial resources maintained (see Section 1.3 Financial Resources), they are often subject to heightened supervisory
scrutiny (see Section 1.6 Supervisory Programming).
• Stress-testing Capital Adequacy: Regulation YY includes requirements for both supervisory and company-run stress
tests. The Federal Reserve conducts stress tests to ensure that large banks are sufficiently capitalized and able to lend
to households and businesses even in a severe recession.91 In the capital framework, this is especially consequential
as these stress tests are now used to size the Stressed Capital Buffer (SCB) (See Section 1.3.1.2 Stress Capital
Buffer).
• Stress-testing Liquidity Coverage: Regulation YY requires banks to perform internal liquidity stress tests (ILST),
which assess the adequacy of financial resources to meet a bank’s funding needs. Estimating net cash outflows over a
30-day period is a required inputting for calculating liquidity coverage (See Section 1.3.2.1 Liquidity Coverage Ratio).
• Estimating Current Expected Credit Losses (CECL): CECL consolidates a number of impairment models that had
existed in US Generally Accepted Accounting Principles (GAAP) and requires setting aside loan reserves for the
estimated life of an exposure. Taking into account the life of an exposure requires banks to maintain higher loss
reserves in general, and has increased the sensitivity for adjusting reserve levels during periods of economic
deterioration.92 Regulation Q details the requirements for transitioning to CECL.
The processes for generating financial forecasts require an extensive use of modeling and infrastructure, dependent on
data and subject-matter expertise across finance, treasury, risk, business units, technology, and others. As models are
foundational to stress testing and financial planning and analysis (FP&A), additional investment in both systems and
personnel has been required to manage risk within the model development process, including model validation,
governance and other internal controls. By investing in these capabilities and adopting their use within the regulatory
framework, both supervisors and senior management can assess a financial institution’s risk profile through a
forward-looking approach under a range of “what-if” scenarios. The heightened requirements and guidance for loss
estimation, forecasting and other model-based approaches reflect the importance of those processes designed to identify
and measure material risks and their contribution in evidencing a bank’s safety and soundness.
91
Board of Governors of the Federal Reserve, 2023 Stress Test Scenarios, Last update: February 22, 2023.
92
Bert Loudis, Sasha Pechenik, Ben Ranish, Cindy M. Vojtech, and Helen Xu, “New Accounting Framework Faces Its
First Test: CECL During the Pandemic.” FEDS Notes, December 3, 2021.

1.4.1 Background on Forecasting
Regulatory stress testing requires banks to translate changes in the macroeconomic environment into financial forecasts.
This translation is performed by developing sets of forecasts for key economic and market variables to represent various
economic scenarios (e.g., a baseline forecast or a severely adverse economic recession). Depending on the use case,
economic scenarios may be provided by a regulatory body, developed internally or purchased from a third party data
provider. Banks must then use these macroeconomic and market variables as inputs into their models to produce financial
forecasts. Figure 15 below illustrates the supervisory stress testing framework while Figure 16 lists some of the key
variables used as inputs in stress testing and financial forecasting models.
Figure 15: Supervisory Stress Testing Modeling Framework93
93
Board of Governors of the Federal Reserve, 2022 Supervisory Stress Test Methodology, Last updated: April 12, 2022.

Figure 16: Stress Test Key Variables
Figure 17 presents some of the projections for key variables under different economic scenarios produced in 2021 through
2023. The charts demonstrate the differentiation in severely adverse and baseline scenarios, with GDP growth and equity
markets showing sharp declines, credit spreads widening and Treasury yields falling in severely adverse scenarios.
Baseline scenarios, in contrast, generally show a consensus outlook for variable paths. Projection paths, such as these,
are then used as inputs in financial forecasting models used for stress testing, reserve setting and business planning.
Importantly, the divergence between baseline and severely adverse variable pathways can result in material differences in
forecasted outcomes, with the effect of forecasting losses or gains under different economic conditions.

Figure 17: Key variable paths within Supervisory Severely Adverse and Baseline scenarios94
Banks have taken significant steps to enhance their forecasting capabilities since the adoption of stress testing
requirements:
• designing an organizational structure and governance framework to manage model development, validation, and
review and challenge of model results,
• enhancing existing models or developing new models to meet a wider range of use cases including regulatory stress
testing, business planning and BAU processes, and
• investing in new infrastructure to facilitate model execution and reduce production timelines.
The growing significance in forecasting for the purposes of complying with new regulatory requirements and use in BAU
processes has led to banks designing and implementing new organizational structures and governance to manage the
process. Enhancements to model execution have focused on increasing straight-through processing and implementing
automated sensitivity analysis to inform decision making by senior management. Leading banks are now in a state where
roles and responsibilities have been clearly defined, with different departments responsible for data provision, model
development and execution, model validation, and review and challenge of model outputs used in BAU processes or for
regulatory exercises (CCAR, DFAST and CLAR). Additionally, model governance has been streamlined to account for
differences between business planning, dynamic financial resource management and regulatory deliverables.
94
Data Source: CCAR results and scenarios.

Stress-testing requirements are part of the Dodd-Frank Act under section 165(i).95 Stress tests are a particular type of
forecast that is designed to test the adequacy of a bank’s liquidity and capital resources, with the aim of demonstrating
that a bank is well-capitalized or well-funded by passing the conditions of the test. Regulation YY requires stress tests for
capital adequacy and internal liquidity stress tests for all banks with total assets above $100 billion.96 Table 10 includes the
schedule for meeting stress testing and capital planning requirements for each category under tailored supervision.
Table 10: Tailored Requirements for Stress Testing
Company-Run Capital Supervisory Capital Plan Submission Internal Liquidity

Bank Category
Stress Tests Capital Stress Tests Stress Tests
Category I Annual Annual Monthly

Annual
G-SIB Framework
Method 1 or Method 2
Category II Monthly
Annual Annual Annual
≥ $700b Total Assets or
≥ $75b in
CrossJurisdictional Activity
Category III Biennially Monthly

Annual Annual
≥ $250b Total Assets or
≥ $75b in non-bank assets,
wSTWF, or off-balance
sheet exposure
Category IV Not Applicable Biennially, occurring in Quarterly

each year ending in an Annual
Other banks with $100b to even number
$250b Total Assets
1.4.2 Stress-Testing for capital adequacy

Stress-testing requirements were introduced as part of the Dodd-Frank Act under section 165(i).97 These requirements are
assessed through two supervisory programs: the Dodd-Frank Act Stress Test (DFAST) and the Comprehensive
Capital Analysis and Review (CCAR) (see Section 1.6 for additional information on the execution and expectations of
capital planning supervision). Stress-testing for capital adequacy includes supervisory stress tests and may include
company-run stress tests. Results from these stress tests are intended to show that the banks are generally well
capitalized and able to withstand a severe economic downturn. Supervisory stress tests refer specifically to an analysis
performed by the Board of Governors of the Federal Reserve System. The stress tests evaluate the financial resilience of
banks by estimating losses, revenues, expenses and resulting capital levels under hypothetical recession scenarios.98 The
outcomes of these tests inform senior management and a bank’s board of directors about a bank’s risk profile, as well as
provide broad-based confidence that the US financial system is resilient through publication of stress test results.
Supervisory Stress Testing Requirements
95
Office of the Comptroller of the Currency, “Dodd-Frank Act Stress Testing (DFAST) Reporting Instructions for the
DFAST-14A,” January 2022.
96
12 CFR 252 (Subparts B, D, E, F, N, O).
97
Office of the Comptroller of the Currency, “Dodd-Frank Act Stress Testing (DFAST) Reporting Instructions for the
DFAST-14A,” January 2022.
98
Board of Governors of the Federal Reserve, 2023 Stress Test Scenarios, Last update: February 22, 2023.

The Federal Reserve generates two scenarios for the supervisory stress tests, a “baseline” and “severely adverse,” which
subject a company’s relevant exposures and businesses to specified economic and financial conditions.99 The baseline
scenario generally reflects a set of conditions that affect the US economy or the financial condition of a covered company
and that reflect the consensus views of the economic and financial outlook.100 The severely adverse scenario is generally
characterized by conditions that overall are significantly more severe than those associated with the baseline scenario
and may include trading or other additional components, for example negative GDP growth, the unemployment rate
reaching at least 10%, equity markets declining by greater than 50% and credit spreads widening significantly.101
The Federal Reserve may also require the Global Market Shock (GMS) scenario and Largest Counterparty Default
scenario based on the size, complexity and risk profile of a company that has large trading and counterparty exposures.102
The GMS scenario simulates a severe market dislocation through specific market-factor instantaneous shock to individual
asset classes, such as BBB-rated corporate bonds or US equities (S&P 500). The counterparty default scenario simulates
the instantaneous default of a bank's largest counterparty. The profits and losses from these scenarios are incorporated
within the first quarter of the stress test planning horizon and provide an additional degree of conservatism to the stress
tests by ensuring this impact is reflected earlier within the projection of the bank’s capital ratios.103
Supervisory stress tests measure the depletion of a bank’s capital ratios, with common equity tier 1 capital (CET1) being
the binding constraint for most banks. Figure 18 below shows the average of bank starting CET1 ratios, minimum CET1
ratios, and CET1 depletion estimated across all CCAR exercises for US banks. The CET1 ratio, which measures the
proportion of common equity tier 1 capital to Risk Weighted Assets (RWA), is used to evaluate a bank's capitalization
through equity. The highest metric in the chart represents the starting CET1, the second is CET1 depletion, and the third
is minimum CET1. CET1 depletion measures the change in the amount of equity capital that would be lost in a severely
adverse economic scenario, and is calculated as the difference between peak CET1 and the trough of CET1 over the
nine-quarter projection horizon. This peak-to-trough calculation takes into consideration capital action assumptions that
include, for example, zero dividend payments on CET1 and zero issuance of new common or preferred stock.104 The chart
indicates that in the event of a severe economic contraction, banks can maintain adequate capital levels that are well
above minimum requirements even after distributing dividends for four quarters. While banks are in the midst of
concluding their submissions for the 2023 stress testing exercise, all 33 banks that participated in the 2022 annual stress
tests maintained capital ratios above their risk-based minimum capital requirements.
99
Previous requirements for an “adverse” scenario have been removed as part of the EGRRCPA.
100
12 CFR 252.42.
101
12 CFR 252.42.
102
Board of Governors of the Federal Reserve System, “Federal Reserve Board releases hypothetical scenarios for its
2022 bank stress tests,” (Press Release), February 10, 2022.
https://www.federalreserve.gov/newsevents/pressreleases/bcreg20220210a.htm.
103
Board of Governors of the Federal Reserve System, “Supervisory Scenarios, Dodd-Frank Act Stress Test 2019:
Supervisory Stress Test Results June-2020,” Last update: August 29, 2022.
104
Board of Governors of the Federal Reserve System, “Supervisory Stress Test Framework and Model Methodology,
Dodd-Frank Act Stress Test 2020: Supervisory Stress Test Results June-2020,” Last update: August 29, 2022.

Figure 18: Projected Average Capital Ratios in the Supervisory Severely Adverse Scenario105
Company-run Stress Testing Requirements
Larger banks are also required to perform additional company-run stress tests. Company-run stress tests refer to the
internally developed baseline and severely adverse scenarios that are developed in addition to scenarios provided by the
supervisors. Banks must use at least one scenario that stresses the specific vulnerabilities of the bank's activities and
associated risks, including those related to the company's capital adequacy and financial condition.106 Review of a bank’s
company-run stress testing models is a component of the CCAR exam, and banks are required to execute their
company-run stress tests annually. Guidance expects that banks provide quarterly updates to the board of directors on
capital adequacy and review capital planning processes either quarterly or semi-annually.107 This often includes running
company-run stress tests on a quarterly or semi-annual basis, even though the company-run submission is only required
annually or biennially.
The scenario design process is informed by banks’ risk identification process and associated risk assessment. In other
words, material risks identified in a bank's risk identification process should be stressed in the internally developed
severely adverse scenario. The stress tests are applied end-to-end to bank portfolios across banking and trading books.
Similar to supervisory stress tests, Regulation YY prescribes specific assumptions regarding capital distributions, such as
dividends and share repurchases, and other capital actions that may influence outcomes.108 As with supervisory stress
tests, the goal is to demonstrate that the largest banks can remain well-capitalized and absorb unexpected losses during
an economic downturn while continuing to lend to creditworthy businesses and consumers. Company-run stress tests are
105
Chart data includes all US Category I - IV banks that participated in each CCAR cycle and looks at the simple average
across their results. Note, up until 2015, the FRB measured tier 1 common ratios for assessing capital adequacy. From
2016 onwards, Common equity tier 1 capital ratios are assessed. The dotted line of 4.5% reflects the minimum CET1
requirement under Regulation Q.
106
Board of Governors of the Federal Reserve System, “Federal Reserve Supervisory Assessment of Capital Planning
and Positions for Firms Subject to Category I Standards” (SR 15-18), January 15, 2021.
107
Category I, II, and III banks are expected to provide quarterly updates to the board of directors on the bank’s capital
adequacy. Category I banks are expected to review capital planning processes quarterly, while Category II and III banks
are expected to review capital planning processes semi-annually. For additional information on capital planning
expectations see SR 15-18: Federal Reserve Supervisory Assessment of Capital Planning and Positions for Firms
Subject to Category I Standards, and SR 15-19: Federal Reserve Supervisory Assessment of Capital Planning and
Positions for Firms Subject to Category II or III Standards.
108
12 CFR 252.56(b).

publicly disclosed as well. Importantly, the company-run stress test results are required to be reported to the board of
directors, who are responsible for approving a bank’s capital plan and stress testing policies and procedures. As such,
these stress tests also support the safety and soundness of a bank’s operations by supporting corporate governance and
overall risk management.
Reporting Requirements
As part of the capital assessment and stress testing process, banks are required to generate and submit the following
regulatory reports:109
• FR Y-14A: an annual report that collects data on bank holding companies’ (BHCs), savings and loan holding
companies’ (SLHCs), and intermediate holding companies’ (IHCs) quantitative projections of balance sheet assets and
liabilities, income, losses and capital across a range of macroeconomic scenarios for internal projections of capital.
• FR Y-14Q: a quarterly report that collects detailed data on BHCs', IHCs', and SLHCs’ various asset classes, capital
components and categories of pre-provision net revenue (PPNR).
• FR Y-14M: a monthly report that collects data on BHCs', IHCs’, and SLHCs’ loan portfolios. The report is composed of
three loan- and portfolio-level collections and one detailed address matching collection.
1.4.3 Stress-Testing for liquidity coverage

In addition to capital-specific supervisory and company-run stress tests, the enhanced prudential standards within
Regulation YY also require a bank to run internal liquidity stress tests (ILST). Internal liquidity stress testing is a
scenario-based approach to assessing a bank’s liquidity profile and increases its resiliency by reducing the likelihood that
it will need extraordinary liquidity from the central bank, beyond the use of the Discount Window. Unlike capital-related
stress tests, which contemplates a 9-quarter horizon for absorbing losses, banks must consider more near-term
time-horizons within their scenarios: overnight, 30-day, 90-day, one-year, and any other planning horizons that are
relevant to the bank's liquidity risk profile.110 Liquidity stress test scenarios consider relevant factors, such as cash flows,
profitability and solvency, taking into account current liquidity conditions while also incorporating on- and off- balance
sheet exposures into stress testing assumptions.111 Additionally, these calculations must take into account the operational
requirements for monetizing assets as needed, and incorporate the impact of market and credit volatility to the fair value
of assets. Liquidity stress scenarios must reflect, at a minimum:112
• adverse market conditions;
• an idiosyncratic stress event for the bank; and
• combined market and idiosyncratic stresses.
The time-sensitivity of liquidity is linked to specific supervisory requirements for HQLA, such as cash or Treasuries, which
banks are required to hold to cover funding needs.113 Banks are required to maintain a liquidity buffer that meets the net
109
Board of Governors of the Federal Reserve System, “FR Y-14 Information Collection Q&As.” Last updated: February
10, 2023.
110
12 CFR 252.35(a)(4).
111
12 CFR 252.35(a)(1).
112
12 CFR 252.35(a)(3).
113
Covered banks are required to hold unencumbered and “high quality liquid assets” (HQLA), which is detailed in asset
requirements 12 CFR 252.35(b)(3). Criteria for Level 1, Level 2A and Level 2B HQLA is defined in 12 CFR 249.20.

stressed cash flow need for the 30-day planning horizon.114, 115 The liquidity buffer must be composed of highly liquid
assets, such as cash or assets with low credit and market risk, that are unencumbered and diversified. Category I-III
banks are required to run internal liquidity stress tests at least monthly; for Category IV banks at least quarterly.116, 117
Complex Institution Liquidity Monitoring Report (FR 2052a)
Shortly after finalizing the US LCR rule in 2014, the FRB established the Complex Institution Liquidity Monitoring Report
(FR 2052a) to improve oversight of banks subject to LCR and enhance supervision of liquidity across the industry.
Regulators noted that a single, consolidated view is not sufficient to understand an institution’s liquidity profile and
highlighted the need for insight into intercompany flows. The FRB’s 2052a data structure is designed to collect trade-level
details aggregated by unique combinations of common attributes, such as product, maturity, counterparty and legal entity
as a result.
2052a applicability and reporting instructions have been revised multiple times since its introduction. In fact, only the
largest banks were initially required to submit 2052a reports while smaller institutions submitted the Liquidity Monitoring
Report (2052b). However, in 2017, the FRB discontinued the 2052b and most banks transitioned to the 2052a.
The FRB’s most recent “6G” proposal, which became effective in 2022, included new elements to enable NSFR capture
as well as modifications to improve general monitoring. Collectively, “6G” requirements reflected significant changes to
liquidity reporting. Banks spent anywhere from 12 to 24 months analyzing new data sources, developing methodologies
and enhancing processes and controls ahead of the compliance date.
The report is currently divided into three general categories and thirteen tables:
• Inflows
– Assets
– Unsecured
– Secured
– Other
• Outflows
– Deposits
– Wholesale
– Secured
– Other
• Supplemental
114
The net stressed cash-flow need for a bank holding company is defined as the difference between the amount of its
cash-flow need and the amount of its cash flow sources over the 30-day planning horizon. See 12 CFR 252.35(b)(2).
115
12 CFR 252.35(b).
116
Is free of legal, regulatory, contractual, or other restrictions on the ability of such company promptly to liquidate, sell or
transfer the asset; and is either: Not pledged or used to secure or provide credit enhancement to any transaction; or
Pledged to a central bank or a US government-sponsored enterprise, to the extent potential credit secured by the asset is
not currently extended by such central bank or US government-sponsored enterprise or any of its consolidated
subsidiaries.
117
12 CFR 252.35(a)(2).

– Derivatives and Collateral
– Liquidity Risk Management
– Balance Sheet
– Informational
– Foreign Exchange
1.4.4 Loss estimation for reserves

Allowances for credit losses (ACL) are reserves that banks must set aside to cover expected losses on their lending
exposures. ACL is not part of capital, as ACL exists to absorb expected losses and capital is to absorb unexpected loss,
and increases in ACL generally need to be funded through capital and earnings. Reserving for expected loss requires a
methodology for estimating future credit losses that may occur. These forecasting and loss estimation methodologies are
consequential for the estimation of allowances for credit losses (ACL) through the introduction of the current expected
credit losses (CECL) methodology, which was issued by the Financial Accounting Standards Board (FASB) in 2016 and
replaced the existing methodology in Financial Instruments — Credit Losses - ASC 326 (the “Standard”).118
Accounting for expected credit losses is required upon recognition of the financial asset. The income statement reflects
the measurement of credit losses for newly recognized financial assets, as well as the change in expected credit losses
on existing assets occurring over the remaining life. In this update, the FASB introduced CECL as a replacement to the
existing Allowance for Loan and Lease Losses (ALLL) standard as a means of computing required reserves for loan
losses. CECL differs from the ALLL standard in that it requires lending institutions to measure expected credit losses over
the expected life of a financial asset. CECL was implemented partially to solve the recognition delay of credit losses on
financial assets under existing US GAAP at the time, by removing the probable initial recognition threshold. Additionally,
the Standard updated the loss recognition for available-for-sale (AFS) debt securities by requiring institutions to record
credit losses through an allowance for credit losses. Under previously applied US GAAP, the losses were recorded as a
write-down only when considered other than temporarily impaired. The Standard requires that entities record expected
credit losses in current period net income, which in turn should align the income statement recognition of credit losses
with the reporting period in which changes occur. Previously, applied incurred loss methodology considered only historical
information, and recognition of credit losses was only triggered when expectation of a loss passes the probable threshold.
Loss recognition was supported by observable evidence (e.g. decrease in collateral values, past-due status) combined
with expert judgment. Under CECL, the valuation of expected credit loss is based on relevant information about past
events, including historical experience, current conditions and reasonable and supportable forecasts that affect the
collectibility of the reported amount.
The updated standard applies to all banks, savings associations, credit unions and financial institution holding companies,
regardless of asset size. CECL became effective for most SEC filers at the beginning of 2020 and in 2023 for all others.
It is important to note that banks complying with International Financial Reporting Standards (“IFRS''), as opposed to US
GAAP, were made to implement a similar update to loss estimation methodologies, called IFRS 9. While the updated
credit impairment accounting guidance under both US GAAP and IFRS shift from an “incurred” loss model to an
“expected” loss model, the standards are not exactly the same. The major difference is that under US GAAP, the entire
lifetime expected credit loss on financial instruments measured at amortized cost is recognized at inception, whereas
under IFRS 9, generally only a portion of the lifetime expected credit loss is initially recognized. Subsequently, if there is a
significant increase in credit risk, the entire lifetime credit loss is recognized.119
118
In response to the financial crisis of 2008, the FASB revisited the accounting model for impairments of financial assets,
resulting in the issuance of ASU 2016-13, Financial Instruments — Credit Losses (codified in ASC 326). “7.1 CECL
Chapter Overview.” Chapter 7: Current expected credit losses impairment model. Loans & investments guide - July 2022,
PwC, September 30, 2022.
119
PwC, “Contrasting the new US GAAP and IFRS credit impairment models: A comparison of the requirements of ASC
326 and IFRS 9” No. US 2017-24. September 26, 2017.

CECL Adoption
Beginning with CCAR 2020, all banks were required to incorporate CECL into their stress scenario projections. While
stress testing and CECL have different objectives, there are many similarities in that both require the ability to reflect an
expected loss view given certain economic scenarios. CECL consolidates a number of impairment models that had
existed in US Generally Accepted Accounting Principles (GAAP) by covering a broad range of financial assets, including
certain off-balance sheet exposures. This estimation must consider historical, current and future economic conditions.120 In
doing so, CECL is intended to support a bank’s ability to be more responsive to economic conditions when setting aside
reserves for losses. As a practical matter, the requirement to consider the lifetime of the exposure has had the effect of
requiring more capital to be reserved, thereby increasing the capital cost for certain types of exposures.121
The adoption of CECL created extra operational costs during the transition period, where banks gathered new information
and data, and built and tested new models. However, these changes pushed many non-adopters (primarily non-public
institutions) to take a closer look at how they monitored and forecasted expected losses. Clients who had more
experience with CCAR were perhaps less incrementally impacted by the Standard given their existing size, complexity
and more rigorous stress testing regimes. Both non-CECL adopters and firms with mature stress testing programs alike
began to rethink their approach to credit loss forecasting. Institutions found that it was beneficial to ensure consistency
between stress testing, business loss forecasting and CECL in order to avoid non-intuitive (or contradictory) outcomes. In
addition, regulatory and general market expectations drove the adoption of more granular and complex modeling
approaches especially for non-public, non-CCAR institutions. Similar to the experience of 2020 adopters, the remaining
institutions which adopted on January 1, 2023, have experienced increases to their allowance estimates given the
life-of-loan requirements of the Standard.
The Federal Reserve conducted a study in December 2021, which compares how the allowance for loan losses changed
over 2020 and 2021 for banks that adopted CECL against those that had not (Figure 19).122 CECL adopters' allowances
responded more quickly than non-adopters to changes in the economic outlook. In the pandemic stressed economy
beginning in 2020, CECL adopters increased loss provisions more rapidly than non-adopters, and decreased loss
provisions more rapidly when the economy recovered in 2021. In addition, CECL adopters maintained a higher level of
allowances compared to non-adopters.
120
“7.1 CECL Chapter Overview.” Chapter 7: Current expected credit losses impairment model. Loans & investments
guide - July 2022, PwC, September 30, 2022.
121
122
ibid.

Figure 19: Allowances for CECL Adopters and Non-Adopters
The 2020 CECL transition provision123
In order to mitigate the impact of CECL implementation on banks’ retained earnings, Regulation Q subpart G § 217.301,
notes that if the Board-regulated institution records a reduction in retained earnings due to the adoption of CECL as of the
beginning of the fiscal year in which the Board-regulated institution adopts CECL, it may elect to use a CECL transition
provision.124 The transition period was initially set at three years. In September 2020, the Federal Reserve approved a
final rule which provides banking organizations that implemented CECL during the 2020 calendar year, the option to delay
for two years an estimate of CECL's effect on regulatory capital, relative to the incurred loss methodology's effect on
regulatory capital, followed by the original three-year transition period. This adjustment to the rule was enacted in light of
the economic disruption brought on by the COVID pandemic to alleviate pressure on the banks and allow them to
prioritize lending to support creditworthy households and businesses.125 In the transition period, an institution may elect to
use the transitional amounts and modified transitional amounts per the 2020 CECL transition provision calculation to
adjust its calculation of regulatory capital ratios during each quarter of the transition period in which a Board-regulated
institution uses CECL for completion of its Call Report or FR Y-9C.
The 2020 CECL final rule states that an electing banking organization must calculate transitional amounts for the following
items:
• retained earnings,
• temporary difference deferred tax assets (DTAs),
• and credit loss allowances eligible for inclusion in regulatory capital.
123
124
12 CFR 217.301.
125
Office of the Comptroller of the Currency, Treasury; the Board of Governors of the Federal Reserve System; and the
Federal Deposit Insurance Corporation, Final Rule for Regulatory Capital Rule: Revised Transition of the Current
Expected Credit Losses Methodology for Allowances. September 30, 2020.

To calculate the transitional amounts for these items, an electing banking organization must first calculate the CECL
transitional amount, the adjusted allowances for credit losses (AACL) transitional amount and the DTA transitional
amount. Calculations for each of these items are specified in the Table below:
Table 11: Transitional Amounts and Modified Transitional Amounts
Transitional Amounts and Modified Transitional Amounts
CECL transitional amount pre-CECL retained earnings* - post-CECL retained earnings** at adoption
Modified CECL transitional amount Adjusted to reflect changes in retained earnings due to CECL that occur during the first two years of the
five-year transition period
AACL transitional amount pre-CECL AACL* - post-CECL AACL** at adoption
Modified AACL transitional amount Estimated change in credit loss allowances attributable to CECL that occurs during the first two years of the
five-year transition period
DTA transitional amount pre-CECL DTA* - post-CECL DTA** at adoption due to temporary differences
* pre-CECL amount refers to the electing banking organization’s closing balance sheet amount for the fiscal year-end immediately prior to its adoption
of CECL
** post-CECL amount refers to the electing banking organization’s balance sheet amount as of the beginning of the fiscal year in which it adopts
CECL
The modified CECL and modified AACL transitional amounts are calculated on a quarterly basis during the first two years
of the transition period. An electing banking organization is not required to apply the transitional amounts in any quarter in
which it would not reflect a positive modified CECL transitional amount. A positive transitional amount is defined as a
period for which transitioning to CECL would result in a decline in retained earnings. A bank, however, may resume
applying the transitional amounts in the remaining quarters of the transition period if it calculates a positive modified CECL
transitional amount during any of those quarters. After two years, the cumulative transitional amounts become fixed and
are phased out of regulatory capital. The phase out of the transitional amounts from regulatory capital occurs over the
subsequent three-year period according to the Table below. Beginning in year six, the banking organization will not be
able to adjust its regulatory capital by any of the transitional amounts.
Table 12: CECL Transitional Amounts years 3-5
CECL Transitional Amounts to Apply to Regulatory Capital Components

Year 3 Year 4 Year 5
Increase retained earnings and average total consolidated assets by the following percentages of
the modified CECL transitional amount
Decrease temporary difference DTAs by the following percentages of the DTA transitional amount 75% 50% 25%
Decrease AACL by the following percentages of the modified AACL transitional amount
1.5 Trading and Counterparty Risk Management

Overview
Counterparty credit risk is the risk that a counterparty will default on its contractual obligations. During the crisis, fear that
one bank’s default could result in a cascade of defaults from other firms drove instability and uncertainty in financial
markets. New risk-management standards address these risks by reducing market and product complexity, placing limits
on counterparty exposures and prohibiting higher risk activities with hedge funds and private equity.

• Central Clearing and Margining: New requirements have reduced the complexity and financial risk of less
transparent over-the-counter (OTC) derivative markets through central clearing and margining mandates. Central
clearing for swaps facilitates increased product standardization, allows supervisors to better monitor market conditions
and reduces counterparty risk by ensuring that trades are subject to margin. Central clearing counterparties (CCPs)
also support contract performance and maintain additional mutualized financial resources that support market
functioning and reduce contagion risk in the event a firm defaults. Firms must maintain margin for non-cleared OTC
derivatives as well, which reduces the risk of exposure in the event of a counterparty default.
• Single Counterparty Credit Exposures: Regulation YY adopts aggregate limits on exposures to any single
counterparty to reduce the risk of financial contagion by preventing the failure of one financial firm from resulting in the
failure of others.
• Volcker Rule: Section 619 of the Dodd-Frank Act, referred to as “the Volcker Rule,” uses prohibitions to restrict
short-term proprietary trading and sponsoring hedge funds and private equity. The Volcker Rule is intended to prevent
banks taking excessive risk by using their own funds to invest in these areas. While the Volcker Rule was amended in
2020, the largest banks are still required to demonstrate compliance with the Volcker Rule through an extensive
program of internal controls, limits and monitoring of trading desks.
• SA-CCR: The adoption of Standardized Approach for Counterparty Credit Risk (SA-CCR) has increased the risk-based
capital requirements for the largest banks, as the exposure amount calculated using SA-CCR is higher than current
Internal Model Methodologies (IMM). Higher exposure amounts are driven by the conservatism of the alpha factor and
mitigated realization of benefit from both variation and initial margin, which impact replacement cost (RC) and potential
future exposure (PFR) calculations.126
1.5.1 Central Clearing and Margin

The Group of Twenty (G20) developed a framework that included, among other initiatives, the centralized clearing of OTC
derivative trades through centralized clearing counterparties (CCPs) and higher capital requirements for non-centrally
cleared derivative contracts.127 This framework intended to address the counterparty and interconnectedness risks posed
by international OTC derivative markets and increase transparency in the market overall.128 Title VII of the Dodd-Frank Act
adopted the reforms for the centralized clearing of OTC derivative products; while Regulation KK incorporated the rules
for margining uncleared swaps.129 This framework grants regulatory authority over the swap market to the Commodities
Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC), with respect to security-based
swaps.
Central Clearing
Since 2012, the CFTC and SEC have phased in clearing requirements, with the goal of reducing the complexity and
systemic risk of bilateral OTC derivative trades by requiring most swaps to be cleared through centralized clearing
126
ISDA and FIS, “SA-CCR: Why a Change is Necessary.”
127
Basel Committee on Banking Supervision and International Organization of Securities Commissions (IOSCO), “Margin
requirements for non-centrally cleared derivatives,” last modified April 3, 2020. G20 reforms also include proposals for
Swap Execution Facilities (SEFs) and Trade Repositories, which are not covered here.
128
See 15 U.S.C.§ 8302(d)(1).
129
Congress.gov “H.R. 4173 - 111th Congress (2009-2011): Dodd-Frank Wall Street Reform and Consumer Protection
Act: Title VII - Wall Stress Transparency and Accountability.” July 21, 2010.

counterparties (CCPs).130 The simplification of market structure is illustrated in Figure 20.131 CCPs reduce counterparty
credit risk for firms by aggregating collateral from their clearing members, whose trades are subject to initial and variation
margin, backed by additional mutualized resources to manage defaults. CCPs also improve market functioning by
guaranteeing contract performance and facilitating multilateral netting, which reduces aggregate notional exposures.
Figure 20: Bilateral vs. Centrally Cleared Market
The increase in global initial margin for cleared OTC derivatives (Figure 21) at the largest CCPs reflects the significant
progress made towards standardizing OTC derivative contracts for clearing and ensuring these types of counterparty
exposures are consistently margined. Initial margin for global cleared Interest Rate Derivatives and Credit Default
Swaps has increased from $129 billion to $336 billion, an increase of 160%. Moreover, the collateral maintained
by the largest CCPs is 46% cash, held either at the central bank or in commercial deposits.132
130
The CFTC adopted as final rule in 17 CFR Part 50, “Swap Transaction Compliance and Implementation Schedule:
Clearing Requirement Under Section 2(h) of the CEA;” the SEC adopted Rule 17Ad-22 in accordance with Section 17A of
the Securities Exchange Act of 1934 (“Exchange Act”), Section 763 of Title VII (“Title VII”) of the Dodd-Frank Wall Street
Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”), and Section 805 of Title VIII (“Title VIII”) of the
Dodd-Frank Act. Rule 17Ad-22 establishes minimum requirements regarding how registered clearing agencies must
maintain effective risk management procedures and controls as well as meet the statutory requirements under the
Exchange Act on an ongoing basis.
131
ISDA Research Note, “Evolution of OTC Derivatives Markets Since the Financial Crisis,” page 15.
132
Calculated with CPMI-IOSCO quantitative disclosures of LCH Ltd, CME Clearing, ICE Clear Credit, ICE Clear Europe.

Figure 21: Initial Margin for Cleared Interest Rate Derivatives and Credit Default Swaps133
Since the adoption of the central clearing mandate, 91% of interest rate derivatives (IRD) and 83% of credit
derivatives in the US have been cleared (Figure 22).134
Figure 22: Required Initial Margin for Cleared Interest Rate Derivatives and Credit Default Swaps135
In addition to margin, CCPs collect financial resources from their members in the form of a default or guarantee fund
contribution, which in the event of a clearing member default may be required to absorb losses and trigger cash
133
134
135
Ibid, page 17. Data for LCH inclusive of LCH SA and LCH Clearnet Ltd. Percentages based on traded notional
volumes.

assessments by the CCP. Given the concentration of clearing activity through CCPs, Title VIII of Dodd-Frank empowers
the Financial Stability Oversight Council (FSOC) to designate systemically important financial utilities, which would require
CCPs to meet enhanced supervisory standards.136, 137 Beside gains in transparency, the central clearing model presents
risks for banks, particularly in scenarios of market stress, where calls for variation margin and default fund assessments
could generate demand in liquidity and capital resources from CCPs (see Figure 23).138 The most recent example of this
occurred in 2018 at Nasdaq Clearing AB in Sweden, where volatility in the German-Nordic spread on electricity futures
resulted in the default of a clearing member. Once the CCP had finished auctioning the defaulter’s portfolio, the clearing
member’s prefunded resources had been exhausted, with further losses realized against the exchange’s committed
capital and the other members’ contributions to the commodity service default fund.139
Figure 23: Hypothetical Default Waterfall140
Margining Non-cleared Derivatives
The BCBS and IOSCO published initial guidance on margin requirements for non-centrally cleared derivatives in
September of 2013, which was further updated and revised in 2020.141 The goals of the standard are to prevent the
inconsistent margining of trade exposures, while promoting central clearing by increasing costs associated with
non-standard swap contracts.142 This principles-based approach sets expectations on margin collection, collateral
136
Designated financial market utility. The term ‘‘designated financial market utility’’ means a financial market utility that
the Financial Stability Oversight Council has designated as systemically important under § 1320.13.
137
Enhanced supervisory standards are informed by the CPMI-IOSCO Principles for Financial Market Infrastructures
(PFMI) and adopted by the CFTC and SEC, which are the primary supervisors for designated CCPs.
138
Umar Faruqui, Wenqian Huang and Előd Takáts, “Clearing risks in OTC derivatives markets: the CCP-bank nexus,”
BIS Quarterly Review. December 16, 2018.
139
ibid.
140
International Swaps and Derivatives Association (ISDA), “CCP Loss Allocation at the End of the Waterfall,” August
2013.
141
Basel Committee on Banking Supervision and International Organization of Securities Commissions (IOSCO), “Margin
requirements for non-centrally cleared derivatives,” last modified April 3, 2020.
142
ibid.

eligibility, including standardized collateral haircuts, methodologies for baseline margin collection and recommendations to
regulators for adopting consistent requirements across jurisdictions.143 In 2020, the CFTC and SEC adopted requirements
for collecting margin on swaps that remain uncleared, whereby swap dealers would be required to collect margin from a
counterparty for each outstanding position.144
The Federal Reserve has also adopted margin and capital requirements for swap entities under Regulation KK. For both
securities-based swaps and other swap products that remain uncleared or are not subject to the clearing mandate, a
dealer:145
• must collect and post variation and initial margin
• meet prohibitions or requirements surrounding the use of initial margin models
• may use third-party custodians for collateral management
• segregate accounts
• meet requirements relating to the rehypothecation of initial margin collateral
Consistent margining for uncleared swaps further reduces counterparty risk throughout the financial system as it now
ensures that financial resources will be available in the event of default to support liquidation of bilateral trades and
mitigate contagion between counterparties. Figure 24 shows the growth in initial margin held to cover uncleared trades
(Regulatory IM), and additional resources held to cover transactions that are not in scope for the non-cleared margin rules
(Independent Amount).146
143
ibid.
144
For non-cleared security-based swaps, SEC requirements are included in 17 CFR part 240, “Capital, Margin, and
Segregation Requirements for Security-Based Swap Dealers and Major Security-Based Swap Participants;” For
uncleared swaps, the CFTC requirements are included in 17 CFR part 23, “Swap Dealers and Major Swap Participants.”
145
US Securities and Exchange Commission, “At Joint Open Meeting, SEC and CFTC Approve Final Rule on Security
Futures Margin and Request for Comment on Portfolio Margining,” (Press Release), October 22, 2022.
146
ISDA 2021 survey. Margin levels reflect the 20 firms covered under phase one.

Figure 24: Regulatory Initial Margin (IM) and Independent Amount (IA) Received for Non-Cleared Derivatives147
1.5.2 Single-Counterparty Credit Limits (SCCL)

The final rule on the requirement for Single-Counterparty Credit Limits (SCCL) was published by the Federal Reserve
on October 5, 2018. As part of Regulation YY, the rule is applicable to large banks with total consolidated assets above
$250 billion, and foreign banking organizations with assets above $250 billion in US non-branch assets.148 This
requirement implements section 165(e) of the Dodd-Frank Act, which intended to reduce interconnectedness and the risk
of contagion between financial institutions by establishing limits on the amount of credit exposure a US or foreign holding
company can have to an unaffiliated entity.149 The rule requires covered institutions to calculate: aggregate net credit
exposure; gross credit exposure; and net credit exposure to a counterparty. SCCL includes the following two general
limits:150
• Aggregate net credit exposure to any counterparty cannot exceed 25% of tier 1 capital
• Aggregate net credit exposure to any major counterparty cannot exceed 15% of tier 1 capital.
When calculating gross credit exposure, banks must consider, for example:151
• Deposits
• Debt securities
147
Phase One firms include the largest and most active dealers, defined as those with an average notional amount of
non-centrally cleared derivatives (over certain 3-month periods) starting at USD 3 trillion in September 2016.
148
Board of Governors of the Federal Reserve System, “Summary” Final Rule for Single-Counterparty Credit Limits for
Bank Holding Companies and Foreign Banking Organizations. August 6, 2018.
149
Board of Governors of the Federal Reserve System, “I.Introduction: A. Background.” Final Rule for Single-Counterparty
Credit Limits for Bank Holding Companies and Foreign Banking Organizations. August 6, 2018.
150
For the SCCL, covered institutions are defined in 12 CFR 252.70(a)(2)(i) as Category I, II, and III bank holding
companies.
151
12 CFR 252.73(a).

• Equity securities
• Securities financing transactions (e.g. repos)
• Committed lines of credit
• Derivative transactions
The gross credit exposure is used to calculate the net credit exposure by incorporating eligible forms of collateral,
guarantees, equity and credit derivatives or other hedges. This includes any adjustments required for currency or maturity
mismatches.
If the net credit exposure to any counterparty exceeds 5% of tier 1 capital, the covered company must assess its
relationship with the counterparty to determine whether it is economically interdependent. The rule specifically defines two
counterparties as economically interdependent if the failure, default, insolvency or material financial distress of one
counterparty would cause the failure, default, insolvency or material financial distress of the other counterparty.152 The
criteria of this assessment process is detailed in Table 13.153
Table 13: Assessment Criteria for Economic Independence
Assessment Criteria for Economic Interdependence
Whether 50% or more of one counterparty's gross revenue is derived from, or gross expenditures are directed to,
Revenue
transactions with the other counterparty;
Whether counterparty A has fully or partly guaranteed the credit exposure of counterparty B, or is liable by other
Credit Exposure
means, in an amount that is 50% or more of the covered company's net credit exposure to counterparty A
Whether 25% or more of one counterparty's production or output is sold to the other counterparty, which cannot easily
be replaced by other customers;
Whether the expected source of funds to repay the loans of both counterparties is the same and neither counterparty
Source of Income
has another independent source of income from which the loans may be serviced and fully repaid
Whether two or more counterparties rely on the same source for the majority of their funding and, in the event of the
Source of Funding
common provider's default, an alternative provider cannot be found.
Banks are required to comply with counterparty limits on a daily basis at the end of each business day and report this
compliance to the Federal Reserve as of the end of the quarter.154 The Federal Reserve collects compliance with the
SCCL rule through FR 2590 forms.155 The form collects general information and descriptive information about the covered
company or covered foreign entity's exposures to its top 50 counterparties and the data required to calculate its gross
credit exposure, net credit exposure and aggregate net credit exposure to those counterparties in accordance with the
SCCL rule.
152
12 CFR 252.76(b)(1).
153
12 CFR 252.76(b)(2).
154
12 CFR 252.78(a).
155
Board of Governors of the Federal Reserve System, FR 2590 Single-Counterparty Credit Limits, Reporting Forms, Last
updated: October 31, 2022.

1.5.3 Volcker Rule
By implementing section 619 of the Dodd-Frank Act (the “Volcker rule”), regulators have sought to prohibit banking entities
from engaging in business activities that are perceived to have higher risk, such as proprietary trading or investing in or
sponsoring hedge funds or private equity funds. Specifically, the prohibition includes:156
• engaging in short-term proprietary trading of securities, derivatives, commodity futures and options on these
instruments for their own account.
• owning, sponsoring or having certain relationships with hedge funds or private equity funds, referred to as ‘covered
funds.’
Exemptions to the final rule include:
• Underwriting activity
• Market making
• Hedging activity
• Trading in certain government securities
• Trading of foreign banking entities
• Trading on behalf of a customer as a fiduciary or in a riskless principal trade, and activities of an insurance company for
its general or separate account
To comply with the Volcker Rule, banks are required to meet the six elements specified in the compliance program:
1. Written policies and procedures
2. Internal controls
3. Governance
4. Independent testing and audit
5. Training
6. Record keeping
The Volcker Rule was further revised in 2019 to simplify and ease, among other areas, the associated compliance
requirements by providing a tailored approach to the rule’s application. This includes the following categorizations:157
Table 14: Tailored Application of the Volcker Rule
Tailored Application of the Volcker Rule
156
Board of Governors of the Federal Reserve System, “Joint Press Release: Agencies issue final rules implementing the
Volcker rule,” (Press Release), December 10, 2013.
157
Office of the Comptroller of the Currency, Treasury (OCC); Board of Governors of the Federal Reserve System (Board);
Federal Deposit Insurance Corporation (FDIC); Securities and Exchange Commission (SEC); and Commodity Futures
Trading Commission (CFTC). Final Rule for the Revisions to Prohibitions and Restrictions on Proprietary Trading and
Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds, July 31, 2020.

Banks with trading assets and liabilities of at least $20 billion or more are required to meet the six elements of the
Full Compliance
compliance program and CEO attestation
Banks with trading assets and liabilities between $1 billion and $20 billion are required to meet a simplified compliance
Moderate Compliance
program with CEO attestation
Limited Compliance Banks with trading assets and liabilities below $1 billion are presumed compliant
1.5.4 SA-CCR158
On December 2, 2019, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve
System, and the Federal Deposit Insurance Corporation issued the final rule on the standardized approach for
counterparty credit risk (SA-CCR) calculation.159 SA-CCR was first proposed by the BCBS as an approach for
measuring exposure relating to a bank’s counterparty credit risk. This includes OTC derivatives, exchange-traded
derivatives and long settlement transactions. As a standardized approach, it is designed to simplify the calculation of
exposures and provide a replacement to existing Current Exposure Method (CEM) and the Standardized Method (SM).
Compared to SA-CCR, CEM and SM include limitations that result in less risk-sensitive outcomes. These limitations
include, for example, a lack of differentiation between margined and unmargined transactions, as well as insufficiently
capturing the level of volatilities observed over recent periods of stress.160 The SA-CCR methodology may be used by an
advanced approaches bank to calculate its advanced approaches total risk-weighted assets, and must be used to
calculate standardized risk-weighted assets. A non-advanced approaches bank may use SA-CCR or CEM to calculate its
standardized total risk-weighted assets.
The required use of SA-CCR by advanced approaches banks for determining the exposure amount of derivative contracts
translates to the capital framework through the Supplementary Leverage Ratio (SLR) through the bank’s total leverage
exposure. The mechanics of the SA-CCR calculation are as follows:
Exposure amount = alpha factor × (replacement cost + potential future exposure)
The SA-CCR rule became effective on April 1, 2020 with mandatory compliance required by January 1, 2022. In general,
the adoption of SA-CCR has increased the risk-based capital requirements for the largest banks, as the exposure amount
calculated using SA-CCR is higher than current Internal Model Methodologies (IMM). Higher exposure amounts are driven
by the conservatism of the alpha factor and mitigated realization of benefit from both variation and initial margin, which
impact replacement cost (RC) and potential future exposure (PFR) calculations.161
1.6 Supervisory Programming

Overview
Bank supervisory authorities perform regular examinations with the goal of identifying any material weaknesses that may
hinder or undermine the safety and soundness of a bank’s operations. Guidance, while not binding, establishes
expectations for how examiners assess and evaluate a banks’ policies and procedures. The output of the examination
process includes supervisory feedback that can be provided through Matters Requiring Attention (MRAs), which detail
supervisory requirements for remediating deficiencies; or further escalation using other enforcement tools that can inhibit
158
See Basel Framework (BIS) and the Federal Reserve’s site on Advanced Approaches Capital Framework
Implementation for additional information.
159
Board of Governors of the Federal Reserve System, Final Rule for Standardized Approach for Calculating the
Exposure Amount of Derivative Contracts. January 24, 2020.
160
See background of the BCBS “The standardised approach for measuring counterparty credit risk,” March 2014 (rev.
April 2014).
161
ISDA and FIS, “SA-CCR: Why a Change is Necessary.”

a bank’s growth or ability to return capital to shareholders. In providing this feedback, the supervisory community
contributes to the resilience of banks and mitigates the risk to financial stability by identifying materially deficient practices.
Consistent with the size-based approach to regulation that was introduced by the Dodd-Frank Act, the Federal Reserve
established the Consolidated Supervision Framework for Large Financial Institutions, which includes the Large Institution
Supervision Coordinating Committee (LISCC) for the supervision of G-SIBs. The goals of the Federal Reserve’s
supervisory programs include:162
• Enhancing resiliency of a bank across: capital and liquidity planning and positions; corporate governance; recovery
planning; management of core business lines; and
• Reducing the impact of a bank’s failure through: management of critical operations; support for banking offices;
resolution planning; and additional macroprudential supervisory approaches to address risks to financial stability.
These programs support the adoption of enhanced standards through horizontal examinations, some of which include
public disclosure of results, creating a new level of transparency into supervisory approaches, as well as accountability for
covered firms (Figure 25).
Figure 25: LISCC Supervisory Programs
The supervisory programs which assess the planning and adequacy of financial resources and their use for both going
and gone concern include:
• Capital: The Federal Reserve coordinates two horizontal exams that evaluate how a bank executes its stress testing
and capital planning: (1) The Dodd-Frank Act Stress Test, which includes supervisory stress tests that cover baseline
and severely adverse conditions; and (2) the Comprehensive Capital Analysis and Review (CCAR), which includes
company-run stress tests and the capital plan submission, in addition to supervisory-run stress tests. Through these
examinations, the Federal Reserve may prohibit a bank from paying dividends or executing share buy-backs if the
bank is at risk of breaching required levels of regulatory capital.
• Liquidity: The Comprehensive Liquidity Assessment and Review (CLAR) applies to Category I or global and
systemically important banks (G-SIBs). CLAR has three pillars that assess internal liquidity stress testing processes,
liquidity positions, and liquidity risk management. Supervisory feedback occurs through a midyear and final year letter
that contains a liquidity component rating.
• Recovery and Resolution: Title I of the Dodd-Frank Act requires the largest banks to produce “living wills” that
support their orderly wind down or recapitalization in the event of their failure. Regulation details the required
162
Board of Governors of the Federal Reserve System, “Consolidated Supervision Framework for Large Financial
Institutions” (SR 12-17), December 17, 2012.

components of resolution plans, while guidance outlines additional expectations for developing credible resolution
strategies. These plans are reviewed and assessed jointly by the Federal Reserve and FDIC, who provide feedback on
any deficiencies. The Federal Reserve also requires G-SIBs to maintain recovery plans, which provide an additional
set of actions a bank may take in order to prevent bankruptcy.
1.6.1 Capital planning

CCAR and DFAST
The evolution of financial requirements coincides with new supervisory programs, which also place greater emphasis on
resource planning and adequacy testing.163 For capital, the Supervisory Capital Assessment Program (SCAP), which was
an initial form of supervisory stress testing designed to restore confidence in the US financial system, informed the
development of the Dodd-Frank Act Stress Test (DFAST) and Comprehensive Capital Analysis and Review (CCAR). In
2020, the Board of Governors of the Federal Reserve integrated stress testing results into capital requirements by
introducing the stress capital buffer, which incorporates a measure of stressed capital consumption from DFAST into
on-going capital requirements.
These requirements are enacted in the form of two supervisory programs: the Dodd-Frank Act Stress Test (DFAST) and
the Comprehensive Capital Analysis and Review (CCAR). Both CCAR and DFAST are managed by the Federal
Reserve. Initially, supervisors could reject a bank’s capital plan for quantitative reasons, such as a breach of capital ratio
minima, or qualitative reasons if there were material weaknesses identified in the capital planning process. These
objections could prevent a bank from distributing capital in the form of dividends or share repurchases. Since 2019, the
qualitative assessment of the capital plan and capital planning processes has been incorporated into the supervisory
examination process, while the quantitative assessment has been removed and replaced by the stress capital buffer
(SCB) requirements.164 The Federal Reserve’s decision to limit the use of the qualitative objection reflected a view that
many banks had made significant progress in their capital planning, and that the supervisory process had sufficient tools
for addressing weak and deficient practices.165 Adoption of the stressed capital buffer more directly aligned stressed
capital needs with other non-stress capital requirements and minimums.
Capital Planning Requirements
In addition to running supervisory, and where relevant, company-run stress tests, banks are required to submit capital
plans annually. Beyond the regulations that detail capital requirements, banks are expected to demonstrate they have a
sound capital planning process with respect to the following:166, 167
• Governance
• Risk management
• Internal controls
• Capital policy
163
Board of Governors of the Federal Reserve System, “Consolidated Supervision Framework for Large Financial
Institutions” (SR 12-17), December 17, 2012.
164
Board of Governors of the Federal Reserve System, “Stress Tests,” Last updated: June 22, 2022.
165
Board of Governors of the Federal Reserve System, “Federal Reserve Board announces it will limit the use of the
"qualitative objection" in its Comprehensive Capital Analysis and Review (CCAR) exercise, effective for the 2019 cycle,”
(Press Release), March 6, 2019.
166
Regulation Q (12 CFR part 217), Capital Adequacy Requirements for Board-regulated Institutions; Regulation YY (12
CFR part 252, subparts E and F); Regulation LL (12 CFR part 238, subparts O, P, and S); and Regulation Y (12 CFR
225.8).
167
and Positions for Firms Subject to Category I Standards” (SR 15-18), January 15, 2021. Category II and Category III
banks are subject to SR 15-19.

• Incorporating stressful conditions and events
• Estimating impact on capital positions
Regulation Y prescribes specific elements for a capital plan that include, among other requirements:168
• An assessment of the expected uses and sources of capital under baselines and stressed scenarios, including
estimations for revenues, losses, and pro forma capital levels; consideration of legal and regulatory requirements; and
a description of any capital distributions or actions taken over the planning horizon.169, 170
• A description of the bank holding company's process for assessing capital adequacy that details how the company will
maintain capital above the regulatory capital ratios and continue to operate under stress.
• The bank holding company's capital policy.
• Any expected changes to the bank holding company's business plan that are likely to have a material impact on capital
adequacy or liquidity.
To support consistent and repeatable capital planning, banks are expected to have and maintain policies and procedures
that cover “risk-identification, measurement and management practices and infrastructure; methods to estimate inputs to
post-stress capital ratios; the process used to aggregate estimates and project capital needs; the process for making
capital decisions; and governance and internal control practices…including detailed information to enable independent
review of key assumptions, stress testing outputs, and capital action recommendation.”171
The modeling process should be subject to particular scrutiny, especially with regards to:172, 173
• Model use and estimation approaches
• Model overlays
• Use of benchmark models
• Sensitivity analysis and assumptions management
• Scenario design
• Risk-weighted asset (RWA) projections
• Operational loss projections
168
12 CFR 225.8(e)(2)(i-iv).
169
Consistent with tailoring, Category IV banks must include an internal baseline and at least one internal stress scenario,
while Category I-III will include internal baseline, at least one internal stress, and any scenarios provided by the Federal
Reserve.
170
12 CFR 225.8(e)(2).
171
and Positions for Firms Subject to Category I Standards” (SR 15-18), January 15, 2021. pg 8-9.
172
The Federal Reserve and the OCC published joint guidance in 2011 “Supervisory Guidance on Model Risk
Management” (SR 11-7) that covers supervisory expectations on model risk management, model development,
implementation and use, model validation, and related governance, policies, and controls.
173
and Positions for Firms Subject to Category I Standards” (SR 15-18), January 15, 2021.

1.6.2 Liquidity
In February 2012, the Federal Reserve established the Comprehensive Liquidity Assessment and Review (CLAR) as
part of its supervisory framework for large and complex financial institutions under the Large Institution Supervision
Coordinating Committee (LISCC).174 CLAR provides a horizontal assessment of liquidity risk and risk-management
practices at large banks, including liquidity stress testing planning and processes.175 Consistent with other supervisory
programs, CLAR produces a final rating that is provided to the banks through formal feedback letters twice a year.
Supervisory feedback and the need to address any weaknesses identified further strengthens the safety and soundness
of a bank’s liquidity risk management.
This assessment is performed across three pillars:176
Table 15: Three Pillars of CLAR
Pillar I Pillar II Pillar III

(Internal Stress Testing) (Liquidity Position) (Liquidity Risk Management)
Liquidity Risk Measurement Liquidity Position Liquidity Risk Management
• Evaluation of internal liquidity stress testing • Evaluation of the liquidity position of a bank • Evaluation of liquidity risk management
including assumptions and output from the using the Federal Reserve’s internal metrics practices, which includes requirements for
following scenarios: and publicly available models and data, policies and procedures that cover:
– A scenario reflecting adverse market including: – Governance
conditions; – Liquidity adequacy – Contingency funding
– A scenario reflecting an idiosyncratic – Funding structure – Liquidity event management
stress event for the bank holding – Market access – Liquidity risk limits
company; and – Liquidity testing and monitoring
– A scenario reflecting combined market
and idiosyncratic stresses.
Pillar I and Pillar III of CLAR also support liquidity risk reviews necessary for the Supervisory Assessment of Resolution
and Recovery Preparedness.
1.6.3 Recovery and Resolution Planning

Resolution Planning
On November 30, 2011, the Federal Reserve and the FDIC adopted section 165(d) of the Dodd-Frank Act requiring large
bank holding companies to submit Living Wills (resolution plans under Title I) periodically.177, 178 The supervisory
framework for resolution planning is supported by enhanced prudential standards and newly published supervisory
guidance. Specifically, this includes additional rule-making (Regulation QQ), inclusive of additional capital requirements
174
12 CFR 252.35.
175
The bank holding companies within the LISCC portfolio are Category I global systemically important banks (G-SIBs).
176
Office of the Inspector General, Knowledge Management for the Board’s Comprehensive Liquidity Analysis an Review
Is Generally Effective and Can Be Further Enhanced, September 5, 2018, p. 9-11.
177
Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation, Final Rule for
Resolution Plans Required. November 30, 2011.
178
The FDIC has an additional resolution planning requirement for Insured Depository Institutions, 12 CFR § 360.10.

(Regulation YY, TLAC Rule), and guidance for “Heightened Supervisory Expectations for Recovery and Resolution
Preparedness” (SR 14-1), which has been superseded by the Final Guidance for 2019.179
The goal of the resolution planning process is to detail how an institution can be unwound in a rapid and orderly manner
without having broader adverse impacts on financial stability. To demonstrate this to the Federal Reserve and FDIC,
banks are required to develop and submit a resolution plan, part of which is confidential and the other made public.180
Resolution plans must incorporate consideration of various areas of enterprise risk management including capital and
liquidity allocation, in addition to other considerations that relate to the bank’s governance, operations and legal structure.
These considerations must credibly show that a bank is resolvable under bankruptcy and can generate the necessary
resources to support restructuring, including through the sale or wind down of businesses if needed. To ensure these
considerations are fully reflected in submissions, Regulation QQ requires that full resolution plans should include the
following sections:
• Executive summary
• Strategic analysis
• Corporate governance relating to resolution planning
• Organizational structure and related information
• Management information systems
• Interconnections and interdependencies
• Supervisory and regulatory information181
The Regulation allows for the FDIC and FRB to request additional targeted information which they have most recently
done following the COVID-19, pandemic-fueled market stress.182
In its original inception, these requirements applied to any bank holding company with consolidated assets of $50 billion or
more, as well as non-bank financial companies designated by the Financial Stability Oversight Council (FSOC). The first
resolution plans were filed with the FDIC and Federal Reserve between 2012 and 2013, with the initial expectation that
these plans would be updated and filed on an annual basis.
Since the passage of the EGRRCPA, which reformed certain provisions of the Dodd-Frank Act, the Federal Reserve has
made several changes to the resolution planning supervisory program, which include changes to the scope of filers,
submission cycles and required content. Consistent with these reforms, which are captured as part of the Tailoring Rule,
the following changes have been adopted since 2019:183
179
See 12 CFR 243; 12 CFR 252; Board of Governors of the Federal Reserve System, Final Rule for Total
Loss-Absorbing Capacity, Long-Term Debt, and Clean Holding Company Requirements for Systemically Important US
Bank Holding Companies and Intermediate Holding Companies of Systemically Important Foreign Banking Organizations.
January 24, 2017.; and Board of Governors of the Federal Reserve System, “Heightened Supervisory Expectations for
Recovery and Resolution Preparedness for Certain Large Bank Holding Companies - Supplemental Guidance on
Consolidated Supervision Framework for Large Financial Institutions (SR letter 12-17/CA letter 12-14)” (SR 14-1), January
24, 2014.
180
Board of Governors of the Federal Reserve System and Federal Deposit Insurance Corporation, “Section I:
Background,” Final Guidance for the 2019, February 4, 2019.
181
12 CFR 243.5(b) - 243.5(h).
182
Board of Governors of the Federal Reserve System, and Federal Deposit Insurance Corporation “Agencies announce
several resolution plan actions,” (Joint Press Release), December 9, 2020.
183
The Tailoring Rule applies to Regulation LL, Regulation YY, and Regulation QQ to ensure consistency with the
Economic Growth, Regulatory Relief, and Consumer Protection Act.

• Regulation QQ has been amended to apply to any bank holding company with $250 billion or more in total
consolidated assets, as determined based on the average of the company's four most recent Consolidated Financial
Statements for Holding Companies as reported on the Federal Reserve's Form FR Y-9C.184
• Submission cycles have been altered to reflect a bank’s size and risk. Currently, large and complex banking
organizations are required to file a resolution plan every other year (Category I), while other US bank holding
companies and foreign banking organizations (FBOs) are required to file a resolution plan every three years (Category
II and Category III). A third group of banks are required to submit abbreviated resolution plans every three years (Other
FBOs).185
• Biennial and Triennial full filers will be required to submit full resolution plans and tactical resolution plans on an
alternating basis, while Triennial reduced filers will need to submit only a reduced resolution plan.186
The review and assessment of resolution plans is conducted jointly by the Federal Reserve and FDIC, which jointly decide
whether a resolution plan is credible. If a resolution plan is determined to be deficient, a bank must resubmit their
resolution plan within 90 days of receiving the notification, which will include written detail on the areas of the plan that
undermine its feasibility.187
Recovery Planning
In addition to resolution planning, the Federal Reserve maintains an additional requirement for large and complex financial
institutions to submit recovery plans. The Federal Reserve issued guidance on consolidated Recovery Planning,
“Consolidated Recovery Planning for Certain Large Domestic Bank Holding Companies” (SR 14-8) on September 25,
2014 for the eight domestic bank holding companies in the Large Institution Supervision Coordinating Committee (LISCC)
portfolio, which is designed to help large banks address the need for adequate and feasible plans in response to severe
stress.188 Specifically, a plan for recovery is meant to increase the resilience of a bank by providing a set of actions that
can be taken in a timely manner, which will support a bank’s ability to return to a position of financial strength, thereby
reducing the possibility of bankruptcy and insolvency.
The expected components of a recovery plan include: internal governance, recovery options, execution plan and impact
assessment. Both timeliness of action and efficacy of decision-making are essential components to the credibility of a
recovery plan, which should contain, among other things, triggers for escalations, options for supporting capital and
liquidity, including the sale, transfer, or disposal of assets to raise funds, as well as operational assessments and
assumptions that are critical for influencing the implementation and feasibility of various options.189 In this respect,
184
Under Regulation QQ a covered company can also refers to: any non-bank financial company supervised by the
Board; any global systemically important bank holding company (BHC); any foreign bank or company that is a bank
holding company or is treated as a bank holding company under section 8(a) of the International Banking Act of 1978 (12
U.S.C. 3106(a)), and that has $250 billion or more in total consolidated assets, as determined annually based on the
foreign bank's or company's most recent annual or, as applicable, quarterly based on the average of the foreign bank's or
company's four most recent quarterly Capital and Asset Reports for Foreign Banking Organizations as reported on the
Federal Reserve's Form FR Y-7Q; and any additional covered company as determined pursuant to § 243.13.
185
Regulation QQ defines a biennial filer as: (i) any global systemically important BHC; and (ii) any non-bank financial
company supervised by the Board that has not been jointly designated a triennial full filer by the Board and Corporation or
that has been jointly re-designated a biennial filer by the Board and the Corporation; a triennial filer is: (i) any Category II
banking organization; (ii) any Category III banking organization; and (iii) any non-bank financial company supervised by
the Board that is jointly designated a triennial full filer by the Board and Corporation; and triennial reduced filer is: any
covered company that is not a global systemically important BHC, non-bank financial company supervised by the Board,
category II banking organization, or category III banking organization.
186
12 CFR 243.6(b); 12 CFR 243.7; 12 CFR 243.4(a-c).
187
12 CFR 243.8(a-c).
188
Board of Governors of the Federal Reserve System, “Consolidated Recovery Planning for Certain Large Domestic
Bank Holding Companies” (SR 14-8), September 25, 2014.
189
ibid.

recovery plans should complement resolution planning by supporting the financial resilience of the consolidated
organization, which supports the insured depository institution; and complement other areas of business-as-usual risk
management, including capital management, which is built on a detailed understanding of the bank’s operations, risk
profile and material legal entities.
Enhanced Resolution Capabilities of Supervisory Authorities
Further supplementing the new requirements for covered entities, the Dodd-Frank Act provided new resolution-specific
authorities under Title II, which support the capacity of the Federal Deposit Insurance Corporation (FDIC) to manage the
orderly liquidation or restructuring of a complex financial institution in bankruptcy.
Orderly Liquidation Authority (OLA) was enacted in the Dodd-Frank Act under Title II in July 2010 to provide efficient
liquidation of large, complex financial institutions, to eliminate the potential of future government bailouts and to reduce
moral hazard associated with failing financial companies. As an alternative to bankruptcy, OLA allows for the FDIC to be
appointed as a receiver to carry out the liquidation process within a three-to-five-year timeframe. While certain conditions
must be met for the FDIC to be appointed as receiver, post-appointment, the FDIC is empowered to transfer or sell
assets, create bridge financing and new organizations or ensure that valid claims are paid.190 The administrative cost
associated with this authority is supported by the creation of the Orderly Liquidation Fund (OLF), which is managed by
the US Treasury.191 Unlike the FDIC’s pre-funded resources, the OLF would operate through a loan provided to the FDIC
from the US Treasury to support the resolution process, with any net losses to be repaid by the surviving company.
Title II resolution is further supported by the preferred strategy of Single Point of Entry (SPOE), which is designed to allow
for the parent holding company to be placed into receivership, while other solvent subsidiaries, including overseas
operations, can continue operating as usual and meeting financial obligations to minimize disruption. Through SPOE, the
FDIC would be able to facilitate the transfer of solvent businesses to a bridge entity, supported by the OLF, while isolating
the failing entities within the holding company, where equity and debt holders would absorb losses.192
Beyond the legal enhancements provided by the Dodd-Frank Act, greater coordination among relevant supervisors,
central banks and other resolution authorities has been supported by the establishment of Crisis Management Groups
(CMGs), which are designed to support the sharing of information between key stakeholders across home and host
country jurisdictions where large and systemically important financial institutions have operations. The cooperation across
authorities within and between jurisdictions is informed by the Financial Stability Board’s Good Practices for Crisis
Management Groups, which provides guidance on the structure and operation of CMGs and the ways in which they can
assist coordination and crisis preparedness.193
1.7 Supplemental Enhancements to Risk Management

Overview
Effective risk management is supplemented by strong corporate governance and oversight, dependent on management
information systems that provide accurate and timely information when decisions are made that materially affect a banks’
exposures. The board of directors are specifically required to play a role in supporting the stature and independence of
risk management in a bank, and rely on detailed reporting to make informed judgments when setting bank strategy, risk
appetite and approving capital plans. Additionally, senior management need robust information systems to execute
business strategy within risk limits. Enhanced prudential standards and guidance detail how policies, procedures and
reporting are a critical part of a bank’s risk-management framework and support a bank’s capacity to both consider and
reduce risk across businesses and products.
190
Congress.gov, “Section 203: Systemic Risk Determination, Title II: Orderly Liquidation Authority.” H.R. 4173 - 111th
Congress (2009-2011): Dodd-Frank Wall Street Reform and Consumer Protection Act. July 21, 2010.
191
Congress.gov, “Section 210(n): Powers and duties of the Corporation, Title II: Orderly Liquidation Authority.” H.R. 4173
- 111th Congress (2009-2011): Dodd-Frank Wall Street Reform and Consumer Protection Act. July 21, 2010.
192
US Department of the Treasury, “Orderly Liquidation Authority and Bankruptcy Reform,” February 21, 2018.
193
Financial Stability Board, Good Practices for Crisis Management Groups (CMGs), November 30, 2021.

• Leveraged Lending Guidance – Leveraged lending guidance (SR 13-3) encourages stronger underwriting and credit
risk-management practices for leveraged lending activities given lender protections were often relatively limited in
leveraged loans prior to the guidance being released. By stressing loan portfolios, banks are expected to better
measure and manage their risk to loans and the securitization pipeline.
• Corporate governance and the role of the board of directors: Among its responsibilities, a Board of Directors
approves a bank’s strategy, risk appetite statement and capital plan. Regulation YY and additional guidance on board
effectiveness (SR 21-3) affirm the critical role that the Board of Directors has in contributing to a bank’s financial and
operational resilience given its oversight of the bank’s risk profile. Under Regulation YY, the Board of Directors of a
banking organization is required to have an independent risk committee with responsibilities for overseeing
risk-management policies, procedures and systems. Additionally, a Board should effectively engage senior
management, including oversight and accountability, and direct senior management regarding the board’s information
needs.
1.7.1 Leveraged Lending

Guidance on Enhanced Leveraged Lending (SR 13-3) was published by the Federal Reserve on March 21, 2013, which
updated and replaced the 2001 guidance on leveraged financing.194 The goal of the guidance is to provide a set of
practices and principles for institutions to follow when underwriting and managing leveraged loans. Since the issuance of
the 2001 guidance, the volume of leveraged credit and the participation of unregulated investors has increased
significantly. Additionally, debt agreements have frequently included features that provided relatively limited lender
protection including, but not limited to, the absence of meaningful maintenance covenants in loan agreements or the
inclusion of payment-in-kind (PIK)-toggle features in junior capital instruments, which lessened lenders' recourse in the
event of a borrower's subpar performance.195
The guidance encourages safe and sound practices by recommending the use of a sound risk management framework
and maintaining effective underwriting requirements for loans associated with high leverage. For example, to support the
management of risk within leverage lending, the guidance expects banks to maintain credit risk management policies and
procedures that should include, among other items:
• a limits framework for single obligors and transactions, the aggregate hold portfolio, aggregate pipeline exposure, and
industry and geographic concentrations;
• underwriting standards for the origination of loans and acquisition of secondary loans;
• and processes for the ongoing monitoring of credit quality, including the management of problem credits, which should
be supported by appropriate valuation methodologies.
Banks are also expected to conduct stress tests on leverage loan portfolio, as well as loans planned for distribution, at
loan and portfolio levels. These results should be integrated into the institution-wide stress testing engagements. The
benefit of these practices should be further supported by effective management information systems, which are essential
to support risk oversight by senior management and the board of directors, and are necessary for the maintenance of a
bank’s approved risk appetite limits. The guidance recommends that management acquire reports about the attributes of
the institution’s leveraged lending portfolio quarterly. The internal policies should highlight the specific data fields attained
by management information systems, which provide accurate, reliable and on-time reporting to management and the
board of directors.
These practices should contribute to sound risk governance and control, aided by reporting and analytics that enable
management to identify, aggregate and monitor leveraged exposures and comply with policy across all business lines.
194
Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, and Office of the
Comptroller of the Currency, “Interagency Guidance on Leveraged Lending” (SR 13-3), March 21, 2013.
195
Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, Office of the Comptroller
of the Currency, “Interagency Guidance on Leveraged Lending” (SR 13-3), March 21, 2013.

1.7.2 Corporate governance and the role of the board of directors
The board of directors has a critical role in supporting the safety and soundness of a bank through their oversight of senior
management, and responsibilities surrounding the oversight of a bank’s risk profile. In this capacity, an effective board of
directors can contribute to the prevention of excessive and speculative risk-taking by effectively challenging management
decision-making and foster greater accountability where material weaknesses are identified in risk management and
information systems. To achieve this goal, Regulation YY requires a board of directors to establish an independent risk
committee. The independence of the risk committee, which must meet quarterly and report directly to the board of
directors, reflects the importance of its role as an input into the board’s broader effectiveness, particularly its responsibility
to approve risk appetite and bank strategy.196 The enhanced prudential standard requires the scope of the risk committee
to consider and maintain:197
• A risk-management framework
• Corporate governance requirements
• Minimum member requirements
Additional guidance (SR 21-3) provides recommendations for how the board should execute its core responsibilities in a
manner that supports the alignment of risk appetite and bank strategy. This includes challenges to management
recommendations, inquiry into material deficiencies within risk management or internal controls and promotion of
compliance with laws and regulations.198 The Board can support the reduction and management of risk by supporting the
establishment of risk management processes and control functions and maintaining appropriate resources that support
the independent stature of risk management within the bank’s operations. This includes support for a Chief Risk Officer
(CRO) who is responsible for, among other things:199
• The establishment and oversight of risk limits
• Implementation of and ongoing compliance with the policies and procedures
• The management of risks and risk controls, including remediation of deficiencies
• Reporting risk-management deficiencies and emerging risks to the risk committee
The board of directors performs an essential role in the governance of a bank holding company and should align risk and
incentives to promote the ongoing financial and operational resilience of the bank in a way that promotes general safety
and soundness.200
1.8 Conclusion
In summary, post-GFC regulatory reforms have strengthened financial resources and banks’ risk management capabilities
to support the financial industry in an economic downturn or period of market turmoil. Given that Basel III Endgame is
expected to materially increase capital requirements, the next section evaluates the literature analyzing optimal capital
levels and compares estimates of optimal capital levels to the levels in the system today.
196
Board of Governors of the Federal Reserve System, “Supervisory Guidance on Board of Directors' Effectiveness” (SR
21-3), February 26, 2021.
197
12 CFR 252.22(a).
198
21-3), February 26, 2021. See section 3, “Oversee and Hold Senior Management Accountable.”
199
12 CFR 252.22(b)(2).
200
21-3), February 26, 2021. See “Introduction.”

Section 2: Literature Review
2.1 Overview
There has been extensive study of capital requirements by researchers given its far-reaching implications for lending
activity, macroeconomic growth and financial stability. Consequently, regulators, international standard-setting
organizations and academics have explored ways to estimate the benefits and costs of capital requirements. They have
achieved this by examining the effects of these requirements and quantifying optimal capital levels, with the aim of guiding
policy-making and capital management practices within the industry.
The purpose of this section is to analyze the available research and synthesize the key conclusions that can be drawn
when considering what optimal capital levels should be and evaluate how the literature can inform policy debates
regarding the impact of capital levels on economic growth and financial stability.
In performing this review, this analysis considers a broad scope of literature that attempts to assess the benefits and costs
of increasing capital requirements. The initial exploratory analysis identified over 20 published papers. From the initial list,
a selection process narrowed down the scope to 11 most relevant papers, prioritizing those that met the following criteria:
are authored by key regulators, standard-setting bodies or academics; and consider a broad range of post-GFC regulatory
regime elements (e.g., TLAC, liquidity regulations) or the impact of the non-bank financial sector. For analysis of optimal
capital levels, the selection process applied the further filtering criteria of selecting papers that conclude with an optimal
capital level or optimal range of capital levels. Of the 11 papers, six met this final criteria, while five did not conclude with
an optimal capital level estimate.201
This section then evaluates the 11 most relevant papers to identify predominant schools of thought, including common
approaches, assumptions and outcomes. It also identifies limitations that some more recent studies have tried to address
and those that persist in the current literature.
The basic framework for evaluating optimal capital levels is consistent throughout the initial scope of literature and was
established over fifteen years ago. Subsequent papers have built upon this basic framework to incorporate new
regulations, additional data, and other considerations. In the framework, there is a general consensus that increased
capital requirements result in a marginal benefit and a marginal cost to the economy:
• Marginal benefit: Researchers generally define the marginal benefit to be an improvement in the financial stability of
the commercial banking sector, as measured by a lower frequency and severity of a crisis stemming from the sector.
As such, increased capital requirements translate to a financial system that is better able to function smoothly and
efficiently, absorb shocks, allocate resources, and manage risk effectively.
• Marginal cost: Researchers generally define the marginal cost to be a reduction in macroeconomic growth, driven by
greater capital requirements increasing bank funding costs. Within the basic framework, the increase in bank funding
costs is ultimately passed on to borrowers, reducing lending volume and investment.
For both marginal costs and benefits, the analysis in the literature has expanded to consider interactions with non-bank
financial intermediaries on both growth and financial stability. It has also begun to incorporate how post-financial crisis
changes in the regulatory environment and market practices also impact the likelihood of financial stress. The non-bank
financial sector consists of money market funds, the insurance sector, the government-sponsored enterprises (Fannie
Mae, Freddie Mac, and the Federal Home Loan Bank system), hedge funds and other investment vehicles, and other
non-bank lenders. Regulators do not generally subject these non-bank financial intermediaries to the enhanced regulatory
standards imposed on banks.202 While non-bank lenders are a diverse group of institutions with varying levels and sources
of capital, these entities are generally more thinly capitalized and, with the exception of the GSEs, not prudentially
201
For a complete discussion of the papers evaluated, selection criteria and rationale, and analysis of papers that do not
conclude with an optimal capital level, please see Section 2.2 Literature Review Scope.
202
This definition is aligned with the one used in Michael S. Barr’s speech “Why Bank Capital Matters,” December 1,
2022. Available at https://www.federalreserve.gov/newsevents/speech/barr20221201a.htm

regulated. Although these entities have a fiduciary responsibility to maximize returns for their clients, taking into account
investment objectives and suitability, and some act as opportunistic buyers of financial assets in stress, research suggests
that a subset of non-bank financial intermediaries reduce syndicated lending more than commercial banks during
crises.203 The additional considerations outlined above influence the level of benefit and cost that is netted to determine an
optimal capital level that maximizes growth and welfare.
Another challenge in determining an optimal level of capital is that the benefit and cost of additional capital depends on
the current level of capital, with the marginal benefit declining and the marginal cost increasing as the level increases. For
instance, if capital levels are near zero, the probability and cost of a future financial crisis is high, negatively impacting
growth. On the other hand, if firms were 100% capitalized with equity, there would be significantly less lending, also
negatively impacting growth. The papers try to tackle what optimal capital levels are, while balancing the benefits and
costs.
Researchers have used a common basic framework to determine an optimal range of capital levels through the lens of
two impact channels:
1. Impacts to financial stability: The theory of why higher capital impacts financial stability is based on the fact that
greater capital requirements reduces commercial banking leverage, reducing the probability and cost of a financial
crisis stemming from commercial banks. This has an impact on overall macroeconomic growth and stability, as the
failure of very large, or otherwise important banks has potential implications beyond the banks’ shareholders. This
contagion effect can happen if a bank has to conduct a fire sale of assets in its portfolio or its failure leads to the
failure of other large financial institutions through counterparty relationships. The failure of a large bank may also
lower confidence in the banking system, reduce liquidity, and lead to disruption in the supply of credit. However, at the
same time, some papers consider that increased commercial banking capital requirements may shift credit creation
activities towards the non-bank financial sector, increasing leverage in that sector and potentially offsetting some of
the gains in financial stability.
The Figure below depicts the predominant school of thought regarding the impact of increased capital requirements
on financial stability:
203
Source: Non-bank lending during crises, February 2023 (BIS). https://www.bis.org/publ/work1074.pd

Figure 26: Impacts to Financial Stability204
2. Impacts to the supply of credit: The predominant theory of how higher capital impacts the supply of credit is that
greater capital requirements increase a commercial bank’s funding costs, which increases its lending rates and
reduces its loan volumes. However, there are some alternative ideas that posit that the relationship is nonlinear or that
there has been no evidence of greater capital requirements being associated with greater lending rates. One
alternative school of thought is that greater capital requirements are associated with a decrease in cost of debt,
including deposits, over time, allowing banks to reduce their overall cost of funds under a stricter capital regime and
increase loan volume. Additionally, some papers consider that increasing capital requirements for commercial banks
may lead to reduced bank lending activity, with non-bank lenders likely filling some or all of the unmet financing
demand. While the participation of non-bank financial intermediaries promotes effective competition in the financial
sector, some research suggests that non-bank financial intermediaries reduce syndicated lending more than
commercial banks in times of stress.205
The Figure below depicts the predominant school of thought regarding the impact of increased capital requirements
on the supply of credit:
204
Under “Bank’s Response”, banks may also increase capital by issuing equity. However, Kashyap, Stein, and Hanson
note in their 2010 paper An Analysis of the Impact of “Substantially Heightened” Capital Requirements on Large Financial
Institutions that firms typically avoid issuing new equity as this is perceived negatively by the market and often results in
significant declines to share prices.
205

Figure 27: Impacts to the Supply of Credit206
In essence, the literature attempts to answer the question of whether increased capital requirements promotes or hinders
macroeconomic growth, while considering the supply of credit, financial stability, and, in some cases, the influence of a
larger non-bank financial sector on the other two drivers.
BCBS (2022) does not fund sufficient evidence to support this channel, which would imply that there is no cost to
additional capital requirements. This result should be interpreted with caution for many reasons. It is difficult to isolate the
impact of capital requirements from all other factors that may drive funding costs and lending volume. The sample
appears to include banks from economies that have very different debt and equity markets than the US, including Turkey,
Saudi Arabia and Argentina. The study also relies on comparing lending and the cost of capital before and after a
jurisdiction formally proposes Basel III implementation. The selection of the announcement date is likely correlated with
macroeconomic and banking system conditions, which could bias the results.
Although the basic framework is fairly consistent throughout the initial scope of literature, it has evolved over time to
include additional factors, and the quantitative methods used to apply the framework have become more sophisticated. As
such, this section narrows down the initial scope of literature to 11 most relevant papers that are written by relevant
authors, additive to the analytical framework, account for a broad range of drivers, and consider an optimal range of
capital levels. Section 2.2 provides a more detailed discussion of the criteria applied to narrow down the scope of the
literature review.
Table 16 lists the papers selected for further review below:
Table 16: 11 Most Relevant Studies207
# Title Institution(s) Author(s) Publication Date
206
Under “Bank’s Response”, banks may also increase capital by issuing equity. However, Kashyap, Stein, and Hanson
note in their 2010 paper An Analysis of the Impact of “Substantially Heightened” Capital Requirements on Large Financial
Institutions that firms typically avoid issuing new equity as this is perceived negatively by the market and often results in
significant declines to share prices.
207
The views expressed in the papers listed below are generally those of the named authors and do not necessarily
represent the official position or policies of their affiliated institutions or organizations.
University of Chicago Booth
An Analysis of the Impact of “Substantially School of Business, Harvard
1 Heightened” Capital Requirements on Large University Economics Kashyap, Stein, and Hanson 2010
Financial Institutions Department, and Harvard
University
An assessment of the long-term economic

impact of stronger capital and liquidity Basel Committee on Banking
2 Multiple Authors 2010
requirements Supervision
Also referred to as BCBS LEI (2010)
Martin Brooke, Oliver Bush,

Measuring the macroeconomic costs and Robert Edwarts, Jas Ellis, Bill
3 benefits of higher UK bank capital Bank of England Francis, Rashmi Harimohan, 2015
requirements Katherine Neiss, and Caspar
Siegert
An Empirical Economic Assessment of the

Federal Reserve Bank of St.
4 Costs and Benefits of Bank Capital of the Firestone, Lorenc, and Ranish 2019
Louis
United States
Capital Requirements, Risk Choice, and

Stanford Graduate School of
5 Liquidity Provision in a Business -Cycle Begenau 2020
Business
Model
Johns Hopkins Carey

Business School, University of
Pennsylvania - The Wharton
A Macroeconomic Model with Financially School, University of Elenev, Landvoigt, and Van
6 2021
Constrained Producers and Intermediaries Pennsylvania - Finance Nieuwerburgh
Department, and Columbia
University Graduate School of
Business
Katarzyna Budnik, Ivan Dimitrov,

Carla Giglio, Johannes Groß,
Occasional Paper Series: The growth-at-risk
Max Lampe,
7 perspective on the system-wide impact of European Central Bank 2021
Andrei Sarychev, Matthieu
Basel III finalization in the euro area
Tarbé,
Gianluca Vagliano, Matjaž Volk

Financial Regulation in a Quantitative Model Business, and Wharton
8 Begenau and Landvoigt 2022
of the Model Banking System School, University of
Pennsylvania
The Welfare Effects of Bank Liquidity and

9 Federal Reserve Board Skander J. Van den Heuvel 2022
Capital Requirements
CP16/22 - Implementation of the Basel 3.1

10 Standards. Appendix 7: Aggregated Cost Bank of England Multiple Authors 2022
Benefits Analysis (CBA)
Evaluation of the impact and efficacy of the Basel Committee on Banking

Basel III reforms Supervision
While these are the most comprehensive papers that leverage some post financial crisis data, none of the papers fully
address the entire spectrum of post financial crisis regulatory reforms that were implemented to reduce risk in
the financial system – enhancing liquidity requirements, recovery and resolution planning, TLAC, enhanced risk
management capabilities, and changes in market conditions.
• The increase in financial resources at large US banks, including TLAC and liquidity, aim to reduce risk in the
financial system by providing a cushion in adverse environments, reducing an individual bank’s risk of failure and
therefore, strengthening the system overall.

• The implementation of stress testing of capital and liquidity provides a risk-based measure of financial resource
needs in a period of stress, enhances the transparency of bank risk through regulatory reporting, and necessitates
significant investment by banks in their risk management processes. As a result, these tests reduce an individual
bank’s risk of failure and therefore strengthen the system overall. In addition, capital stress tests are expected to
achieve a higher degree of risk sensitivity than the standard Basel risk weights.208
• Reforms to reduce counterparty and trading risk, which introduced margin requirements for non-cleared
derivatives, single counterparty credit limits and restrictions on proprietary trading, reduce the contagion risk of the
impact of single counterparty defaults spreading throughout the economy and the level of risk taking on firms’ trading
desks.
• Supervisory programs evaluate large banks’ capital planning and risk management capabilities and their results,
building trust within the financial system. In addition, supervision supports adequate resolution planning, which
enhances banks’ ability to unwind in a bankruptcy event without destabilizing the financial system, reducing the loss to
macroeconomic output from bank failures.
• Supplemental enhancements to risk management, including heightened risk management requirements for specific
products, the role of directors and enterprise risk management, have generally reinforced the importance of having an
effective risk management culture throughout individual banks.
In aggregate, these reforms have reduced risk both on bank’s balance sheets and on their earnings. In addition, while four
papers discuss the potential impacts of credit creation activities moving to non-bank financial institutions as a result of
increasing capital requirements, only Begenau and Landvoigt (2022) attempts to account for the effects this phenomenon
may have on financial stability and supply of credit in its model:
• Non-bank financial sector: The non-bank financial sector has grown since the GFC. This may have been driven by
increased capital requirements reducing the competitiveness of commercial banks in favor of non-banks, driving
borrowers to seek credit from alternative lenders.209 While expansion of the non-bank financial sector may support
effective competition, it may also increase risk in the financial sector, offsetting some of the gains from capital
regulation.
To illustrate the outcomes and range of drivers considered across the select studies, the Tables below summarize the
results across the 11 most relevant papers. The first Table includes the 6 optimal capital papers, while the second includes
the papers that focus on the impacts of implementing Basel III reforms or stricter capital requirements given a fixed
increase in capital requirements:
Table 17: Range of Outcomes from the 6 Optimal Capital Papers
Economic Impact of Transmission Channel, under Increased Capital Requirements
Optimal
Tier 1
Cost of Capital Commercial Non-bank Recovery and Regulatory Trading Book
Capital
Paper Objective Driving Lending Banking Sector Financial Resolution Liquidity and Market
Ratio
Volume Resilience Sector Size Requirements Requirements Liquidity
and
Range
208
Michael S. Barr: “Why Bank Capital Matters.” American Enterprise Institute. December 1, 2022.
209
Michael S. Barr notes the growth of the non-bank sector is partially driven by increased bank capital requirements and
supports this statement with cited academic literature. Source:
https://www.federalreserve.gov/newsevents/speech/barr20221201a.htm

Negative Positive Mixed
Cost of capital Probability Liquidity

Increases, and Cost of a requirements
reducing future are
lending volume Financial independent of
BCBS LEI Maximize 17.5%
and GDP Crisis Not considered Not considered capital Not considered
(2010) GDP (16-19%)210
decreases requirements
and reduce the
probability of a
crisis, but
increase the
cost of lending
Negative Positive Positive Positive
Cost of capital Probability TLAC Liquidity

Increases, and Cost of a Requirements requirements
reducing future are are
Bank of
Maximize lending volume Financial independent of independent of 12%
England Not considered Not considered
GDP and GDP Crisis capital capital (10-14%)
(2015)
decreases requirements requirements
and reduce the and reduce the
probability and probability of a
cost of a crisis crisis, but not
the cost
Negative Positive Positive Positive
Cost of capital Probability TLAC Liquidity

Increases, and Cost of a Requirements requirements
Federal
reducing future are are
Reserve
Maximize lending volume Financial independent of independent of 19.5%
Bank of Not considered Not considered
GDP and GDP Crisis capital capital (13-26%)
St. Louis
decreases requirements requirements
(2019)
and reduce the and reduce the
cost and probability of a
probability of a crisis, but not
crisis the cost
Negative Positive
Elenev,
Cost of capital Probability
Landvoigt,
Maximize Increases, and Cost of a
and Van Not considered Not considered Not considered Not considered 6%211
Welfare reducing future
Nieuwerbu
lending volume Financial
rgh (2021)
and GDP Crisis
decreases
Begenau Mixed Positive Mixed

(2020); (Considered in
Begenau, Cost of capital Probability 2022 only)
and may increase and Cost of a
Landvoigt or decrease, future Non-bank
(2022) because as Financial lending share 12.4%
cost of equity Crisis increases, (2020)
Maximize
(Note: this increases, cost decreases enhancing Not considered Not considered Not considered
Welfare 16%
row of debt competition, (2022)
contains decreases but increasing
two risk in stress
papers,one
which built
upon the
other)
210
The LEI study reported optimum tier 1 ratios ranging from 13.5-17.5% expressed in Basel II terms. These numbers
represent the range converted to a Basel III equivalent, as reported in the Bank of England (2015) paper.
211
Represents a CET1 capital ratio, rather than a tier 1 capital ratio.

15.5%
Optimal tier 1 capital ratio results across all papers
(12-26%)212
Table 18: Range of Outcomes from Five of the 11 Most Relevant Studies That Do Not Publish a Range or Estimate of Optimal Capital
Ratios
Intermediate Impacts of Increasing Capital Requirements
Assumed Increase
Paper in Tier 1 Capital Costs Benefits Net Costs/Benefits
Ratios213
Increase in Lending Rates of Increased stability in the

Kashyap, Enhanced capital requirements
25-45 bps commercial banking sector,
Stein, and raise significant concerns about
1% but the benefit is not quantified
Hanson the migration of lending share to the
Increase of risk in non-bank
(2010) non-bank financial sector
financial sector
Increase in Lending Rates in Reduced cost of Financial GDP Levels with and without
the first four years after Crisis by 0.2% of Euro Area reform tend to converge in the
ECB (2021) 2.5% implementation GDP for four years after a crisis long run, and the benefit of reduced
risk in banking sector is persistent
and cumulative over time
£10.8Bn (or 0.5%) removed £21Bn (or 1.0%) added per

Bank of per year from the UK’s annual year to the UK’s annual GDP,
£10.3Bn Pounds (or 0.5%) added
England 3.1% GDP, due to the cost of due to a reduction in the
per year to the UK’s annual GDP
(2022) compliance higher borrowing probability of a recession
cost of lending
Increased capital requirements Increased stability in the

reduce consumption by commercial banking sector,
0.17%. but the benefit is not quantified Basel III reforms are expected to
FRB produce net gains in welfare due
10%
(2022) Under separate analysis, a 10% to increased financial sector and
increase in liquidity economic stability.
requirements drives a 0.02%
decline in consumption.
No indication that Basel III Improvement in banks’ market Overall banking sector resilience
reforms impaired the aggregate based resilience, as indicated has increased without an
BCBS
~6.5% supply of credit to the economy by a reduction in market based indication of macroeconomic
(2022)
measures of systemic risk costs in the form a reduction in the
supply of credit
The first Table above presents a wide range of estimates for the optimal level of bank capital, while listing out the factors
under consideration and the directionality of their impacts on the objective function. It is important to note, however, that
the papers do not consider all factors, such as current regulations and their impacts on systemic risk. Consideration of
all additional factors may reduce estimates for optimal capital levels, such that the optimal level may be lower
than the current tier 1 Capital ratios banks currently hold. The second Table indicates a level of disagreement
regarding marginal benefits and costs, even across papers that do not provide an optimal capital level estimate.
The range of optimal capital ratios presented across papers is wide, exhibiting a lower bound of 6% and upper
bound of 26%. Moreover, each regulatory paper presents its own range, in which the outer bounds reflect the most
extreme assumptions for costs and benefits. As such, it may be reasonable to select the midpoint of each regulatory
212
Average across papers is computed as the simple average of all papers, excluding Elenev (2021), due to it appearing
as an outlier and presenting an optimal estimate for a CET1 ratio rather than a tier 1 ratio. For papers that conclude with a
range of optimal capital ratios, the midpoint of the range is used as the point estimate for the simple average.
213
This value represents the assumed increase in tier 1 capital ratio, on an additive basis, rather than a relative basis, and
is used as an input into the model to assess the costs, benefits, and resulting net costs/benefits.

range when trying to identify an optimal capital level across papers. The Figure below shows the estimates for optimal tier
1 capital ratios, including the ranges and midpoints for the regulatory papers and the point estimates for the academic
literature.
Figure 28: Optimal Tier 1 Capital Estimates Across Select Studies
When viewed in aggregate, and after selecting the midpoint for the optimal capital ranges for regulatory papers, the 6%
optimal capital ratio proposed by Elenev, as shown in Table 18, appears to be an outlier. Elenev (2021) differs from other
papers due to its output representing a CET1 ratio rather than tier 1 capital ratios. While this paper offers a valuable
perspective on optimal capital levels, it is sensible to exclude its point estimate on this basis when identifying a range
across papers. By selecting the midpoint of the regulatory ranges and excluding Elenev (2021), the optimal capital
range is 12-19.5%, with an average estimate of 15.5%. This figure aligns closely with the actual average tier 1
bank capital ratios of 15.5% and 15.2%, as of the fourth quarter of 2021 and 2022, respectively, for bank holding
companies that are expected to be subject to Basel III Endgame capital requirements.214, 215
Table 19: Average of Optimal Capital across Select Studies vs. Actual Tier 1 and CET1 Capital Ratios
Average of Estimated Optimal Capital

Capital Ratio Average Actual Capital Ratios
Ratios
Tier 1 15.5% 15.2%
214
Estimates for 4Q2021 actual tier 1 and CET1 capital ratios cover the 33 banks participating in the 2022 CCAR
submission, which aligns with Category I - IV banks, and represent simple averages across all firms. The estimates were
sourced from 2022 CCAR submission data: “Stress Test Results, 2013-2021 (CSV)”,
https://www.federalreserve.gov/supervisionreg/dfa-stress-tests.htm. Estimates for 4Q2022 actual tier 1 and CET1 capital
ratios were sourced using the FR Y-9C reported figures for the same 33 firms and represent simple averages across all
firms.
215
The papers tend to take a global view regarding applicability of capital rules, whereas in the U.S., Basel III Endgame is
only expected to be applicable to large banks. Whether the NPR or final rule will include all Category I - IV banks is
uncertain at this time. This comparison to average actual tier 1 capital ratios at large banks assumes that all Category I -
IV banks would be subject to the final rule. The average tier 1 ratio is computed as a simple average across the banks.

CET1 13.7%216 13.2%
However, as noted above, none of the papers consider all relevant factors, and there exists some disagreement regarding
the directionality of certain factors. In regards to the directionality of factors considered, there is a general consensus on
the benefit of reducing the cost and probability of a financial crisis for commercial banks, and when considered, existing
regulations also reduce the cost and probability of a financial crisis, partially reducing the marginal benefit of further
increasing capital requirements. Some disagreement exists, however, on the cost of capital side, with a predominant view
that increasing capital requirements results in increased cost of funds, impacting lending rates and reducing loan volumes.
Factors not considered by this school of thought those related to investor behavior and trading book and market liquidity:
• Investor behavior: Begenau (2020) and Begenau and Landvoigt (2022) propose that increased capital requirements
may result in lower cost of funds and increased lending volumes due to deposit scarcity driving up consumer demand
for deposits. This interaction allows banks to reduce the rate offered on deposits and bring down their weighted
average cost of capital, ultimately reducing lending rates and increasing loan volume.
Additionally, the FRB (2019) paper notes that current models do not consider the reduction in risk premia on bank
equity and debt that may result from a safer banking system brought about by higher capital requirements. The
reduction in risk premia would then offset the increased costs of capital expected to occur as a result of raising capital
requirements.
• Trading book and alternative funding sources: FRB (2019) notes, amongst a list of factors not considered, that
corporate bonds are an alternative funding source for borrowers, potentially reducing the impact of an increase in bank
lending rates on non-bank corporate funding costs. However, inclusion of this factor would only partially offset the
reduction in lending volumes, as not all firms have access to capital markets.
It is also important to note that there is some consideration necessary for the Modigliani-Miller Offset. The
Modigliani-Miller theorem posits that cost of capital is invariant to the capital structure, and FRB (2019) cites evidence that
suggests that this is largely true for Category I - IV firms.217 The majority of regulatory papers, including BOE (2015) and
FRB (2019), include an offset that captures the applicability of the Modigliani-Miller theorem to large banks. BCBS (2022),
as shown in Table 18, finds little evidence that the post-financial crisis increase in capital requirements have increased
lending rates and reduced loan volume.
In addition to disagreement on factor directionality, the papers do not thoroughly examine all relevant factors. The factors
omitted by some papers include non-bank financing, trading book and market liquidity, liquidity requirements, improved
risk management capabilities and prudential standards for large banks, and advancements in market standards.
Generally, these factors are anticipated to have a negative effect on optimal capital level estimates, because these factors
may reduce many of the same risks to financial stability that higher capital would address.
For instance, increasing capital requirements may increase the size of the non-bank financial sector. While an expansion
of the non-bank finance sector benefits economic growth by supplying additional credit and promoting effective
competition, driving down borrowing costs, this may be partially offset by an increased probability and cost of a crisis. The
potential increase in probability of a crisis would be driven by greater leverage in less regulated and less transparent
financial intermediaries, and the potential increase in cost would be due to resiliency of the credit supply being reduced. It
may also reduce trading book and market liquidity, increasing funding costs and reducing credit supply, though if the
models considered alternative funding sources, such as corporate bonds in the trading book, this could dampen the
overall impact on corporate funding costs. Similarly, enhanced regulation around liquidity requirements and recovery and
resolution planning can lower the marginal benefit and marginal cost of increasing capital requirements. Where studies
216
Estimate for the implied optimal CET1 ratio is derived by multiplying the average tier 1 optimal capital estimate by the
quarterly average historical ratio of CET1 to tier 1 capital ratios across G-SIBs from 1Q2018 to 4Q2022. The relationship
between CET1 and tier 1 capital ratios across G-SIBs has been stable since 2018.
217
FRB (2019) cites that since the 2007-09 Financial Crisis, Clark, Jones, and Malmquist (2015) find that the
Modigliani-Miller theorem holds for banks with assets of at least $100 billion.

consider these regulatory factors, the reduction in marginal benefits is material, because these regulations have been
found to substantially reduce the probability of a crisis.218 Additionally, enhanced risk management capabilities and
prudential standards can allocate capital more efficiently and better manage risks, reducing the optimal capital level
needed. Finally, improvements in market standards like the Volcker Rule and clearing standards can reduce overall risk in
the financial system, potentially reducing the marginal benefit of increased capital requirements.
Overall, the existing body of literature on optimal capital levels is vast, and conclusions regarding what is optimal vary due
to differences in approach and assumptions. Therefore, when policymakers consider increases in capital levels that could
stem from the implementation of Basel III Endgame, it is important to not only examine the optimal levels of capital
discussed in the literature but also to consider the limitations of the analysis presented, such as the partial inclusion of
post-crisis regulatory reforms and the complex interactions between bank capital requirements, the size of the non-bank
financing sector, the cost of credit and financial stability.
2.2 Literature Review Scope

In the evaluation of the literature surrounding capital requirements, the analysis examines many studies covering a wide
range of methodologies and conclusions. The types of studies that are prioritized for this review attempt to identify costs
and benefits associated with increased capital level requirements. Although the review is not restricted to a distinct subset
of authors, the common classes of researchers typically include standard setting bodies, regulators and academics with a
focus on the regulated banking industry.
The Table below provides a full listing of all of the studies considered in the revenue. The highlighted studies are
considered the most relevant for a more detailed evaluation.
Table 20: Studies in Scope for Review219
# Title Institution Author(s) Publication Date

The welfare cost of bank capital University of Pennsylvania - The
1 Skander J. Van den Heuvel 2008
requirements Wharton School
Quantifying the Effects on
2 Lending of Increased Capital The Brookings Institute Douglas J. Elliott 2009
Requirements
An Analysis of the Impact of
School of Business, Harvard
“Substantially Heightened”
3 University Economics Anil K Kashyap, Jeremy C. Stein, Samuel Hanson 2010
Capital Requirements on Large
Department, and Harvard
Financial Institutions
University
As assessment of the
long-term economic impact of Basel Committee on Banking
stronger capital and liquidity Supervision
requirements
Mapping Capital and Liquidity
Bank for International
5 Requirements to Bank Lending Michael R King 2010
Settlements
Spreads
Bank Behavior in Response to
6 Basel III: A Cross-Country International Monetary Fund Thomas F. Cosimano and Dalia S. Hakura 2011
Analysis
Macroeconomic Impact of Basel
7 OECD Economics Department Patrick Slovik, and Boris Cournede 2011
III
8 Optimal Bank Capital Bank of England David Miles, Jing Yang, Gilberto Marcheggiano 2013
218
For instance, FRB (2019) assumes that increased resolvability requirements reduces the probability of a crisis by 30%.
This assumption is derived from Financial Stability Board (2015), which relies on work by Afonso, Santos, and Traina
(2014) and Marques, Correa, and Sapriza (2013).
219
The views expressed in the papers listed below are generally those of the named authors and do not necessarily
represent the official position or policies of their affiliated institutions or organizations.
Do Strict Capital Requirements
Raise the Cost of Capital? National Bureau of Economic
9 Malcolm Baker, and Jeffrey Wurgler 2013
Banking Regulation and the Low Research
Risk Anomaly
Banks' Endogenous Systemic Universidad Carlos III, CEMFI, David Martinez-Miera and Javier Suarez
10 2014
Risk Rating CEPR
Capital Regulation in a Laurent Clerc, Alexis Derviz, Caterina Mendicino,
11 Macroeconomic Model with Three Bank of France Stephane Moyen, Kalin Nikolov, Livio Stracca, Javier 2014
Layers of Default Suarez, and Alexandros P. Vardoulakish
Testing the Modigliani-Miller
Peterson Institute for
12 Theorem of Capital Structure William R. Cline 2015
International Economics
Irrelevance for Banks
Bank Capital Requirements: A
13 Fisher College of Business Thiên T. Nguyễn 2015
Quantitative Analysis
Measuring the macroeconomic Martin Brooke, Oliver Bush, Robert Edwards, Jas
14 costs and benefits of higher Bank of England Ellis, Bill Francis, Rashmi Harimohan, Katharine 2015
UK bank capital requirements Neiss and Caspar Siegert
Strengthening and Streamlining Jeremy C. Stein, Robin Greenwood, Samuel G.
15 Harvard University 2017
Bank Capital Regulation Hanson, and Adi Sunderam
The Minneapolis Plan to End Too Federal Reserve Bank of
Big to Fail Minneapolis
Are Higher Capital Requirements Federal Reserve Bank of
17 Pablo D’Erasmo 2018
Worth it? Philadelphia
An Empirical Economic
Assessment of the Costs and Federal Reserve Bank of St.
18 Simon Firestone, Amy Lorenc, and Ben Ranish 2019
Benefits of Bank Capital in the Louis
United States
Capital requirements, risk
19 choice, and liquidity provision Juliane Begenau 2020
Business
in a business-cycle model
A Macroeconomic Model With
Vadim Elenev, Tim Landvoigt, Stijn Van
20 Financially Constrained The Econometric Society 2021
Nieuwerburgh
Producers and Intermediaries
The growth-at-risk perspective
Katarzyna Budnik, Ivan Dimitrov, Carla Giglio,
on the system-wide impact of
21 European Central Bank Johannes Groß, Max Lampe, Andrei Sarychev, 2021
Basel III finalisation in the euro
Matthieu Tarbé, Gianluca Vagliano, Matjaž Volk
area
Financial Regulation in a
National Bureau of Economic
22 Quantitative Model of the Juliane Begenau and Tim Landvoigt 2022
Research
Modern Banking System
The Welfare Effects of Bank

23 Liquidity and Capital Federal Reserve Board Skander J. Van den Heuvel 2022
Requirements
CP16/22 - Implementation of
the Basel 3.1 Standards.
24 Bank of England Multiple Authors 2022
Appendix 7: Aggregated Cost
Evaluation of the impact and Basel Committee on Banking
efficacy of the Basel III reforms Supervision
Of the papers in scope, the analysis resulted in 11 of 25 papers being selected for detailed review and evaluation.
These papers are highlighted in red. To determine this subset, the analysis applied three criteria for prioritization:
1. Author’s relevance to stakeholders: The analysis focuses on studies that are conducted by supervisory/regulatory
institutions that govern a large market share of regulated banks, and researchers that are renowned for their
contributions to the academic literature on the banking industry.
2. Contribution to analytical framework: The analysis considered papers that introduce or materially advance the
analytical framework by, for example, incorporating additional drivers that may influence the costs and benefits of
increased capital requirements. These drivers include details of the current regulatory environment and the complex
interactions between bank capital requirements, the size of the non-bank financing sector, the cost of credit and

financial stability. These papers are considered more relevant because they seek to address the impact of
post-financial crisis regulatory reforms beyond capital, thereby providing a more expansive analysis of the impact of
capital levels in conjunction with other risk-reducing reforms and the interaction with the non-bank financing sector.
3. Conclusion about optimal range of capital: The objective of this article is to assess research on optimal capital
levels, rather than solely analyzing the impact channels related to marginal costs and benefits. Therefore, in
comparing optimal capital levels with actual capital levels, the analysis prioritizes papers that present a specific
optimal capital level or range, as this is a necessary element in constructing a comparison.
Each of the studies selected meets some of the criteria described above. For more insight into the rationale for the
selection, a detailed explanation as to why each study was selected can be found in the Table below, Table 21:
Table 21: 11 Most Relevant Studies and Rationale for Selection
# Study Rationale for Selection
While this paper was published too early to consider much of the regulation
An Analysis of the Impact of “Substantially Heightened”
instituted after the global financial crisis, it is one of the earliest and most
1 Capital Requirements on Large Financial Institutions (2010)
influential papers in regards to the consideration of non-bank financial
Kashyap, Stein, and Hanson
institutions.
This study by BCBS establishes the common framework leveraged across

An assessment of the long-term economic impact of
papers by regulators to estimate the benefits, costs and net benefits of
2 stronger capital and liquidity requirements (2010)
increased capital levels. Moreover, while the purpose of the study is not to
Multiple Authors
propose an optimal capital, it includes an optimal capital level estimate.
Measuring the macroeconomic costs and benefits of higher This study by the Bank of England builds upon the 2010 BCBS study and
3 UK bank capital requirements (2015) incorporates the impact of resolvability regulation (i.e., TLAC) in
Multiple Authors determining the optimal capital level estimate.
This study is the most recent study on the impacts of Basel III
An Empirical Economic Assessment of the Costs and implementation by a US regulatory agency that follows the BCBS LEI
4 Benefits of Bank Capital of the United States (2019) framework. Moreover, this paper considers the impact of Regulatory Capital
Firestone, Lorenc, and Ranish Regulation, specifically the impact of TLAC and liquidity requirements, on
the reduction in cost of a future potential financial crisis.
This study lays out the basic framework for the Begenau school of thought
on optimal capital levels. This differs from many other papers in that it
Capital Requirements, Risk Choice, and Liquidity Provision
postulates that increasing capital requirements may ultimately reduce
5 in a Business -Cycle Mode (2020)
lending costs through the consideration of a convenience yield on
Begenau
deposits. Additionally, this paper publishes an estimate for optimal capital
levels.
This study provides a contrarian view to the Begenau school of thought on

A Macroeconomic Model With Financially Constrained
optimal capital levels. Specifically, it argues that raising capital requirements
6 Producers and Intermediaries (2021)
will not have the downward force on lending rates that Begenau proposes.
Elenev, Landvoigt, and Nieuwerburgh
Additionally, this paper publishes an estimate for optimal capital levels.
ECB - Occasional Paper Series: The growth-at-risk implementation by the European Central Bank, which leverages data from
perspective on the system-wide impact of Basel III the regulatory filings of its constituents to better assess the costs and benefits of
7
finalisation in the euro area (2022) increased capital levels. This paper uses a unique growth-at-risk perspective for
Multiple Authors evaluating the outcomes of raising capital requirements under periods of
economic uncertainty.
Financial Regulation in a Quantitative Model of the Model This study builds upon the framework established in Beganau (2020) by
Banking System (2022) introducing the impact of the non-bank financial sector on systemic risk
8
Begenau and Landvoigt into the equilibrium model. Additionally, this paper publishes an estimate for
Building on prior study from 2022 optimal capital levels.
The Welfare Effects of Bank Liquidity and Capital This study presents the Federal Reserve’s most recent thinking regarding
Requirements (2022) the cost of increased capital requirements. Additionally, Van den Heuvel
9 Skander J. Van den Heuvel measures the welfare costs of increased capital requirements separately from
Building on prior study from 2008 those of increased liquidity requirements, allowing for a direct comparison.

CP16/22 - Implementation of the Basel 3.1 Standards. This study is the most recent study on the impacts of Basel III
Appendix 7: Aggregated Cost Benefits Analysis (CBA) implementation by the Bank of England, which leverages data from the
(2022) regulatory filings of its constituents to better assess the costs and benefits of
10
Multiple Authors increased capital levels. This paper uses the NiGem model to estimate
building on prior study from 2015 macroeconomic costs and benefits to better understand the impact of enhanced
capital requirements.
BCBS Evaluation of the impact and efficacy of the Basel III implementation by the BCBS, the drafting committee behind the Basel III
reforms (2022) standard itself. This paper is unique in that it provides a backwards looking
11
Multiple Authors assessment of the impacts the Basel III reforms implemented to date.
building on prior study from 2010 Additionally, it provides a thorough investigation of the interactions between
current relevant regulations (e.g., TLAC, NSFR) and macroeconomic impacts.
The aforementioned papers comprise the scope of the literature review and provide an extensive amount of material on
the costs and benefits of increased capital levels and identification of a range of optimal capital levels.
2.3 Overview of Select Papers - Methodology, Conclusions, and Limitations

The following section provides a detailed review of the methodologies, conclusions and limitations of the papers selected.
This review aims to provide the reader with a thorough understanding of the leading thoughts and limitations existing in
the literary landscape on optimal capital levels and impacts of raising capital requirements on regulated banks. The
papers in scope for this detailed review are provided in the Table below:
Table 22: 11 Most Relevant Studies
# Title Institution(s) Author(s) Publication Date

An Analysis of the Impact of “Substantially School of Business, Harvard
1 Heightened” Capital Requirements on Large University Economics Kayshap, Stein, and Hanson 2010
Financial Institutions Department, and Harvard
University
An assessment of the long-term economic

impact of stronger capital and liquidity Basel Committee on
requirements Banking Supervision
Also referred to as BCBS LEI (2010)
Martin Brooke, Oliver Bush,

Measuring the macroeconomic costs and Robert Edwarts, Jas Ellis, Bill
3 benefits of higher UK bank capital Bank of England Francis, Rashmi Harimohan, 2015
requirements Katherine Neiss, and Caspar
Siegert
An Empirical Economic Assessment of the

Federal Reserve Bank of St.
4 Costs and Benefits of Bank Capital of the Firestone, Lorenc, and Ranish 2019
Louis
United States
Capital Requirements, Risk Choice, and Stanford Graduate School of

5 Begenau 2020
Liquidity Provision in a Business-Cycle Model Business
Johns Hopkins Carey

Business School, University
of Pennsylvania - The
A Macroeconomic Model With Financially Wharton School, University Elenev, Landvoigt, and Van
6 2021
Constrained Producers and Intermediaries of Pennsylvania - Finance Nieuwerburgh
Department, and Columbia
University Graduate School
of Business
Occasional Paper Series: The growth-at-risk Katarzyna Budnik, Ivan Dimitrov,

7 perspective on the system-wide impact of European Central Bank Carla Giglio, Johannes Groß, 2021
Basel III finalization in the euro area Max Lampe,

Andrei Sarychev, Matthieu
Tarbé,
Gianluca Vagliano, Matjaž Volk

Financial Regulation in a Quantitative Model of Business, and Wharton
8 Begenau and Landvoigt 2022
the Model Banking System School, University of
Pennsylvania
The Welfare Effects of Bank Liquidity and

9 Federal Reserve Skander J. Van den Heuvel 2022
Capital Requirements
CP16/22 - Implementation of the Basel 3.1

10 Standards. Appendix 7: Aggregated Cost Bank of England Multiple Authors 2022
Evaluation of the impact and efficacy of the Basel Committee on

Basel III reforms Banking Supervision
The following sections provide a detailed analysis of the 11 most relevant papers. For each paper, the deep dive provides
an introduction to the paper, an overview of the model methodology, an overview of the paper’s conclusions, and a
discussion of the paper's limitations.
2.3.1 An Analysis of the Impact of “Substantially Heightened” Capital Requirements on Large Financial
Institutions (2010)
Anil Kashyap, Jeremy C. Stein, and Samuel Hanson
In May 2010, prior to the announcement of post-crisis Basel III regulatory requirements, Anil Kashyap, Jeremy C. Stein,
and Samuel Hanson published a study exploring how raising capital requirements will impact large financial institutions.
The authors begin by trying to understand why banks have higher leverage than firms in other industries, as well as
examine the reasons for higher costs of equity for banks, before turning to an analysis of capital requirements. In their
analysis of capital requirements, they assume that increased capital requirements “offer a benefit in terms of increased
systemic stability,” and instead mainly focus on the costs associated with raising capital requirements. After outlining the
hypothesized costs of raising capital requirements, the authors review other empirical studies and conduct their own
regressions to estimate the magnitude of these costs. The authors arrive at three main conclusions from their analysis.
The first is that any new requirements which raise capital requirements, should be phased in gradually in order to avoid
banks contracting their lending to comply with the new requirement. The second conclusion is that the long-run
steady-state impact on loan rates is expected to be relatively low. The authors estimate that a ten percentage point
increase in capital requirements would lead only to a 25-45 basis point increase in loan rates. The third conclusion is that
while the impact to lending rates is small, there will be a large migration of credit-creation to the non-bank financial sector.
According to Kashyap, Stein and Hanson, the migration of credit-creation to the non-regulated non-bank financial sector
makes the entire banking system more fragile. As such, the authors recommend that in addition to enhanced regulations
on banks and other large financial institutions, there should be increased regulations on the non-bank financial industry as
well.
Methodology
The Methodology is divided into four sections, broken out by the key topics the authors address: Bank Capital
Requirements Increasing Cost of Capital, Bank Capital Requirements Impacting Effective Competition, Banks Adjusting
Asset Levels in Response to Increases in Capital Requirements, and Bank Loan Volumes Impacting the Real Economy.
Within each topic, a hypothesis regarding the topic is investigated and the author’s literature review and empirical analysis
regarding the hypothesis is discussed.
Bank Capital Requirements Increasing Cost of Capital
Kashyap, Stein, and Hanson propose that Increasing capital requirements increases the weighted average cost of capital
for banks, as equity financing is more costly than debt financing. The analysis of equity capital versus debt financing is
based on Modigliani and Miller (1958), which shows that under certain idealized conditions, a firm’s cost of capital is

invariant to its capital structure. These idealized conditions suppose an environment in which there are no taxes,
information is symmetric, pricing is rational and risk-based, and a firm’s cash flows are fixed and independent of its
financial policy. While these idealized conditions are unrealistic, the theory allows for the identification of which deviations
have the greatest impact on cost of capital. The authors identify the deviations that are most likely to impact the banking
industry, such as the negative signal sent to investors when a bank raises external equity, leading to a decline in share
price and a higher cost of funds. They also highlight corporate taxes as a significant factor that makes equity capital more
expensive than debt, due to the tax deductibility of interest payments on debt and the lack of tax deductibility of dividend
payments on equity.
The authors refer to the costs related to issuing new equity as "flow costs of equity" and the tax-related costs as "balance
sheet costs of equity." Flow costs of equity are mainly based on the work of Myers and Majluf (1984), which identifies the
problem as better-informed management and less-informed investors. When a firm issues new equity, it sends a negative
signal to outsiders who perceive it as management trying to sell overvalued shares. To avoid this negative market signal,
a bank may prefer to lower its leverage by adjusting its loan volume rather than issuing new equity. On the other hand,
balance sheet costs of equity primarily arise due to the tax advantages of debt, as first described by Miller (1977).
Additionally, Diamond and Rajan's research (2001) suggests that the highly transformable nature of bank assets creates
significant agency problems that drive up the cost of equity. Agency problems refer to when management has incentives
to take risks that are not in the interest of the bank investors. The authors conclude that there are plausible deviations
from the idealized Modigliani-Miller framework that contribute to driving up the cost of equity.
The authors initially aim to test the Modigliani-Miller (MM) principle of risk conservation as it pertains to the banking sector.
This principle suggests that as firms increase the portion of equity on their balance sheet, the equity becomes less risky,
resulting in a lower equity beta. To do this, the authors conduct regression analyses on public banking data for large
banks (with over $10bn in assets) from 1976 to 2008, which includes market beta, return volatility, and book
equity-to-assets. The authors find that the MM principle holds true for the banking sector, thus validating the use of the
MM framework.
Next, the authors analyze the impact of raising the required equity-to-assets ratio under three different scenarios, aiming
to understand the balance sheet costs of holding more equity. They assess the incremental effect of a given increase in
the required equity-to-assets ratio on a bank's weighted average cost of capital (WACC) in each scenario. This reveals the
impact on WACC and customer loan rates, assuming that all increases in capital costs are passed on to loan customers.
In the first scenario, considered a baseline, it is assumed that new equity capital displaces long-term debt for banks, with
the only effect on WACC being the lost tax shields on debt. The second scenario assumes that new equity capital
displaces short-term debt, with a non-risk-based "money" premium on wholesale short-term debt. The third, most
aggressive scenario assumes that, in addition to tax effects, each incremental unit of equity costs 200 basis points more
than the debt it displaces, serving as an intentionally aggressive upper bound. The calibration results can be seen in the
Table below.
Table 23: The effects of an increase in required ratio of equity to assets on WACC220
Increase in WACC: Equity Crowds Increase in WACC: Equity Crowds Increase in WACC: Aggressive
Increase in Required Ratio of
out Long-Term Debt (Tax Effects out Short-Term Debt (Taxes Plus Case (Taxes Plus 2% M-M
Equity to Assets
Only) 1% Money Premium) Violation)
2% 5 bp 7 bp 9 bp
4% 10 bp 14 bp 18 bp
6% 15 bp 21 bp 27 bp
8% 20 bp 28 bp 36 bp
10% 25 bp 35 bp 45 bp
220
Kashyap, Anil Kumar et al. “An Analysis of the Impact of 'Substantially Heightened' Capital Requirements on Large
Financial Institutions.” (2010). 17.
Furthermore, the authors conduct a historical analysis to examine the variation in capital ratios over time and the
relationship between capital ratios and loan rates. They found significant fluctuations in capital ratios from 1840 to 2009,
with book capital ratios starting at 50% in the 1840s and dropping to 6% by the 1940s. They then compare historical
capital ratio data to data on bank net interest margins (NIM), earning yield on loans (interest income/loans) minus the rate
paid on deposits, and the prime rate (borrowing rate for top customers) minus the rate on short-term treasury bills.
Overall, the authors conclude that the results are too noisy to definitively establish a relationship between equity ratios
and lending rates.
Bank Capital Requirements Impacting Effective Competition
The authors propose that the distinct nature of bank competition contributes to the high level of leverage within the
banking sector. They argue that banks' main competitive advantage stems from their ability to obtain low-cost funding
through short-term debt, namely insured and highly liquid deposits. Consequently, banks increase leverage to stay
competitive, which results in the systemic risk observed in the sector. Additionally, the authors argue that while higher
capital requirements can reduce leverage and improve bank safety, it may shift banking activities towards the non-bank
financial sector, which is not generally prudentially regulated or as transparent as the commercial banking sector.
The authors reference various papers that support this competition hypothesis, which connects banks' inexpensive
short-term debt funding to increased leverage, which drive higher capital requirements, resulting in a transfer of lending
activities to the non-bank financial sector. They reference Gorton (2010) and others who argue that the "money-like"
quality of banks' short-term debt, due to its relative safety and liquidity, leads to a convenience yield that lowers the cost of
such debt for banks. The authors also discuss research that examines strategies for capital regulation arbitrage, such as
adjusting portfolios towards riskier assets within a risk-weight category, securitization, and certain asset-backed
commercial paper structures. This examination yields three key insights: 1) regulators often understand these arbitrage
strategies but cannot address them without significant regulatory changes that can take years to implement, 2) these
strategies contribute to financial crises, and 3) the nature of arbitrage constantly evolves, with banks expected to discover
new ways to reduce capital charges. The authors anticipate that regulators will prioritize preventing banks from exploiting
rules to lower capital charges, which may result in assets being moved from the banking system to the non-bank financial
sector.
To support the hypothesis that competition increases bank leverage, the authors analyze historical variations in capital
ratios among banks of different sizes. They find that smaller banks usually have higher capital ratios than larger banks
from 1976 to 2009, indicating that less competitive small local banks experience less pressure to raise leverage. Another
supporting data point is the decreasing dispersion of capital ratios among banks of different sizes after 2008, which is
likely due to larger banks participating in the US Treasury's Capital Purchase Program and the increase in equity
issuances after the Supervisory Capital Assessment Program in May 2009.
The authors further test the competition hypothesis by examining state-level banking deregulation. They use data from
Stiroh and Strahan (2003) and other sources to analyze the effects of relaxed intrastate branching restrictions and the
introduction of interstate banking on bank leverage. Regressions are performed on bank equity-to-asset ratios against
dummy variables representing these deregulations. The results reveal a 30 basis point decrease in equity-to-assets
following relaxed intrastate branching restrictions and another 20 basis point decrease after relaxed interstate banking
restrictions. Moreover, the dispersion of equity-to-asset ratios across banks narrows after deregulation, with the highest
capital ratio banks experiencing the largest declines. The 50 basis point reduction in capital ratios and the decreased
dispersion support the competition hypothesis. For the NBFI aspects of the hypothesis, the authors rely on the research
and literature previously discussed.
Banks Adjusting Asset Levels in Response to Increases in Capital Requirements
The authors pose the hypothesis that increases in bank capital requirements will reduce bank lending volume. The theory
behind this hypothesis is that banks will prefer to reduce risk-weighted assets, instead of issuing new equity, to meet
capital requirements, because of the flow costs of issuing equity described above. The question of whether changes in
bank lending are caused by shocks to capital or whether shocks to capital are caused by changes to bank lending and
economic conditions is investigated by the authors in this section.
To explore this hypothesis, the authors evaluate and analyze the conclusions of existing literature instead of introducing a
new analytical framework. They examine several studies on the effects of capital shocks on bank lending. One such

example, which serves as a natural experiment, involves Japanese banks operating in the United States. Many of these
banks fell below the 8% Basel minimum between 1989 and 1992. The outcome revealed that a 1% decrease in bank
capital led to a 6% decline in lending. Additional research indicates that smaller banks' lending is more sensitive to
changes in capital, and better-capitalized banks are less sensitive to fluctuations in lending. In general, the evidence
suggests that capital shocks do impact bank lending, supporting the hypothesis. However, the extent of the impact varies
across different studies.
Bank Loan Volumes Impacting the Real Economy
The authors propose the hypothesis that alterations in banks' lending activities influence the real economy. They suggest
that companies may experience negative effects if they are unable to replace funds previously obtained from banks
through securities markets or other intermediaries, or if they cannot secure these funds at comparable borrowing costs.
The authors recognize causality issues related to this hypothesis, as the real economy and bank lending activities affect
each other. To examine the impact of bank lending on the broader economy, they review literature on US branches of
Japanese banks in the late 1980s and early 1990s, which reveals some correlation between bank lending and the overall
economy. Additional research using vector autoregressions - comparing GDP, inflation, the federal funds rate, aggregate
loan growth, bank equity-to-assets, and senior loan officer opinion survey results - also identifies significant relationships
between these variables. However, long-term studies on OECD countries find minimal overall connections between bank
loan activity, capital, and GDP. Consequently, the authors conclude that while the question is crucial, the existing literature
on the subject remains inconclusive.
Instead of conducting their own statistical analysis or modeling for these hypotheses, the authors rely on the literature
discussed above. As mentioned, there is some evidence supporting the hypothesis, but the magnitudes remain uncertain.
The relationship between bank lending activities and the real economy thus continues to be an open question.
Conclusions
The analysis finds evidence to support the idea that banks face higher equity costs than debt and that competition in the
banking sector contributes to increased leverage and regulatory arbitrage. Although capital shocks do affect bank lending,
the magnitude of this impact is uncertain, and the relationship between bank lending and the broader economy remains
unclear.
Based on these findings, the authors conclude that implementing capital standards for banks is still a worthwhile means of
mitigating the systemic risks inherent in bank competition. They recommend regulators gradually introduce these
standards, so that banks may avoid the immediate costs associated with raising new equity. The authors anticipate that
the overall effect of higher capital requirements on the weighted average cost of capital (WACC) and bank lending rates
will be relatively small, and this effect may be offset by the increased stability of the banking system which contributes to
greater overall household welfare.
The authors acknowledge the potential risks of regulatory arbitrage and suggest addressing this risk by expanding
regulations beyond merely controlling commercial banks' capital levels. For instance, they propose imposing minimum
haircut requirements on certain asset-backed securities, regardless of the holder. In conclusion, the paper advises
regulators not to shy away from modifying capital requirements but also to explore ways to minimize regulatory arbitrage
in order to enhance the safety of the entire financial system.
Limitations
Kashyap, Stein, and Hanson perform quantitative analysis to measure the costs and benefits of increased capital
requirements. However, the analysis does not consider certain, potentially material factors, which could impact the paper’s
conclusion. These factors not considered are summarized below:
1. Enhanced regulation and bank balance sheet composition: The model does not account for the impact of
enhanced regulatory standards, particularly enhanced liquidity and recovery and resolution planning requirements.
Liquidity regulations aim to increase the level of high quality liquid assets on bank balance sheets, potentially reducing
the overall risk of bank assets. Recovery and resolution requirements aim to enhance the resolvability of firms,

potentially reducing the cost of a potential future crisis. As such, if the paper considered these regulations, the
marginal benefit from increasing capital requirements could be reduced, potentially lowering the optimal capital level.
2. Impact to bank trading books and market liquidity: Similar to other studies, the framework applied does not
account for the potential impact to bank’s trading books and market liquidity. To meet higher capital requirements,
banks may reduce their trading inventories, thereby lowering market liquidity. This could translate into a higher
liquidity premium on corporate bonds, raising corporate borrowing costs and reducing investment and GDP.
On the other hand, the model does not consider the fact that corporate bonds are a substitute product for bank debt.
The availability of corporate bonds as a funding source may mitigate the impact of an increase in corporate lending
rates and thus mitigate the estimated decrease in macroeconomic output.
The Table below provides a summary of the anticipated impacts the consideration of each factor may have on the model’s
estimated net benefits, under an increase in capital requirements:
Table 24: Potential Impact of Factors Not Considered on Net Benefits Estimate
# Factor Not
Potential Impact on Net Benefits, Under Increased Capital Requirements
Considered
Enhanced Negative
regulation and bank
1
balance sheet Without considering enhanced regulation and bank balance sheet composition, the model may overstate the
composition marginal benefit of capital requirements, resulting in an overstated optimal capital level
Mixed
Bank trading books
2 and market liquidity Without considering trading book, the marginal cost of increased capital requirements may be overstated or
is not considered understated, as corporate bonds act as a substitute funding source, but increased capital requirements may reduce market
liquidity.
The Table above highlights that the directional impact of the unconsidered factors would be difficult to determine in
aggregate. While the lack of consideration for enhanced regulation and bank balance sheet composition may overstate
the model’s estimates for benefits, resulting in the net benefit being overstated, the lack of consideration for trading book
has a mixed effect on the model's outputs. These considerations would have to be incorporated in the model to
understand which channel would dominate under increased capital requirements and ultimately, how this would impact the
model’s existing estimates for the net benefits of increasing capital requirements.
In addition to the factors not considered listed above, the model assumes that all increases in cost of capital are passed
on to borrowers. However, in reality, competition in the banking sector may reduce firm pricing power with respect to
lending rates, reducing the portion of the increase in cost of capital that can be passed on to borrowers. Moreover, the
framework does not perform a quantitative assessment of the welfare benefits of capital and requirements. The authors
assume that all else equal, increased capital requirements offer a benefit in terms of increased systemic stability. An
assessment of the benefits would be valuable for determining the overall welfare of the heightened capital requirements.
2.3.2 Basel Committee on Banking Supervision - An assessment of the long-term economic impact of
stronger capital and liquidity requirements (2010)
Multiple Authors
The Basel Committee on Banking Supervision (BCBS) published a pivotal study in August 2010 titled “An assessment of
the long-term economic impact on stronger capital and liquidity requirements,” which serves as a foundation for evaluating
the costs and benefits of Basel III reforms. As the first comprehensive analysis of the reforms by the standard setting
body, this report significantly influenced subsequent studies performed by regulators.
This study compares two scenarios: one in which proposed regulatory enhancements are implemented, another in which
they are not. By doing so, the Basel Committee identifies the costs, benefits, and net benefits of the regulatory reforms.
Although the report is not intended to pinpoint an optimal capital level, it does provide net benefits estimates for various
capital levels.

Concluding that the net benefits are positive across a wide range of capital ratios, the study suggests that the greatest net
benefits are achieved within a 13-15% TCE/RWA range. However, the results are subject to considerable uncertainty, as
the Committee employs multiple methodologies and models to ensure a thorough evaluation. In addition, since the
analysis was conducted prior to Basel III’s implementation, the assessment must make a wide range of assumptions
regarding the impacts of the reforms.
Methodology
BCBS employs a cost-benefit analysis framework to assess the impact of the Basel III reforms. The model identifies cost
and benefit channels, and then calculates the net impact to economic output for a range of TCE/RWA ratios. Benefits
include a reduced likelihood of a future financial crisis and reduced output volatility, while costs include an increase in the
cost of credit, which subsequently results in a lower economic output.
The following sections delve deeper into the specific methodologies used to quantify the costs and benefits associated
with higher capital and liquidity requirements.
Benefits Channel
BCBS defines the primary benefit of increasing capital and liquidity requirements as a reduction in the likelihood of a
financial crisis. The paper investigates the anticipated frequency and cost of a financial crisis, using empirical literature as
a basis. BCBS then applies reduced-form models, calibrated portfolio models, and calibrated stress test models to
estimate the connection between regulatory requirements and crisis probability. These models demonstrate the likelihood
of crises under various TCE/RWA ratios, model assumptions, and scenarios. The analysis also explores the benefits of
reduced output volatility through enhanced capital and liquidity requirements, using a dynamic stochastic general
equilibrium model to simulate the effects across different capital ratios.
BCBS first determines the frequency of financial crises, citing studies by Reinhart and Rogoff (2008) and Laeven and
Valencia (2008). Taking the results from both studies, and by examining the frequency of crises in BCBS member
countries since 1985, BCBS concludes that the probability of crisis ranges from 3.6% to 5.2%. BCBS adopts the average,
4.5%, as the expected historical frequency, assuming that a crisis lasts for one year.
Next, the analysis evaluates the expected costs of a financial crisis as a percentage of GDP. Literature that takes an
empirical approach to estimating the impact of financial crises is used to calibrate the model’s GDP loss estimates. Two
primary perspectives exist: one suggesting that output eventually recovers to pre-crisis levels, making crisis costs
temporary, and another arguing that GDP remains on a permanently lower trajectory, resulting in permanent crisis costs.
Studies that disregard permanent losses find a median discounted cumulative output loss of 19% of pre-crisis GDP, while
those accounting for permanent losses report a median of 158%. The overall median across all comparable studies is
63%.
After determining the frequency and cost of a future potential financial crisis, BCBS calculates the expected annual benefit
of reducing the crisis probability by 1, 2, or 3 percentage points per year. The benefit is determined by multiplying the
reduction in annual crisis probability by the crisis costs. The Table below displays the expected annual benefit as a
percentage of long-term annual GDP, taking into account a range of assumptions regarding the permanence of crises
costs:
Table 25: Effects of the reduction in the probability of a crisis on GDP output221
GDP Impact, by Assumption Regarding Crisis Permanence (bps)222

Probability of Reduction in Probability of a Crises have no permanent effect Crises have a long-lasing or Crises have a large permanent
a Crisis Crisis from Starting Level on output small permanent effect on output effect on output
221
“Basel Committee on Banking Supervision - Bank for International Settlements.” BIS, Bank for International
Settlements, Aug. 2010, https://www.bis.org/publ/bcbs173.pdf. 13
222
The expected annual benefits are measured as the reduction in the annual probability of a crisis times the (discounted)
cumulative output losses due to a banking crisis. Cumulative output losses are 19% (no permanent effect), 63% (small
permanent or long-lasting) and 158% (large permanent). All figures are in Bps of long-run GDP per year.

4.5% 0% 0 0 0
3.5% 1% 19 63 158
2.5% 2% 38 126 316
1.5% 3% 57 189 474
Given the understanding of the benefit reducing the probability of a crisis has on economic output, BCBS then analyzes
the impact capital and liquidity requirements have on the probability of a crisis. BCBS employs three distinct models to
estimate the relationship between regulatory requirements and crisis frequencies.
1. Reduced-form models (3 models): Reduced-form models calculate the likelihood of crises by examining the
statistical correlation between crisis occurrences and aggregated data on banks' leverage and liquidity, as well as
other control variables. The report analyzed three such models, which studied a panel of countries over nearly 30
years (1980-2008). These models consider the effect of liquidity on crisis probability, using the ratio of liquid assets to
total assets. Two of the three models also differentiate between asset-side and liability-side liquidity by including the
ratio of deposits to total liabilities as an additional variable.
2. Calibrated portfolio models (2 models): Portfolio models use standard portfolio credit risk methods to measure the
influence of heightened regulatory requirements on systemic crisis probability by treating the financial system as a
portfolio of banks, with each bank acting like a security in a portfolio. One model incorporates data from five UK
banks, including counterparty credit risk information in the interbank market, while another model examines a system
of over 50 large global banks. Both models rely on market price data, such as default correlations, to estimate the
likelihood of a systemic crisis. However, due to their structure, these models cannot evaluate the impact of liquidity
requirements. To address this limitation, the global banks model was enhanced with a reduced-form relationship
between the banks' default probability and their capital and liquidity ratios, generating a set of results also relevant to
liquidity ratios.
3. Calibrated stress test models (1 model): The final approach is based on the Bank of Canada's stress testing
framework. This methodology posits that a bank's failure results from either a macroeconomic shock or spillover
effects from other struggling banks. Spillover effects may stem from counterparty exposures in the interbank market or
from asset fire sales impacting the market value of banks' portfolios. In this context, a larger liquid asset buffer is
beneficial only if it prevents asset fire sales that would otherwise cause losses. The system's resilience is assessed by
its response to severe macroeconomic shocks.
The Table below displays the average probability of a crisis occurring under each of the methodologies for a range of
TCE/RWA levels. The results account for models that are able to incorporate the results of changes in liquid assets as
well as models that are not able to assess those changes.
Table 26: The impact of capital and liquidity on the probability of a crisis223
Probability of a systemic banking crises (in percent)
Models unable to assess

All models Models incorporating changes in liquid assets
changes in liquid assets
TCE/RWA
Meeting NSFR
No change in liquid assets No change in liquid assets No change in liquid assets
(NSFR = 1)224
6 7.2 8.7 5.8 4.8
7 4.6 5.1 4.1 3.3
8 3.0 3.1 2.8 2.3
223
Settlements, Aug. 2010, https://www.bis.org/publ/bcbs173.pdf. 15.
224
Meeting the NSFR is modeled as a 12.5% increase in the ratio of liquid assets over total assets.

9 1.9 1.9 2.0 1.6
10 1.4 1.3 1.5 1.2
11 1.0 0.9 1.1 0.9
12 0.7 0.6 0.8 0.7
13 0.5 0.5 0.6 0.5
14 0.4 0.4 0.5 0.4
15 0.3 0.3 0.3 0.3
# of models 6 3 3 3
3 Reduced Form
2 Calibrated Portfolio
Models in Scope 2 Calibrated Portfolio 3 Reduced Form 3 Reduced Form
1 Calibrated Stress Testing
1 Calibrated Stress Testing
Across the various models and methodologies, there is a significant reduction in the probability of a crisis at higher levels
of capital. Additionally, when liquidity requirements are considered, the probability of a crisis is further reduced. However,
as capital and liquidity requirements increase, the marginal benefit decreases. This implies that tighter standards have
bounds and plateau at some capital (or liquidity) level.
Practitioners typically assert that higher capital and liquidity requirements not only reduce the likelihood of a crisis, but
also the severity of a crisis. BCBS assesses this claim using data on the aggregate level of capital and liquidity buffers in
country’s banking systems immediately before the onset of a crisis. The results indicate a relatively weak relationship
between lower capital to asset ratios and greater output losses. As such, BCBS decides not to include a reduction in the
cost of a crisis, resulting from increased capital and liquidity levels, in the calculation of net benefits.
The final benefit explored by the BCBS is the effect that higher capital and liquidity requirements have on reducing the
volatility of output. Output volatility is defined as the deviation in long-run steady state economic output as the result of a
shock to technology. The BCBS uses dynamic stochastic general equilibrium (DSGE) models which explicitly integrate
bank capital. Initially, a baseline case is run in which an economy in a steady state is hit by a positive or negative
technology shock assuming current capital and liquidity ratios are in effect. Then, simulations are run, applying the same
technology shock, but using capital ratios 2%, 4%, and 6% higher than the baseline simulation. The deviation from steady
state outputs resulting from the shock in each simulation is then compared to the change in output in the baseline
simulation. A simulation which produces output deviations less than those observed in the baseline simulation is said to
have lower output volatility. The BCBS then runs a subsequent set of simulations in which liquidity ratios are increased
25% and 50% relative to the baseline. The Table below displays the results of the simulation. The Table shows the
average, minimum, maximum, and median percent decrease in volatility of output compared to the baseline when raising
capital and/or liquidity requirements.
Table 27: Decrease in output volatility under raised capital and liquidity225
Decrease in the Standard Deviation of Output due to Regulatory Tightening

(in percent)
Increase in TCE/RWA
Case226 Average Minimum Maximum Median
(in percent)227
225
Settlements, Aug. 2010, https://www.bis.org/publ/bcbs173.pdf. 19
226
Each case represents a different assumption regarding the level of target liquidity tightening relative to baseline. The
target ratio is measured as the ratio of liquid assets to total assets.
227
The increase in TCE/RWA is a percentage point increase relative to a baseline value of 7%.

2 2.5 5.1 0.5 1.9
No Liquidity
4 5.2 10.8 1.1 3.9
Requirement Increase
6 7.6 16.4 1.5 6.0
2 3.0 4.5 1.4 3.1

25% Liquidity
Requirement 4 5.4 10.3 2.2 4.6
Increase228
6 8.3 15.9 3.1 7.1
2 4.2 5.9 3.4 3.8

50% Liquidity
4 7.3 9.8 5.4 6.9
Requirement Increase
6 -0.1 15.5 7.0 8.9
The results of the analysis demonstrate that increases in capital and liquidity requirements reduce the volatility of output in
response to shocks, despite the magnitude of this effect varying across models and simulations. BCBS proposes that the
reason for the reduction in volatility is that banks are better able to absorb losses in downturns and restrain lending during
booms with higher capital and liquidity requirements.
Costs Channel
BCBS employs various macroeconomic models to assess the long-term costs related to increased capital and liquidity
requirements. Some of these models directly examine changes in the long-term output level by incorporating measures of
bank capital and liquidity. However, others must use lending spreads as an input to assess adjustments in steady-state
output. The analysis emphasizes price adjustments and increased credit costs rather than potential effects of credit
rationing,229 as BCBS considers price adjustments the primary cost.
First, BCBS examines the effects of heightened capital requirements on banks. The analysis uses data from 13 countries
and the balance sheet information of 6,660 banks between 1993 and 2007, including balance sheet, cost of funds, and
return on assets for each bank. To estimate the cost of equity, BCBS assumes a 14.8% return on equity, which is the
average across the sample countries.The cost of liabilities presumes a fixed spread over deposits: 1000 basis points for
short-term debt and 200 basis points for long-term debt, in line with the sample country averages. BVBS also assumes
that raising the TCE/RWA ratio involves increasing equity and reducing long-term debt. The model’s additional key
assumptions are a 100% pass-through of higher funding costs to borrowers via increased loan rates and equity and debt
costs are not impacted by the bank’s lower riskiness.
BCBS simulates a 1 percentage point increase in bank’s capital requirements, which, all else being equal, lowers the
return on equity. Banks are then assumed to pass the extra costs onto borrowers, raising lending spreads. The rise in
lending spreads offset the increased funding costs for banks, keeping ROE unchanged. The results indicate that for each
1 percentage point increase in the capital ratio, lending spreads increase by 13 basis points.
To evaluate the impact of enhanced liquidity requirements, BCBS models the cost of meeting the NSFR requirement. The
liquidity model employs the same assumptions as the capital model, but accounts for the cost of meeting the NSFR
requirement with or without changes in RWA. It is important to note that to meet the NSFR, banks must alter their assets
and liabilities, resulting in reduced interest income or increased interest expense, which then lowers net income. To
prevent a decline in return on equity, banks raise lending spreads. The list below expands on the necessary changes
banks must make to comply with the NSFR requirement:
228
BCBS asserts that a 25% liquidity requirement increase is roughly equivalent to meeting the NSFR requirement.
229
Credit rationing refers to lenders reducing the supply of credit available to borrowers.

1. Lengthen the maturity of wholesale funding: Wholesale funding refers to funds sourced from wholesale markets
such as federal funds, Federal Home Loan Bank advances and other wholesale sources. The BCBS assumes that
25% of banks’ wholesale debt is composed of maturities of less than one year, but as banks work to meet the NSFR,
the proportion of their wholesale debt funded with maturities of less than one year trends towards zero. This results in
an increase in interest expense as banks’ funding shifts towards longer maturity debt which is generally more costly
than short term debt.
2. Banks increase their holding of highly rated, qualifying bonds: Complying with NSFR requires that banks hold
high quality and liquid assets. This forces banks to shift away from lower-rated and higher yielding assets to less risky,
lower yielding assets. The BCBS assumes this shift in bond quality reduces the return on interest-earning assets by
100 bps.
3. If necessary, banks reduce “other assets”: If the preceding two steps are not sufficient to meet the NSFR, then
banks may be forced to reduce their other assets which are generally illiquid. Reducing other assets which generate
returns may lower interest income.
The Table below outlines the results of raising the capital ratio on lending spreads under both new capital and liquidity
requirements.
Table 28: Impact of increasing capital and liquidity requirements on lending spreads230
Impact of increases in capital and liquidity requirements on lending spreads (in bps)
Increase in capital Cost to meet Capital Cost to meet NSFR Cost to meet Capital Cost to meet NSFR Cost to meet Capital
ratio (percentage requirement requirement and NSFR requirement and NSFR
points) (A) (B) requirements (C) requirements
(A+B) (A+C)
Assuming RWA unchanged Assuming a decline in RWA
0 0 25 25 14 14
+1 13 25 38 13 26
+2 26 25 51 13 39
+3 39 24 63 11 50
+4 52 24 76 8 60
+5 65 24 89 6 71
+6 78 23 101 5 83
The BCBS notes that when a bank changes the composition of its balance sheet to comply with NSFR, it increases its
holdings of high-quality assets and therefore, lowers its RWA. The Table above shows the change in lending spreads that
result from complying with NSFR under two RWA scenarios. In the first scenario it is assumed that there is no decline in
RWA when banks shift their portfolios to comply with NSFR, while the second scenario assumes there is a decline in
RWA.
The BCBS then evaluates the impact of the increases in lending spreads on the long-term levels of output. This evaluation
utilizes three different model types including structural models (DSGE), semi-structural models, and reduced-form models
(“VECM”, or Vector Error Correction Models). Each of the models incorporate factors which are affected by the new
proposed regulations. Additionally, the models were selected as they all have a relatively straightforward method for
computing the change in the steady-state. The BCBS selected a total of 13 models, eight of which incorporate bank
230
capital and not liquidity, and five which include both bank capital and bank liquidity. The models leverage the increases in
lending spreads as calculated in the Figure above as inputs.
The Table below displays the impact on output produced through increasing the TCE/RWA ratio by 2,4, and 6 percentage
points. The results also display the impact of complying with NSFR separately assuming a decrease in RWA and
assuming RWA is unchanged. The Table breaks out results by area considered and models used. Additionally, the Table
shows the average across all areas and models.
Table 29: Output loss across countries and model structures231
Long-run GDP loss due to regulatory tightening (percentage deviation from baseline)
Italy, UK
Euro Area United States United States,
Euro Area
Increase in
Semi-
Case TCE/RWA DSGE models, DSGE and DSGE models, Average
DSGE models, structural
(in percent)232 without bank VECM models, without bank
w/bank capital models, without
capital w/bank capital capital
bank capital
2 0.29 0.24 0.10 0.29 0.29 0.25

No Liquidity
Requirement 4 0.53 0.49 0.25 0.58 0.58 0.47
Increase
6 0.81 0.72 0.35 0.84 0.84 0.68
2 0.34 0.34 0.20 0.45 0.45 0.37

NSFR
Requirement
4 0.63 0.61 0.35 0.73 0.73 0.61
met, but RWA
Decreases
6 0.86 0.86 0.50 0.99 0.99 0.80
2 0.49 0.48 0.29 0.56 0.56 0.51

NSFR
Requirement
4 0.73 0.72 0.49 0.82 0.83 0.72
met, but RWA
is Unchanged
6 0.96 0.96 0.59 1.06 1.09 0.92
Conclusion
Using the cost-benefit analysis framework, BCBS combines the economic costs and benefits discussed earlier to measure
the impact to economic output resulting from increased capital and liquidity requirements. The overarching conclusion is
that there is significant room for raising capital and liquidity requirements while still producing net benefits.
The advantages of higher capital and liquidity requirements include a reduced likelihood of a financial crisis and potentially
less severe costs if a crisis does occur. The cost of stricter regulations is a decrease in annual output due to increased
lending rates. Crisis costs are not confined to the year the crisis occurs, as the BCBS demonstrates that crises can have
permanent effects. Additionally, along with meeting capital requirements, BCBS also examines the impact of meeting or
not meeting liquidity requirements on net benefits. The Table below presents the results of raising capital ratios under both
liquidity compliance outcomes, as well as considering various durations for the expected persistence of a crisis’s effects.
The costs and benefits are measured as the percentage impact on the annual output level relative to the pre-reform
steady state.
231
232
The increase in TCE/RWA is a percentage point increase relative to a baseline value of 7%.

Table 30: Total long-run net benefits233
Expected Long-Run Annual Benefits and Costs of Tighter Regulatory Standards

(benefits and costs are measured by the percentage impact on the level of output per year)
Net Benefits Net Benefits Net Benefits

Case Capital Ratio234 Expected Costs235 (Moderate Permanent (No Permanent Crisis (Large Permanent
Crisis Effect)236 Effect)237 Crisis Effect)238
7% 0 0 0 0
8% 0.09 0.87 0.20 2.32
9% 0.18 1.44 0.31 3.87
10% 0.27 1.71 0.33 4.70

Liquidity
Requirements are 11% 0.36 1.87 0.31 5.23
Met
12% 0.45 1.94 0.27 5.54
13% 0.54 1.96 0.21 5.73
14% 0.63 1.95 0.15 5.84
15% 0.72 1.92 0.08 5.90
7% 0.08 0.68 0.15 1.83
8% 0.17 1.23 0.25 3.33
9% 0.26 1.56 0.29 4.30
10% 0.35 1.75 0.28 4.91

Liquidity
Requirements are 11% 0.44 1.85 0.25 5.30
not met
12% 0.53 1.89 0.20 5.55
13% 0.62 1.90 0.14 5.70
14% 0.71 1.89 0.07 5.80
15% 0.80 1.85 0.00 5.85
The primary objective of this study is not to identify an optimal capital ratio. However, the net benefits discussed above,
under various assumptions, suggest that increasing capital ratios beyond their current levels would result in greater net
benefits. The Table also indicates that as capital requirements increase, the expected costs grow relatively linearly, while
the benefits exhibit diminishing marginal returns after the initial increase from 7% to 8%.
233
234
The capital ratio is defined as TCE over RWA.
235
To meet the liquidity requirement, the annual expected output cost is estimated to be 0.08%. Each 1 percentage point
increase in the capital ratio, starting at 7%, thereafter results in a 0.09% fall in the level of output below the baseline.
236
Moderate permanent crisis effect assumes the cost of a crisis equals 63% of output per year.
237
No permanent crisis effect assumes the cost of a crisis equals 19% of output per year.
238
Large permanent crisis effect assumes the cost of a crisis equals 158% of output per year.

Limitations
BCBS (2010) leverages a cost-benefits based approach to identify an optimal capital level. However, the model’s
framework does not consider certain, potentially material factors (summarized below), which could impact the paper’s
conclusion:
enhanced regulatory standards, particularly recovery and resolution planning requirements, on bank balance sheets
and resolvability. Recovery and resolution requirements aim to enhance the resolvability of firms, potentially reducing
the cost of a potential future crisis. As such, if the paper considered these regulations, the marginal benefit from
increasing capital requirements could be reduced, potentially lowering the optimal capital level.
2. Migration of financial intermediation to non-banks: The framework does not account for the potential migration of
financial mediation out of the banking sector and into the less regulated non banks, as a result of higher bank capital
costs. Movement of lending activities to the non-bank intermediaries may reduce the benefits from greater bank
capital requirements, increasing leverage in the non-bank financial sector and potentially offsetting gains in economic
growth stemming from the increased diversity in financing options.
banks may reduce their trading inventories, thereby lowering market liquidity. This may translate into a higher liquidity
premium on corporate bonds, raising corporates’ borrowing costs and reducing investment and GDP.
On the other hand, the model does not consider the fact that corporate bonds are a substitute product for bank debt. The
availability of corporate bonds as a funding source may mitigate the impact of an increase in lending rates on
corporates and thus, mitigate the estimated decrease in macroeconomic output.
4. Reduction in risk premia on cost of capital: The framework does not account for the potential reduction in risk
premia for equity and debt, derived from a greater perceived stability in the financial system. The reduction in risk
premia could ultimately reduce the cost of funds for banks and increase lending volume, increasing GDP
estimated impact to Household, under an increase in capital requirements:
Table 31: BCBS 2010, Factors Not Considered and Potential Impact on GDP and Optimal Capital Level Estimates
# Factor Not
Potential Impact on GDP Potential Impact on Optimal Capital Level Estimate
Considered
Positive
Negative
Enhanced
regulation and Existing recovery and resolution requirements aim to
Without considering enhanced regulation and bank
1 bank balance reduce the risk in bank balance sheets and enhance the
balance sheet composition, the model may overstate the
sheet resolvability of firms during a crisis. Consideration of both
marginal benefit of capital requirements, resulting in an
composition of these factors could have a positive impact on Household
overstated optimal capital level
Welfare.
Mixed
Without considering non-bank financial intermediaries,

Migration of Mixed
the marginal cost of increased capital requirements may be
financial
2 overstated, as increased capital requirements may
intermediation to Non-bank lending share may increase, enhancing
enhance competition reducing lending rates. However, the
Non-banks competition, but potentially increasing risk in stress
marginal benefit may be overstated as well, as increased
capital requirements may increase risk in stress in the
financial sector.
Bank trading Mixed Mixed

books and market
3
liquidity are not Consideration for trading book and market liquidity, Without considering trading book, the marginal cost of
considered introduces a substitution effect where corporate bonds may increased capital requirements may be overstated or

mitigate the impact of lending on GDP, but could reduce understated, as corporate bonds act as a substitute funding
inventory raises borrowing costs source, but increased capital requirements may reduce
market liquidity.
Positive Positive
Reduction in risk
Risk premia on cost of equity and debt could decrease, Without considering reduction in risk premia, the model
4 premia on cost of
reducing weight average cost of capital, potentially may overstate the marginal cost of higher capital levels.
capital
decreasing lending rates and increasing lending volume Incorporating this factor may allow for raising capital levels
and GDP with a smaller cost to the economy.
the model’s estimates for benefits, resulting in the optimal capital level being overstated, the lack of consideration for
reduction in risk premia may overstate the costs of increased capital levels. Additionally, the lack of consideration for
non-bank financing and the trading book has a mixed effect on the model's outputs. These considerations would have to
be incorporated in the model to understand which channel would dominate under increased capital requirements and
ultimately, how this would impact the model’s existing estimates for optimal capital levels.
2.3.3 Bank of England - Measuring the Macroeconomic Costs and Benefits of Higher UK Bank Capital
Requirements (2015)
Martin Brooke, Oliver Bush, Robert Edwards, Jas Ellis, Bill Francis, Rashmi Harimohan, Katherine Neiss, and
Casper Siegert
In 2015, the Bank of England (BoE) conducted a study to evaluate optimal capital levels and the costs and benefits of
requiring UK banks to maintain higher capital levels. The study was in response to the proposal for UK bank capital
requirements to comply with Basel III, which sets out international standards for bank regulation. The BoE evaluated
whether the proposed baseline requirements were appropriate for the UK.
Martin Brooke, Oliver Bush, Robert Edwards, Jas Ellis, Bill Francis, Rashmi Harimohan, Katharine Neiss, and Caspar
Siegert authored the study, titled “Measuring the Macroeconomic Costs and Benefits of Higher UK Bank Capital
Requirements,” building upon previous research by the Basel Committee on Banking Supervision in 2010, which also
evaluated the long-term economic impact of stronger capital and liquidity requirements.
The BoE study accounts for the unique characteristics of the UK banking system and economy. It also considers liquidity
requirements, structural reform, and Total Loss Absorbing Capacity (TLAC) regulations.
The study compares the economic costs and benefits of higher capital requirements and determines an optimal range for
capital under various risk environments. The model defines the benefits as a reduction in the likelihood and cost of a
financial crisis, while the model defines the costs as an increase in lending rates, resulting in a decrease in investment
activity and economic output. The emphasis on the UK banking system, as well as new regulatory requirements, allows
the model to provide a more focused evaluation of how the proposed Basel III requirements will impact the UK economy.
The study arrives at three key conclusions regarding optimal UK bank capital levels. First, contrary to the BCBS LEI study
(2010), which finds an optimal capital requirement of 16-19%, the BoE determines an optimal range of 10-14%. This
difference in part is driven by the BOE accounting for the expected beneficial effects of TLAC requirements and
improvements in the UK’s resolution regime. Second, during periods of elevated economic risk, optimal capital
requirements should be much higher to mitigate the costs of a future financial crisis. Finally, capitalizing the banking
system for heighted risk environments at all times is not efficient. Rather, regulators should implement time-varying
macroprudential tools, such as a countercyclical capital buffer, to minimize economic costs.
Methodology
The Bank of England defines a cost-benefit model structure that evaluates the net benefits of raised capital requirements
as a percentage of GDP. The methodology follows the below equation:

Figure 29: Bank of England (2015), Model Structure
The model evaluates each element of the above equation, at different tier 1 Capital levels (except for the net present cost
of a crisis, which is assumed to be independent of capital levels), to determine a range of optimal tier 1 capital levels. The
following sections describe the components within the cost and benefits channels as well as the key assumptions and
conclusions of the study.
Benefits Channel
The Bank of England estimates the benefits of raised capital requirements as the product of a reduction in the probability
of a crisis and the net present cost of a crisis. To quantify the reduction in the probability of a crisis, the BoE utilizes two
approaches, a bottom-up approach and top-down approach. The model takes the average of the approaches as the
central estimate of the likelihood of a crisis. To identify the net present value of a crisis, the authors expand on Romer and
Romer (2015) by including the experiences of the global financial crisis and narrowing the sample to be more
representative of the UK financial system.239
The bottom-up approach uses semi-annual data of pre-tax net income and assets from banks’ published accounts. The
sample consists of banks from 22 advanced economies. Screens are applied to remove the results from several Greek
Banks and large US government sponsored enterprises (GSEs), as data from these entities represented some of the
most extreme losses in the sample and were not deemed representative of the UK financial system.
The bottom-up approach uses this data to interpret the likelihood of an individual bank failure at any given capital ratio.
The model then translates the likelihood of an individual bank failure into the likelihood of a crisis. To do this, the model
leverages a simulation-based approach. In the simulations, if a bank suffers a large enough loss to push them below the
regulatory capital minimum, then the bank is considered to have failed. The model assumes a banking crisis occurs when
recapitalization costs exceed 3% of GDP.
The simulation estimates a less than 1% chance of a crisis in an average risk environment across all capital ratios above
the current minimum requirement. This result translates to a crisis occurring once every 100 years. However, the BoE
asserts that the results of the bottom-up approach results do not accurately reflect the actual frequency of financial crises.
239
Excluded countries with insufficient data (the Baltic states, Malta, Slovenia, Slovakia) or whose banking systems are
dominated by foreign-owned banks (Luxembourg, Czech Republic, and Finland)

When averaging the results with the top-down approach, the BoE adjusts the bottom-up crisis frequency to yield a crisis
every 25 years, a value the BOE deems more in line with that of advanced economies on average.
The top-down approach uses a cross-country panel logit regression model to estimate the relationship between banking
crises and the capital ratios of banking systems. A logit model, also known as logistic regression, is a statistical method
used for modeling the relationship between a binary dependent variable (with two possible outcomes, such as
success/failure or 0/1) and one or more independent variables, also known as predictors or explanatory variables. The
model equation used in the top-down approach is expressed below:
Figure 30: BoE 2015, Top Down Approach Equation
To predict the probability of a crisis, the model uses five factors, as described below:
• TCE: This variable represents Tangible Common Equity to Tangible Assets.
• Credit_GDP: This variable represents the ratio of total credit supply to GDP.
• VIX: VIX is an Equity volatility index which measures the price volatility in the S&P 500.
• Liquid_TA: This variable represents a given bank’s liquid assets to total assets.
• Deposits_TL: This variable measures the ratio of a given bank’s deposits to total liabilities.
The data used in the model covers 840 advanced economy banks, spanning a time period of 1980 to 2014. A crisis is
identified using the index of systemic banking crises developed by Laeven and Valencia (2012). This method identifies 23
crises in the sample period.
Using the logit regression described above, the BoE determines that a tier 1 capital ratio of 8% results in a 1.8%
probability of a crisis in a given year. Increasing the tier 1 capital ratio to 11% reduces the probability of a crisis to 0.8%.
By averaging the adjusted outcomes from both bottom-up and top-down approaches, the BOE calculates the probability of
a crisis across various tier 1 capital and leverage ratios. Furthermore, the BOE enhances its methodology for estimating
crisis probabilities by considering the effects of Total Loss-Absorbing Capacity (TLAC). To quantify this impact, the BoE
referred to the Financial Stability Board's (FSB) 2015 TLAC Impact Assessment. The findings indicate that, in an average
jurisdiction, the likelihood of a crisis decreases by approximately 30% when accounting for TLAC. The Table below
presents the results of these models, both with and without TLAC considerations. These figures represent the percentage
probability of a crisis during both the midpoint and peak of the risk environment.

Table 32: Crisis Probability Under Different Capital Requirements240
Average of BoE models Average of BoE models with TLAC

consideration
Tier 1 Capital Ratio Tier 1 Leverage Ratio

Midpoint Peak Midpoint Peak
8 3 1.2 5.5 0.8 3.9
11 4 0.7 4.1 0.5 2.9
14 5 0.5 3.1 0.4 2.2
16 6 0.3 2.4 0.3 1.7
As shown above, the approach assumes a meaningful reduction in the probability of a crisis, when considering the impact
of TLAC. In addition, the chart shows that as tier 1 capital ratios increase, the likelihood of a crisis decreases.
Building on Romer and Romer (2015) and drawing from experiences of the global financial crisis, the BoE calculates the
cost of a crisis to the UK economy. The BOE concludes that, on average, the impact of a crisis on GDP levels six years
after the event is approximately 4%. This estimate relies on several key assumptions, including the persistence of a crisis'
effects and the impacts of post-crisis reforms.
Recent experiences show that although the economy has returned to pre-crisis GDP growth rates, it remains below the
trend GDP path that would have been expected in the absence of a crisis. Consequently, the costs of a crisis are
considered permanent. In addition, due to regulatory reforms, the costs of future crises are expected to be lower than
those of the past. Factors contributing to this expectation include more timely bail-ins of private-sector creditors during
bank recapitalizations, a reduced need for fiscal consolidation by decreasing the necessity for bailouts, and the prevention
of sharp increases in private-sector borrowing costs linked to government borrowing costs. TLAC is also considered a
factor that reduces the estimated cost of a future financial crisis.
Taking into account the considerations above, the estimated net present value of a crisis is 43% of GDP for the UK.
Costs Channels
The Bank of England (BoE) assumes that raising capital requirements will lead to a reduction in output due to increased
lending rates. The Figure below illustrates the sequence of events the BoE expects as banks' capital requirements
increase:
Figure 31: Progression of costs of raised capital requirements
240
Brooke, Martin, et al. “Financial Stability Paper No. 35 - Bank of England.” Bank of England, Bank of England, Dec.
2015,
https://www.bankofengland.co.uk/-/media/boe/files/financial-stability-paper/2015/measuring-the-macroeconomic-costs-and
-benefits-of.pdf. 16.

As presented in the flow above, the BoE asserts that because equity-based financing is more expensive than deposit or
bond-based financing, higher capital requirements raise banks' weighted average cost of funds (WACC). This increase
prompts banks to raise their average cost of funds through higher lending rates, which in turn elevates the cost of capital
in the economy, diminishing investment activity and potential output.
The rise in bank lending rates is estimated using a basic loan pricing model, which utilizes information on recent funding
costs and balance sheet structure for UK banks. The BoE estimates that the average cost of UK banks' equity is around
10 percentage points higher than the cost of debt, with the cost of equity equaling the sum of the risk-free rate and the UK
equity risk premium. The cost of debt is derived from 10-year government bond rates and data on UK financial institutions'
monthly interest rates on household deposits. These funding costs, along with the relevant corporate tax rate and
loan-to-asset ratio, imply a lending rate increase of 10 basis points (bp) for every 1 percentage point increase in
risk-weighted capital ratios.
The BoE also takes the relevance of the Modigliani-Miller (MM) theorem into account, which suggests that higher equity
holdings in banks lead to a reduction in their cost of debt funding. Based on data from UK banks between 1997 and 2014,
the BoE assumes a partial MM offset, indicating that banks' overall cost of capital increases by about half of what it would
have without the MM effect. The conclusion is that a 1 percentage point increase in capital requirements results in a 5-10
bp increase in lending spreads.
Using semi-structural macroeconomic models, the BoE assesses the impact of increased lending spreads on GDP. The
model relies on two key assumptions to derive the total decrease in investment and potential output. The first assumption
is that banks can fully pass higher funding costs onto borrowers without any strategic or permanent changes to their
business models or lending practices. If banks cannot fully pass through these higher costs, they may need to reduce
their lending to a greater extent, leading to higher economic costs. The second assumption is that the interest spread
between the costs of equity and debt is approximately 10%. If this difference is, in fact, lower, the economic costs would
also be lower.
Assuming the full pass-through of funding costs to lending spreads, the BoE estimates a permanent annual output loss of
0.01-0.05% of GDP for every 1 percentage point increase in equity capital requirements.
Conclusion
Using a cost-benefit analysis framework, the Bank of England (BoE) concludes that there is a range of increased capital
requirements that yield positive net benefits. The optimal range for these benefits is determined to be between 10-14% of
risk-weighted assets (RWA). As capital requirements increase, benefits initially rise more rapidly than costs, while costs
increase relatively linearly. The Figure below illustrates the optimal point (K*) where maximum benefits are achieved.

Figure 32: Optimal Capital Ratio Chart241
The results are sensitive to a few key assumptions, and the range of optimal capital requirements can shift depending on
the validity of each assumption. The Figure below depicts the different optimal capital ranges when these key
assumptions are altered.
Table 33: Impact of Key Assessments on Optimal Capital Range
Assumption Description Optimal Range
The “Central Case” assumes that the costs of a crisis are permanent,
that improvements in the UK’s resolution arrangements will decrease
Central Case 10-14%
the costs of future crises, and that there are no material and
permanent transition costs to higher capital requirements
The “Temporary Crisis Costs” case assumes that the effects of a crisis
Temporary Crisis Costs are temporal, reducing the marginal benefit of increased capital 7-11%
requirements.
The “Ineffective Resolution” case assumes that if the new resolution

arrangements for the UK only have a limited impact on the costs of a
Ineffective Resolution 15-19%
future crisis, the marginal benefit of increased capital requirements is
greater.
The “Moderate Transition Costs” case assumes that If there is a

Moderate Transition Costs moderate level of transition costs then the marginal cost of increased 7-11%
capital requirements is higher.
The optimal ranges presented by the BoE, above, aim to represent the range where maximum net benefits are realized
during an average point in the risk environment. It is important to note that during the peak of the credit cycle, the
probability of a crisis increases, and the optimal capital range should be higher. The BoE uses this rationale to justify the
implementation of a countercyclical capital tool, which would impose higher capital requirements during periods of
elevated risk.
241
Source: Brooke, Martin & Bush, Oliver & Edwards, Robert & Ellis, Jas & Francis, Bill & Harimohan, Rashmi & Neiss,
Katharine & Siegert, Caspar, 2015. "Financial Stability Paper No. 35: Measuring the macroeconomic costs and benefits of
higher UK bank capital requirements -," Bank of England Financial Stability Papers 35, Bank of England, 23.

Limitations
The BoE analysis includes only a limited number of potential channels in which capital requirements may affect economic
output. The absence of consideration of these channels can lead to varying degrees of change on the optimal range for
capital requirements. Some of the key assumptions and their quantified changes have been described in the previous
section, however, the oversight of the channels below is a key limitation in the findings of this study.
banks may reduce their trading inventories, thereby lowering market liquidity. This may translate into a higher liquidity
On the other hand, the model does not consider the fact that corporate bonds are a substitute product for bank debt. The
premia could ultimately reduce the cost of funds for banks and increase lending volume, increasing GDP
The Figure below displays the potential impacts that each of the above considerations could have on the BoE’s results for
the optimal capital requirements:
Table 34: BoE 2015, Factors Not Considered and Potential Impact on GDP and Optimal Capital Level Estimates
# Factor Not
Potential Impact on GDP Potential Impact on Optimal Capital Level Estimate
Considered
Mixed
Migration of Mixed Without considering non-bank financial intermediaries, the

financial marginal cost of increased capital requirements may be
1
intermediation to Non-bank lending share may increase, enhancing overstated, as increased capital requirements may enhance
Non-banks competition, but potentially increasing risk in stress competition reducing lending rates. However, the marginal
benefit may be overstated as well, as increased capital
requirements may increase risk in stress in the financial sector.
Mixed Mixed
Bank trading
Consideration for trading book and market Without considering trading book, the marginal cost of
books and market
2 liquidity, introduces a substitution effect where increased capital requirements may be overstated or
liquidity are not
corporate bonds may mitigate the impact of lending on understated, as corporate bonds act as a substitute funding
considered
GDP, but could reduce inventory raises borrowing source, but increased capital requirements may reduce market
costs liquidity.
Positive Positive
Reduction in risk
Risk premia on cost of equity and debt could Without considering reduction in risk premia, the model
3 Premia on cost of
decrease, reducing weight average cost of capital, may overstate the marginal cost of higher capital levels.
capital
decreasing lending rates and increasing lending Incorporating this factor may allow for raising capital levels with
volume and GDP a smaller cost to the economy.
aggregate. The lack of consideration for reduction in risk premia may overstate the costs of increased capital levels,
indicating that a higher capital requirement may be viable. However, the lack of consideration for non-bank financing and

the trading book has a mixed effect on the model's outputs. These considerations would have to be incorporated in the
model to understand which channel would dominate under increased capital requirements and ultimately, how this would
impact the model’s existing estimates for optimal capital levels.
2.3.4 Federal Reserve Bank of St. Louis (FRB) - Empirical Economic Assessment of the Costs and
Benefits of Bank Capital in the United States (2019)
Simon Firestone, Amy Lorenc, and Ben Ranish
Federal Reserve Board staff adapted methods from BCBS (2010) and Bank of England (2015) to analyze optimal bank
capital for the US economy. In their 2019 study, "Empirical Economic Assessment of the Costs and Benefits of Bank
Capital in the United States," Simon Firestone, Amy Lorenc, and Ben Ranish (collectively referred to as Firestone et al.)
build upon methodologies from BCBS 2010, Brooke et al. 2015, and FRB Minneapolis 2016. They also take into account
the impact of new regulatory liquidity (LCR) and resolution-planning (LTD and TLAC) requirements to evaluate the
marginal benefits of increasing bank capital.
The framework assumes that the 2017 LCR requirements and the 2019 LTD and TLAC resolution-planning requirements
lessen the expected probability cost of a future financial crises. Firestone et al. places significant emphasis on these
regulations in their adjustments and controls for model assumptions. This distinct methodology provides a more recent
and comprehensive perspective on the US regulatory landscape compared to other studies.
Ultimately, the study proposes a wide range for optimal tier 1 capital levels, indicated by a tier 1 capital ratio between 13%
and 26%. The model includes ranges for several of its key assumptions, including the level of reduction in the probability
of a crisis due to TLAC and the level with which an increased weighted average cost of capital (“WACC”) is passed on to
borrowers, driving this wide range.
Methodology
Firestone et al.'s methodology follows a cost-benefit analysis model structure. As such, the model consists of a cost
channel and a benefits channel that are summed together to generate an estimate for a net increase or decrease in GDP
growth given a certain tier 1 capital requirement. The cost channel estimates the impact of capital requirements on a
bank's cost of funds, driving lending rates, loan volumes, and ultimately long run GDP. The benefit channel estimates the
impact of bank capital levels on the probability and cost of a future potential financial crisis on long run GDP.
The Figure below provides an overview of the model structure, breaking out the cost and benefit channels and the model
components within each:

Figure 33: FRB 2019, Model Structure
The sections below describe the model components within each channel, and the assumptions associated with each
component in more detail.
Benefits Channel
In the benefits channel, the model quantifies the impact of capital requirements on a future potential financial crisis as the
product of the reduction in probability of a financial crisis and the cost of the avoided financial crises for a given tier 1
capital level. Two methods are used to derive the reduction in the probability of a future financial crisis – a top-down
approach and a bottom-up approach. To mitigate the impacts of the assumptions and limitations of each approach,
Firestone et al. averages the results across the two methods. Firestone et al. uses the results from Romer and Romer’s
2015 paper to estimate the cost avoided from a future potential financial crisis, and then discounts the impact back to its
present value using the Gordon Growth model.
To estimate the probability of a financial crisis at a given tier 1 capital level, Firestone et al. takes an average of a
bottom-up and a top-down approach that have both been used in prior studies. In the bottom-up approach, the
methodology simulates historical US bank net income and estimates whether the capital shortfall is large enough to be
considered a financial crisis. The data leveraged for the simulation includes bank data on total assets, RWA, net income,
tier 1 capital, and asset liquidity ratios from 1988-2014, sourced from Bankscope. The estimated capital shortfall is defined
as a change in capital associated with the simulated change in net income. For an estimated capital shortfall to be
considered a financial crisis, the capital shortfall must exceed 3% of GDP. The simulation is run over 10,000 times, each
time selecting a random set of net income reductions from a randomly selected country-year scenario. It is important to
note that the outcomes of this approach are adjusted for the impacts of greater liquidity regulations, improving the quality
of assets and reducing net income losses in a crisis, and enhanced resolvability of firms, based on the introduction of
TLAC requirements. Firestone et al. finds that enhanced liquidity and resolvability requirements have a material impact on
the probability of a future financial crisis.
In the top-down approach, two separate cross-country logit models are used to estimate the probability of a future
financial crisis and the outputs of both are considered as part of the range of benefits. A logit model is a statistical model
that estimates the probability of an event taking place as a linear combination of independent variables. In the models, the
definition of a crisis requires that the following two conditions be met:

1. Significant signs of financial distress in the banking system are present, as indicated by significant bank runs,
losses in the banking system, and/or bank liquidations
2. Significant banking policy intervention measures take place, in response to significant losses in the banking
system
This definition is aligned with that introduced in the Laeven and Valencia (2012) paper.
While the output for each model is the same, the macroeconomic factors under consideration and data available differ in
each equation. The Figure below shows both regression models:
Figure 34: FRB 2019, Top Down Approach Equations242
The variables common to both equations are the tier 1 Capital Ratio for a given country, Liquid Asset ratio for a given
country, VIX and the ratio of total private sector credit to GDP from the World Bank. The second equation includes more
factors, such as the current account balance as a percent of GDP and home price-to-income ratios. However, due to
limitations in data availability for these additional factors, model two is estimated using ~1/3 fewer data points than that of
model one. In order to include more observations, Firestone et al. average the results from model one, which has fewer
factors but more observations, with the results from model two. It is also important to note that, similar to the bottom-up
approach, Firestone et al. attempted to estimate the impacts of liquidity requirements and resolvability on the probability of
a financial crisis in the top-down approach. Unlike the bottom-up approach, Firestone et al. found there to be little
measurable benefit from enhanced liquidity requirements in the top-down approach, but did assume that resolvability
requirements (e.g., TLAC) had a material impact on the probability of a financial crisis. Specifically, Firestone et al.
assume that TLAC reduces the probability of a crisis by 30%. This assumption is based on Financial Stability Board
(2015), which relies on work by Afonso, Santos, and Traina (2014) and Marques, Correa, and Sapriza (2013) to estimate
the reduction in probability due to TLAC.
To estimate the total costs of a financial crisis, the model applies a two-step approach: (1) estimating the future cost of a
financial crisis in terms of GDP and (2) discounting the future cost of a financial crisis to its present value. The first step is
to take a linear interpolation of Romer and Romer’s (2015) generalized least squares (GLS) regression results. Within this
step, the model contemplates two scenarios, one in which the effects of a financial crisis are permanent and one in which
the effects are transitory. Using the Romer and Romer results as a baseline and incorporating the effect of TLAC
requirements, the methodology separately models the impact of a permanent 2 percent reduction in GDP and the impact
of an effect that peaks in magnitude 2.5 years after the crises and then decays 5 percent each year.
To perform the second step, the model estimates the net present cost of a financial crisis using the Gordon Growth Model
and assuming a discount rate equal to the average real yield on 10-year Treasury bonds of 2.7 percent, and a decay rate
of 5 percent per year for tapering effects.
Overall, Firestone et al. estimate that the marginal benefit of increasing capital ratios by 1 percentage point ranges from 8
to 27 basis points of GDP per year. A benefit of 8 basis points assumes that resolvability requirements reduce the
probability of a crisis by 30% and the effect of a crisis on GDP is transitory. A benefit of 27 basis points assumes that
resolvability requirements do not reduce the probability of a crisis and the effect of a crisis on GDP is permanent.
242
Simon Firestone, Amy Lorenc, and Ben Ranish, "An Empirical Economic Assessment of the Costs and Benefits of
Bank Capital in the United States," Federal Reserve Bank of St. Louis Review, Third Quarter 2019, 209.
Costs Channels
In the cost channel, the impact of an increase in capital requirements aligns with the theory that increased capital
requirements increases funding costs, driving up lending rates and reducing long run GDP. The quantification is performed
in three steps:
1. Impact to weighted average cost of capital: The model is estimates the impact of bank capital requirements on
weighted average cost of capital, using the Modigliani-Miller theorem
2. Impact to lending rates: Second the model determines the level of increased cost passed on to lenders, impacting
lending rates
3. Impact to GDP: Lastly, the approach translates the increase in lending rates into impacts to long run GDP, using the
FRB/US Model
To perform the first step, the model leverages the Modigliani-Miller theorem in estimating an impact to the weighted
average cost of capital given a fixed percentage increase in capital requirements. The Modigliani-Miller theorem states
that under certain circumstances a firm’s cost of capital is independent of its capital structure, which means that the mix of
debt and equity used to finance the firm’s assets does not impact its overall value. Firestone et al. cite literature that
suggests that this theorem only applies to very large firms with little risk in their debt financing. As such, because
Firestone et al.’s sample includes more than the few, largest firms, Firestone et al. assumes that the increase in cost of
capital from increasing equity as a proportion of total financing is only partially offset by this theorem. Specifically,
Firestone et al. assumes that the increase is offset by 50%. The formula used in this step is provided below:
Figure 35: FRB 2019, Impact to Weight Average Cost of Capital Formula243
The formula above estimates the increase in weighted average cost of capital given a 1% increase in capital
requirements. The Modigliani-Miller Offset is denoted by MM and is equal to 50%. The Capital Asset Pricing Model
(“CAPM”) is used to estimate the return on equity, RE, while historical data on bank debt returns is used to estimate return
on debt, RD. Finally, t is the corporate tax rate, which is included to capture the reduction in the tax shield from decreased
debt financing. From this formula, the model estimates a 3.1 bps increase in required return on assets per
1-percentage-point increase in capital ratios.
In the second step, Firestone et al. make a simplifying, yet conservative assumption that 100% of the increase in cost of
capital is passed on to borrowers in the form of increased rates on loans. Given that ~40% of bank balance sheets are
comprised of loans, Firestone et al. divide the 3.1 bps increase by 0.4 to arrive at an increase of 7.8 bps increase in
lending rates per 1% point increase in capital requirements. It is important to note that Firestone et al. consider an
alternative case in which only half of costs can be passed on to lending rates, given competition in the banking sector may
reduce pricing power, resulting in 3.9 bps increase per percentage point increase in equity capital.
In the final step, Firestone et al. translate the impact of an increase in lending rates to an impact on long run GDP,
leveraging the FRB/US economic model. The FRB/US model is a large-scale macroeconomic model developed and used
by the staff of the Federal Reserve Board to analyze and forecast the evolution of the US economy over time. Because
the FRB/US model does not include corporate loan spreads, Firestone et al. leverage the change in loan rates, derived in
step 2, to estimate an impact to corporate bond, mortgage and auto loan spreads to be used in the FRB/US model.
Ultimately, the FRB/US macroeconomic model results estimate that the impact is approximately linear: for every 1 bp
increase in lending rates, GDP declines by approximately 1.07 bp. As such, Firestone et al. estimate that, within the cost
channel, a 1 percentage point increase in capital ratios reduces the level of long-term GDP by 8.3 bps.
243
Simon Firestone, Amy Lorenc, and Ben Ranish, "An Empirical Economic Assessment of the Costs and Benefits of
Bank Capital in the United States," Federal Reserve Bank of St. Louis Review, Third Quarter 2019, 218.
Conclusion
Given the framework for assessing the net benefits of increased capital requirements leverages a series approaches, with
varying levels of marginal costs and benefits, Firestone et al. present a range of optimal capital levels. The optimal range
is between 13 and 26 percent and is depicted in the Figure below:
Figure 36: FRB 2019, Optimal Capital Levels244
Each line indicates a different combination of assumptions, driving the optimal capital level. The red lines use high cost
assumptions, while the blue lines use low cost assumptions. The assumption for low cost assumes 50% of the increase in
cost of capital is passed on to lenders, while the high cost assumes 100% is passed on. On the benefits side, the
assumption for high benefit is that financial crises incur a permanent effect on GDP and resolvability regulations (e.g.,
TLAC) reduces the cost but not the probability of a crisis. The assumption for low benefit is that financial crises incur a
non-permanent effect on GDP and that resolvability regulations reduce the probability of a financial crisis by 30%. The
midpoint of the range, 19.5%, represents a middle ground in terms of assumption severity.
The diamonds in the chart indicate optimal capital levels for each combination of assumptions. In these cases, marginal
net benefits from increased capital requirements equal zero. Moreover, while Firestone et al. conclude that their estimates
are wide, given the range of assumptions used in the model, the authors also note that the range is generally in line with
impact analysis performed by other regulators and academics.
Limitations
The Firestone et al. study includes model limitations with regards to potentially material factors not considered in the
model framework. The limitations associated with existing model assumptions introduce uncertainty in the model
outcomes presented by Firestone et al. As such, the limitations associated with factors not considered by the model could
also impact the paper’s conclusion.
244
Diamonds denote optimal capital levels where marginal net benefits equal zero for each cost/benefit scenario. Current
tier 1 Capital used in the Figure is 12.5% which is based on data available as of the publication of the FRB (2019) study.
Source: Simon Firestone, Amy Lorenc, and Ben Ranish, "An Empirical Economic Assessment of the Costs and Benefits
of Bank Capital in the United States," Federal Reserve Bank of St. Louis Review, Third Quarter 2019, 221.

premia could ultimately reduce the cost of funds for banks and increase lending volume, increasing GDP.
3. Interaction of higher capital with TLAC and liquidity requirements: Due to the implementation of TLAC and
liquidity requirements, banks rely more on long-term unsecured debt. This, in turn, likely increases their cost of funds
and makes their weighted average cost of capital less sensitive to an increase in capital levels. However, Firestone et
al.'s methodology does not take into account the impact of these requirements on the cost of funds. Therefore, the
model may overestimate the potential increase in the cost of funds that banks may experience from any further
increase in capital requirements.
4. Impact to bank trading books and market liquidity: The framework does not account for the potential impact to
bank’s trading books and market liquidity. To meet higher capital requirements, banks may reduce their trading
inventories, thereby lowering market liquidity. This may translate into a higher liquidity premium on corporate bonds,
potentially raising corporates’ borrowing costs and reducing investment and GDP.
The introduction of corporate bonds as an alternative funding source to the model may mitigate the impact of an
increase in lending rates on corporates and thus, mitigate the estimated decrease in macroeconomic output.
estimated impact to GDP, under an increase in capital requirements:
Table 35: FRB 2019, Factors Not Considered and Potential Impact on GDP and Optimal Capital Level Estimates
# Factor Not Considered Potential Impact on GDP Potential Impact on Optimal Capital Level Estimate
Positive Positive
Reduction in Risk premia Risk premia on cost of equity and debt could Without considering reduction in risk premia, the
1
on cost of capital decrease, reducing weight average cost of capital, model may overstate the marginal cost of higher capital
decreasing lending rates and increasing lending levels. Incorporating this factor may allow for raising
volume and GDP capital levels with a smaller cost to the economy.
Mixed
Without considering non-bank financial

Mixed
Migration of financial intermediaries, the marginal cost of increased capital
2 intermediation to requirements may be overstated, as increased capital
Non-bank lending share may increase, enhancing
Non-banks requirements may enhance competition reducing
competition, but potentially increasing risk in stress
lending rates. However, the marginal benefit may be
overstated as well, as increased capital requirements
may increase risk in stress in the financial sector.
Positive
Negative
Interaction of Higher Without considering the interaction of TLAC and
Existing TLAC and Liquidity requirements have
3 Capital with TLAC and Liquidity requirements, the model may overstate the
likely increased bank cost of funds. Because the model
Liquidity Requirements marginal cost of higher capital levels. Incorporating this
does not consider this impact, the model likely
factor may allow for raising capital levels with a smaller
overstates the cost to GDP.
cost to the economy.
Mixed Mixed
Bank trading books and
4 market liquidity are not
Consideration for trading book and market Without considering trading book, the marginal cost
considered
liquidity, introduces a substitution effect where of increased capital requirements may be overstated or

corporate bonds may mitigate the impact of lending on understated, as corporate bonds act as a substitute
GDP, but could reduce inventory raises borrowing funding source, but increased capital requirements may
costs reduce market liquidity.
aggregate. While the lack of consideration for risk premia and TLAC and Liquidity Requirements may overstate the
model’s estimates for costs, the lack of consideration for non-bank financing and the trading book has a mixed effect on
the model's outputs. These considerations would have to be incorporated in the model to understand which channel would
dominate under increased capital requirements and ultimately, how this would impact the model’s existing estimates for
optimal capital levels.
2.3.5 Capital Requirements, Risk Choice, and Liquidity Provision in a Business-Cycle Model (2020)
Juliane Begenau
Juliane Begenau’s 2020 paper, Capital Requirements, Risk Choice, and Liquidity Provision in a Business-Cycle Model,
estimates an optimal capital ratio for banks that maximizes household welfare, while considering how capital requirements
impact bank cost of capital and the supply of credit. The traditional school of thought regarding how capital requirements
impact cost of funds and lending rates is that increased capital requirements will shift commercial bank’s capital structure
towards equity, a more costly funding source than debt, increasing the overall cost of capital and driving up the cost of
lending for corporates. However, Begenau proposes an alternative impact pathway, in which banks’ cost of capital may
actually decrease, due to a decrease in the cost of deposits, ultimately driving lower lending rates and greater loan
volume. In Begenau’s model, the cost of deposits decreases with greater capital requirements, because greater capital
requirements initially reduces the availability of deposits. The reduction in supply makes deposits more scarce in the
economy, increasing their perceived value by households, and allowing banks to reduce deposit rates without losing
deposits. Begenau employs this dynamic in a general equilibrium model that optimizes household welfare as a function of
bank capital requirements. Her research suggests that raising capital levels from 9% to 12.4% optimizes household
welfare, with increased consumption, bank lending, and output by the bank-dependent sector. In addition to these
increases, volatility in consumption, deposit rates, and banks’ cost of capital will decrease and the supply of deposits to
banks will increase. Under Begenau’s general equilibrium model, the marginal benefits of higher capital requirements
outweigh the marginal costs, suggesting that US capital requirements are suboptimally low.
Methodology
This section describes Begenau’s general equilibrium model used to determine optimal capital levels, first looking at the
agents defined in the model and then the relationships between them. The model defines five distinct agents: a
bank-independent sector, a bank-dependent sector, banks, households, and governments. The solution of the model (i.e.,
the optimal capital level) considers the relationships between each agent and how the choice of one agent influences
another. The optimization problem essentially balances the trade-off between reducing distortions in bank risk-taking and
reducing useful bank services, such as the credit supply and provision of liquidity, to maximize household welfare.
In the model, the economy produces a single good using two production technologies, each operated by a different sector,
a bank-independent sector and a bank-dependent sector. Each sector is governed by its own production function, and
each has its capital stock owned by a different agent. Specifically, the bank-independent sector’s capital stock is owned by
households, and the bank-dependent sector’s capital stock is owned by banks.
The banking sector plays two roles in the economy, according to the model:
1. Contributes to production: The banking sector contributes to the production of a good that households consume,
through lending to and monitoring bank dependent production technology
2. Households value bank deposits: In this model, banks are owned by households and maximize shareholder value
by generating cash flows.
Further, households own the capital from the bank-independent sector and own bank equity. Moreover, they determine the
bank's discount factor through their demand for deposits.

The government also plays an important role in that it provides banks subsidies that distort bank risk-taking, increasing it
beyond the optimal level. The model also assumes that the government maintains a balanced budget.
The main driver of the model is how capital requirements influence the cost of lending. In the model, greater capital
requirements increase the share of equity in bank capital stock, initially resulting in greater cost of capital, driven by equity
being more costly than debt. As a result, banks de-lever, reducing the size of their balance sheet, and reducing the supply
of deposits to the economy. According to the model, the more scarce deposits become, the more consumers value them.
The paper refers to this as an increase in the convenience yield on deposits. As households gain more benefit from the
convenience yield, they are willing to accept a lower deposit rate, decreasing the cost of debt financing for banks. Thus, in
equilibrium, the reduction in cost of debt outweighs the increase in cost of equity from greater capital requirements,
reducing the overall cost of funds for banks. The decrease in cost of funds ultimately contributes to greater lending activity,
increasing the supply of credit to the bank-dependent sector and households, improving household welfare.
It is also important to note the secondary mechanism of the model, which also plays a part in determining an optimal
capital level. In addition to capital requirements driving lending rates, the model also considers the interplay between
capital requirements, bank’s monitoring intensity (i.e., the process of banks using their expertise to assess good vs bad
investments), and government subsidies. The model assumes that capital requirements and government subsidies have
opposite effects on bank monitoring intensity. As capital requirements increase, banks tend to enhance their monitoring
intensity (i.e., spend more time and money identifying good investments vs bad investments). This is because with a
higher cost of capital, banks require a greater return on their investments. On the other hand, government subsidies,
which reduce the riskiness of deposits, reduce the need for greater monitoring intensity. Not only does this interplay
determine the selection of good and bad investments, but it also influences household welfare, as greater bank monitoring
intensity allocates capital to higher return investments, improving macroeconomic output outside of the banking sector.
Conclusions
Employing the model framework described above, Begenau derives conclusions regarding optimal bank capital levels.
Begenau defines the optimal capital requirement as “the one that maximizes the welfare of the representative household,
as measured by the discounted expected lifetime utility from consumption and bank deposits.” To calibrate the optimal
level, the model is simulated at a benchmark capital requirement of 9.25%. The model is then simulated multiple times at
different levels and evaluated for where welfare is maximized. The Figure below displays the implied percentage change
in consumption if the economy moves from the baseline 9.25% to the new capital requirement, ξ.
Figure 37:Optimal Level of Risk Based Capital Ratio245
245
Source: Begenau, Juliane, Capital Requirements, Risk Choice, and Liquidity Provision in a Business Cycle Model
(January 14, 2019), 37.

As displayed in the Figure above, the optimal level of risk-based capital ratio is 12.38%. Begenau notes that this level
should be interpreted as applying to most large banks as the model is calibrated to data that is dominated by the largest
banks.
Once the optimal capital level is calculated, Begenau determines the impact that calibrating capital requirements to the
optimal level will have on other measures of banking and economic activity. With a transition from 9.3% to 12.4%,
consumption increases by 33 bps and consumption volatility decreases by 18.95%.
Moreover, to reach a capital requirement of 12.4%, the equilibrium level of deposits falls by 86 bps. A reduction in the
deposit rate leads to a reduction in banks’ cost of capital, dropping from 1.2% to 0.4%. A reduction in the cost of capital
makes lending for banks more profitable and encourages banks to increase their credit supply, resulting in an increase in
loan volumes of 2.35%. Additionally, the bank-dependent sector increases its output by 11% at the equilibrium capital
requirement of 12.4%.
With higher capital requirements and lower leverage ratios, banks are also not as incentivized by government subsidies
and thus, align themselves with the incentives of a welfare-maximizing regulator. As a result, banks increase their
monitoring of investment opportunities by 6.5%, which drives up productivity by 27.4%.The increased level of monitoring
results in an increase of 13% on banks’ return on assets. Moreover, in the past, banks have reduced their quality of
lending standards in the run-up of an economic boom. With increased capital requirements, leading to increased
monitoring, there is a reduction in the countercyclicality of monitoring, leading to a smoothing of business cycle
fluctuations in bank production.
In conclusion, according to Begenau’s model, under a capital level of 12.4%, banks realize lower funding costs, increasing
credit supply, and enhance monitoring, reducing risk taking. Overall, the macroeconomic impact is an increase in
consumption due to output increases and a decrease in lower quality investments.
Limitations
The Begenau (2020) study leverages a novel approach to identify an optimal capital level. However, the model’s general
equilibrium framework does not consider certain, potentially material factors. The limitations associated with factors not
considered by the model could also adjust the paper’s conclusion.
enhanced regulatory standards, particularly enhanced liquidity and recovery and resolution planning requirements, on
bank balance sheets and bank resolvability. Liquidity regulations for G-SIBs aim to increase the level of high quality
liquid assets on bank balance sheets, potentially reducing the overall riskiness of bank assets. Recovery and
resolution requirements aim to enhance the resolvability of firms, potentially reducing the cost of a potential future
crisis. As such, if the paper considered these regulations, the marginal benefit from increasing capital requirements
could be reduced, potentially lowering the optimal capital level.
growth stemming from the increased diversity in financing options. Begenau recognizes this limitation and attempts to
address it in a subsequent paper, Begenau and Landvoigt (2022).
3. Impact to bank trading books and market liquidity: Similar to other studies, the framework applied by Begenau
does not account for the potential impact to bank’s trading books and market liquidity. To meet higher capital
requirements, banks may reduce their trading inventories, thereby lowering market liquidity. This translates into a
higher liquidity premium on corporate bonds, raising corporates’ borrowing costs and reducing investment and GDP.
The availability of corporate bonds as a funding source may mitigate the impact of an increase in lending rates on

The Table below provides a summary of the anticipated impacts that each factor above may have on the model’s
estimated impact to Household Welfare and optimal capital levels:
Table 36: Begenau 2020, Factors Not Considered and Potential Impact on Household Welfare and Optimal Capital Level Estimates
# Factor Not Considered Potential Impact on Household Welfare Potential Impact on Optimal Capital Level Estimate
Positive
Negative
Enhanced regulation and Existing liquidity and recovery and resolution
1 bank balance Sheet requirements aim to reduce the risk of bank assets
balance sheet composition, the model may overstate
Composition overall and enhance the resolvability of firms during a
the marginal benefit of capital requirements, resulting in
crisis. Consideration of both of these factors could have
an overstated optimal capital level
a positive impact on Household Welfare.
Mixed
Without considering non-bank financial

Mixed
Migration of financial intermediaries, the marginal cost of increased capital
2 intermediation to requirements may be overstated, as increased capital
Non-bank lending share may increase, enhancing
non-banks requirements may enhance competition reducing
competition, but potentially increasing risk in stress
lending rates. However, the marginal benefit may be
overstated as well, as increased capital requirements
may increase risk in stress in the financial sector.
Mixed Mixed
Bank trading books and Consideration for trading book and market Without considering trading book, the marginal cost
3 market liquidity are not liquidity, introduces a substitution effect where of increased capital requirements may be overstated or
considered corporate bonds may mitigate the impact of lending on understated, as corporate bonds act as a substitute
non-bank financing and the trading book has a mixed effect on the model's outputs. These considerations would have to
be incorporated in the model to understand which channel would dominate under increased capital requirements and
2.3.6 A Macroeconomic Model with Financially Constrained Producers and Intermediaries (2021)
Vadim Elenev, Tim Landvoigt, Stijn Van Nieuwerburgh
Elenev, Landvoigt, and Nieuwerburgh provide a general equilibrium model with novel features for analyzing optimal capital
ratios. The paper defines an equilibrium model, which defines relationships between banks, non-financial firms, and the
macroeconomy. In the model, idiosyncratic and aggregate productivity shocks in the non-financial sector drive economic
shocks. These shocks flow through the financial sector through two mechanisms, dubbed “financial accelerators”, which
can cause these productivity shocks in the non-financial sector to develop into financial crises. Elenev, Landvoigt, and
Nieuwerburgh find welfare to be optimized in their model at a capital ratio of 6%. Additionally, the authors explore a
version of the model with a countercyclical capital buffer requirement, and find this approach to be superior to a 6%
benchmark.
Methodology
This section discusses the model’s methodology, beginning with a description of the five agents in the model, the
relationships between these agents, and the model simulations used to draw conclusions. The five agents are household
borrowers, household savers, non-financial firms, banks, and the government. The paper models the equilibrium effect of
different static capital ratios as well as countercyclical capital requirements.
The paper defines two types of households: borrower-entrepreneurs (“borrowers”), and savers. Borrowers work and
consume, as well as operate an investment technology (equivalent to investing in an equity fund). Through the investment

technology, borrowers are owners of all financial and non-financial firm capital. Borrowers choose the combination of
consumption and investment that maximizes lifetime utility. The other household agents are savers, who similarly work
and consume. The difference is that savers have greater risk aversion than borrowers, and therefore do not invest in
equity. Instead, savers invest in government debt, financial firms’ deposits, or corporate debt. There is a cost imposed on
savers for holding corporate debt directly to account for the comparative advantage banks have in screening, monitoring,
and managing risks. Savers then balance current consumption, short term debt investments (deposits and government
bonds), and long-term corporate debt investments to maximize lifetime utility.
Banks buy long-term corporate bonds and are funded by short term debt (deposits) and equity from households. In each
period, banks receive coupon payments on their portfolio of corporate bonds and have to repay a portion of deposits.
Banks maximize the present value of dividend payments to shareholders. Idiosyncratic profit shocks, like the productivity
shocks on non-financial firms, impact the dividend payments by banks. An idiosyncratic shock represents the variability in
credit quality of loan portfolios amongst banks and influences their decision of whether to default. The government
liquidates defaulting banks and then redeems their deposits at par. Shareholders then replace bankrupt financial firms
with a new one that has an initial equity equal to the average equity of non-defaulting banks.
Non-financial firms produce the one consumption good in the model using a mix of labor and capital. Both types of
households supply their labor, and firms are funded by long term corporate debt that they issue to financial firms and
savers, as well as equity issued to borrower households. Firms face costs on equity issuance and their corporate debt
needs to be collateralized by their equity. Non-financial firms try to maximize the present value of dividend payments to
shareholders. They are subject to idiosyncratic productivity shocks each period, and if they are unable to service debt
costs, they default. Non-financial firms that default get replaced by new firms of an equal size.
The government’s main role is to bailout the intermediaries upon default. When intermediaries default, the portion of
obligations not met by the remaining assets are covered by the bailout. The other government expenditures include
exogenous government spending, and transfer spending. Government revenues come from taxes on firm profits, labor
income taxes, deposit income taxes, and deposit insurance fees.
There are multiple interactions between agents that impact the model. The simulation itself consists of a series of time
periods, with four common steps within each time period. The four steps define the interactions between the agents and
are outlined as follows:
1. Aggregate productivity shocks: Production is a function of productivity, capital stock, and labor. In this step, firms
experience a shock to productivity, and are given a set level of capital stock, which is funded through a mixture of debt
and equity. Firms are able to choose labor inputs, amongst borrowers and savers, incurring a variable production cost.
Firms also pay a fixed production cost. Labor choices are made by banks to maximize profits and non-financial firms
to maximize dividends. It is important to note that there are diminishing marginal returns to increasing labor, such that
the incremental benefit to production of increased labor inputs decreases as each additional unit of labor is added.
2. Production occurs and idiosyncratic productivity shocks for non-financial firms: Non-financial firms produce
goods and services and realize profits from production. Firms that are not able to service their debts with sufficient
profits from production default and declare bankruptcy. Banks and savers repossess the firms, sell the current period’s
output, pay current wages, and sell off remaining assets to yield a recovery value for the bondholders. Moreover,
failed firms are replaced by new producers such that the total mass of producers remains unchanged.
3. Idiosyncratic profit shocks for banks occur, and bankruptcy decisions are made: Based on the productivity
shock, which causes some borrowers to default on their bank debt, some banks may also default and go into
bankruptcy. The government liquidates bankrupt intermediaries, and if assets are insufficient to cover depositors, the
government makes depositors whole. Making depositors whole represents the insurance the FDIC provides on
deposits.
4. Agents make portfolio decisions and households consume: All agents make their investment decisions. Save
and borrower households choose investments for the next period, while non-financial firms and banks make their
investment and borrowing decisions for the next period as well.
Two financial accelerators may produce a recession. Productivity shocks lower the value of non-financial firms’

capital. The lower value of non-financial firm capital increases borrowing constraints, making it difficult to secure more
funding, amplifying the output contraction from the productivity shock. A second financial accelerator stems from the
fact that banks are constrained in their ability to raise new debt and face costs from issuing new equity. This means
that even banks that do not go into default reduce their lending, which feeds back on the real economy causing further
contractions in investment and output.
The papers provides the below Figure, which summarizes the model:
Figure 38: Agent Interaction Map246
The Figure above outlines the three main types of agents in the model, households, firms, and the government, and the
interactions between each. For each agent, assets and funding sources are provided. Arrows are incorporated to indicate
the source of funding. For instance, government debt is a liability for the Government and an asset for savers who
purchase the government bonds.
The model is estimated for a range of CET1 ratio requirements, from 5% to 25%. The authors then analyze the resulting
equilibria on multiple financial metrics, including metrics that indicate welfare, size of the economy, and investment and
consumption volatility. In addition to static capital requirements, a counter-cyclical capital requirement is included as part
of the simulation. The countercyclical capital requirement oscillates between 5% and 9%. The capital requirement is set to
9% when uncertainty, defined as the dispersion of productivity shocks, is high, and 5% when uncertainty is low.
Conclusions
Initially, the authors calibrate a benchmark model with a 7% capital ratio requirement. In the benchmark model, the
authors run simulations for three scenarios: a non-financial recession that expands into a financial recession, a
non-financial recession, and a scenario which does not experience a productivity shock.
Each scenario is run, considering different capital ratios both higher and lower than the initial requirements of 7%. Across
the scenarios, higher required capital ratios decrease default rates, losses given default, and macroeconomic volatility.
There is also a small increase in household consumption for borrowers under stricter requirements. However, increased
246
Source: Elenev, V., Landvoigt, T. and Van Nieuwerburgh, S. (2021), A Macroeconomic Model With Financially
Constrained Producers and Intermediaries. Econometrica, 89: 1361-1418.

capital requirements lead to a significantly smaller banking sector with less credit extended to non-financial firms, resulting
in a reduction in GDP, capital stock, and aggregate welfare.
Under a static capital requirement, aggregate welfare is maximized at a ratio of 6%. The authors also tested the model
with a countercyclical capital ratio requirement that oscillated between 5% and 9% based on the models’ state of
uncertainty (higher requirement when uncertainty is high). This resulted in the most favorable aggregate welfare measure.
Figure 39 below demonstrates the results of the benchmark model, which uses a capital requirement of 7%, relative to
models run under different capital requirements. The 7% initial capital requirement is equivalent to a 93% leverage ratio,
as shown in the Figure below. A leverage ratio less than 93% indicates tighter macroprudential policy, while a ratio greater
than 93% indicates looser macroprudential policy or regulatory requirements. The values in the columns to the right of the
benchmark column represent percent changes from the benchmark value, given a new capital requirement (or leverage
ratio).
Figure 39: Capital Requirements Impact on Economic Output and Welfare247
LR = 80% LR = 85% LR = 91% LR = 95% LR =

Benchmark: LR = 75%
Model Parameter {91%,95%}
Leverage Ratio (LR) = 93%
Welfare
Aggregate Welfare -37.05 -26.14 -15.46 -3.31 1.51 5.08
Value function, B 0.260 3.75 2.72 1.71 0.40 -0.74 -0.21
Value Function, S 0.375 -2.60 -1.87 -1.13 -0.24 0.23 0.30
DWL/GDP 0.741 -37.63 -30.29 -22.02 -9.75 30.05 1.17

Size of the Economy
GDP 0.987 -0.67 -0.42 -0.21 -0.03 0.11 0.09
Capital Stock 2.123 -2.31 -1.44 -0.74 -0.11 0.40 0.31
Aggr. Consumption 0.632 0.22 0.22 0.19 0.10 -0.32 0.02
Consumption, B 0.258 4.14 3.15 2.03 0.50 -0.77 0.17
Consumption, S 0.374 -2.48 -1.80 -1.08 -0.17 -0.01 0.14
Volatility
Investment Gr 10.76 -22.17 -19.70 -16.94 -13.41 31.26 -13.37
Consumption Gr 1.83 -1.56 -3.79 -5.20 -4.50 17.37 -3.81
Consumption Gr, B 2.81 -6.91 -6.81 -6.83 -6.28 17.71 -7.04
247
Source: Elenev, V., Landvoigt, T. and Van Nieuwerburgh, S. (2021), A Macroeconomic Model With Financially
Constrained Producers and Intermediaries. Econometrica, 89: 1361-1418

Consumption Gr, S 2.46 5.89 3.05 1.19 0.04 5.28 -17.27
Log (Mu B/Mu S) 0.04 7.38 6.54 5.24 0.95 3.12 -11.97
Numbers in column 1 are for the benchmark model, in levels. Numbers in columns 2-8 are percentage changes relative to the benchmark
The Figure above indicates that capital requirements greater than 7% reduce welfare, the size of the economy and
volatility. However, reduced capital requirements, shown in the column in which the leverage ratio is equal to 95%,
increase welfare, size of the economy and volatility. The results suggest that reducing capital levels below their current
levels today would have an overall positive impact on the economy.
Limitations
The Elenev, Landvoigt, and Van Nieuwerburgh (2021) leverages a general equilibrium based approach to identify an
optimal capital level. However, the model’s general equilibrium framework does not consider certain, potentially material
factors, which could impact the paper’s conclusion. These factors not considered are summarized below:
bank balance sheets and resolvability. Liquidity regulations aim to increase the level of high quality liquid assets on
bank balance sheets, potentially reducing the overall risk of bank assets. Recovery and resolution requirements aim
to enhance the resolvability of firms, potentially reducing the cost of a potential future crisis. As such, if the paper
considered these regulations, the marginal benefit from increasing capital requirements would be reduced, potentially
lowering the optimal capital level.
Table 37: Elenev, Landvoigt, and Van Nieuwerburgh 2021, Factors Not Considered and Potential Impact on Household Welfare and
Optimal Capital Estimates
# Factor Not
Potential Impact on Household Welfare Potential Impact on Optimal Capital Level Estimate
Considered
Positive Negative
Enhanced
1 regulation and
Existing liquidity and recovery and resolution Without considering enhanced regulation and bank
bank balance
requirements aim to reduce the risk of bank assets overall balance sheet composition, the model may overstate the
sheet
and enhance the resolvability of firms during a crisis. marginal benefit of capital requirements, resulting in an

composition Consideration of both of these factors could have a positive overstated optimal capital level
impact on Household Welfare.
Mixed
Without considering non-bank financial intermediaries,

Migration of Mixed
the marginal cost of increased capital requirements may be
financial
2 overstated, as increased capital requirements may
intermediation to Non-bank lending share may increase, enhancing
enhance competition reducing lending rates. However, the
Non-banks competition, but potentially increasing risk in stress
marginal benefit may be overstated as well, as increased
capital requirements may increase risk in stress in the
financial sector.
Mixed
Mixed
Bank trading
Without considering trading book, the marginal cost of
books and market Consideration for trading book and market liquidity,
3 increased capital requirements may be overstated or
liquidity are not introduces a substitution effect where corporate bonds may
understated, as corporate bonds act as a substitute funding
considered mitigate the impact of lending on GDP, but could reduce
source, but increased capital requirements may reduce
inventory raises borrowing costs
market liquidity.
household bankruptcy may understate the estimates for benefits. Additionally, the lack of consideration for non-bank
financing and the trading book has a mixed effect on the model's outputs. These considerations would have to be
incorporated in the model to understand which channel would dominate under increased capital requirements and
In addition to the factors not considered listed above, the model assumes that all producers that declare bankruptcy are
immediately replaced before the end of the current period such that the mass of producers is constant. This assumption
lessens the impact to economic output that would occur in subsequent periods if the model allowed for a decrease in the
number of producers. This likely results in the model underestimating the cost of a crisis, potentially leading to the model
underestimating the optimal capital level.
2.3.7 European Central Bank - The Growth-at-risk Perspective on the System-wide Impact of Basel III
Finalisation in the Euro Area (2021)
Katarzyna Budnik, Ivan Dimitrov, Carla Giglio, Johannes Groß, Max Lampe, Andrei Sarychev, Matthieu
Tarbé, Gianluca Vagliano, and Matjaž Volk
The European Central Bank (ECB) presents a unique perspective on the impact that the Basel III regulatory framework
will have on the euro area economies, and specifically, a bank’s reactions and abilities to manage economic shocks.
Through the use of a macro-micro model known as the Banking Euro Area Stress Test (BEAST), the ECB analyzes the
long-term benefits that Basel III could have on banks’ resilience and the banking system’s ability to lend during times of
crisis. ECB analyzes the data using a “growth-at-risk” (GaR) framework. GaR focuses on the “left-tail” of the distributions,
or downside risk of macro-financial variables. Specifically, they estimate changes in the lower 5th percentile of the
distribution of expected GDP growth. The ECB concludes that in the first four years following the reforms, annual GDP
growth would be 0.2 percentage points lower than if there were no reforms. However, after the initial four years, GDP
expands by an increase of about 0.5 percentage points for a period of five years. This would result in the impact to
long-term expected growth in euro area GDP being zero. The paper concludes that the key benefits of the reforms would
come from an improvement in macroeconomic variables, particularly GDP, during a crisis. The ECB finds that GDP growth
outcomes that fell into the 10th percentile of GDP growth distribution, are around 0.1 percentage points higher, under the
Basel III reforms.

Methodology
The ECB uses a large-scale semi-structural model that links macroeconomic and bank-level data. The BEAST mode
covers 91 of the largest euro area banks and includes data for 19-euro area economies. The model uses banking book
data to derive credit exposure at the country level, and then calculates credit risk charges at the country level, as well as
market and operational risk charges. In addition, the model leverages a set of behavioral equations to analyze the
behavior of individual banks with regards to profit distribution, lending volumes, interest rates, and changes in liability
structures in response to regulatory requirements and economic conditions. Finally, the model aggregates the impact that
individual bank responses have on the credit supply and lending rates, and translates this to impacts on the euro area
economies in which the banks operate. Figure 40 below is an illustration of the BEAST model.
Figure 40: BEAST model248
The diagram illustrates that real economic factors flow to the banking sector. The right-hand side of the diagram shows
the reaction of individual banks to economic factors with regards to decisions around lending volumes which are then
accompanied by changes in the bank’s liability structure, which in turn drives adjustments to loan pricing, funding costs,
and profit distributions. The left-hand side of the diagram then shows that reactions from each individual bank ultimately
flow back into the real economy. The sections below describe separately the bank behavioral models and the economic
impact model.
Bank Behavioral Models
A series of bank behavioral equations are formulated to estimate changes in bank lending volumes, lending and deposit
margins, and dividend payouts.249
The first set of equations predicts changes in bank lending using a supply-demand framework. Loan demand is modeled
using a fixed effect panel regression model on bank-level loan growth rates with country specific economic conditions as
drivers. The model connects the demand for loans to GDP growth, unemployment rates, and interest rates. Loan supply is
248
Source: Budnik, Katarzyna & Dimitrov, Ivan & Giglio, Carla & Groß, Johannes & Lampe, Max & Sarychev, Andrei &
Tarbé, Matthieu & Vagliano, Gianluca & Volk, Matjaz, 2021. "The growth-at-risk perspective on the system-wide impact of
Basel III finalisation in the euro area," Occasional Paper Series 258, European Central Bank, 12.
249
ECB BEAST model: https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2469~a139d2f5cd.en.pdf

determined based on individual bank characteristics including a bank’s profitability, solvency, and asset quality. The
formulation for loan supply also uses a panel regression. In the regression, a bank’s loan supply is a function of a bank’s
CET1 capital surplus or shortfall, the bank’s share of non-performing loans (NPL), its return on assets (ROA), and
counterparty/time fixed effects. Bank lending volume is then the amount that makes the supply equation equal to the
demand equation.
Lending and deposit interest rate margins are modeled using a panel regression framework at the bank and loan type
level, with the following loan types included: Loans to NFCs, mortgage lending, and consumer credit. Interest rate margins
are estimated as a function of margins from the prior period, the difference in yield between a 10Y government bond and
the German Bundand macroeconomic variables such as GDP growth and housing price growth.
The final behavioral model is the dividend distribution model. The model predicts the ratio of dividend pay-outs to the after
tax profit and maximum distributable amount restrictions. The ratio is estimated through a panel regression framework
using fixed effects and the following lagged variables as drivers in addition to the lagged outcome variable: the CET1
ratio, NPL, the ratio of RWA to total assets, the cost to income ratio, GDP growth in a given country.
Economic Impact Model
Changes in bank lending decisions as estimated in the bank behavioral models are translated into economic impacts
through a vector autoregressive (VAR) panel model.250 The BEAST model constructs a VAR model for each Euro-area
economy with the following endogenous variables: GDP, inflation (measured using consumer price indices),
unemployment rate, short-term interest rates, long-term interest rates, import volumes, export prices, house prices, bank
lending rates, bank loan volumes, and an equity price index. The bank lending rates and bank loan volumes variables are
the result of the Bank Behavioral models.
The ECB ran two sets of simulations to quantify the effects of Basel III reforms. The first set of simulations includes many
iterations using the current regulatory framework, providing a wide range of bank lending and GDP outcomes under the
current regulatory landscape. The second simulation used the same set of scenarios as in the first set; but, with the
assumption that banks have adopted final Basel III reforms. The differences in GDP growth between the two simulations
suggest a net benefit for adopting the reforms.
Utilizing the distribution of outcomes realized by the BEAST model, the ECB employs the GaR perspective. The GaR
perspective utilizes the tails of a distribution to assess economic impact and financial stability. Specifically, the changes in
the left tail of the projected GDP distribution is used as a measure of downside economic risk or as an indicator of
financial-stability risk. The ECB emphasizes examining the changes in financial conditions in the tails of the distribution of
outcomes, rather than the mean or median, as was the case with most other studies. Additionally, changes in financial
conditions are more impactful for displaying downside economic risks, rather than baseline or boom periods. Figure 41
below presents a stylized representation of a GaR based cost-benefit assessment:
250
A VAR model is a statistical model in which each endogenous variable is modeled as a function of its own past values
and the past values of all other variables in the system. Exogenous variables, which are not impacted by previous values,
may also be added to the model.

Figure 41: Illustrative GaR assessment251
The solid lines in the above chart show the mean estimated GDP growth with and without incorporating Basel III
finalization into the scenario. The light blue lines between these solid lines capture the economic costs of Basel III reforms
incurred when implemented in a benign baseline economic scenario. The dotted lines below are the 10th percentile of
GDP growth from the distribution with and without Basel III finalization. These lines are used to assess the impact of
reforms in an adverse economic scenario. The green area between the lines indicate the benefits of Basel III finalization
which are realized in the form of improved financial intermediation during a crisis.
Conclusions
The conclusion reached through the simulations suggest an aggregate net benefit from the implementation of Basel III
reforms. The ECB concludes that while the short-term effect on GDP will be negative, in the long-term GDP growth will
return to a net difference of zero after the 10-year transition period. The chart below shows the minimal impact that Basel
III reforms will have on euro area GDP.
251

Figure 42: Euro Area GDP growth252
By examining the left tail of the distribution of outcomes on GDP, the ECB is able to show that Basel III reforms would
increase banking resilience. The Basel III reforms would result in a lower likelihood of deep recessions and shorter
recessions overall. The chart below demonstrates the difference in recession depth and recovery, with and without Basel
III reforms.
252

Figure 43: Median Recession Outcomes253
The heightened resilience is a result of higher capital stocks that improve both loss absorbing capacity and support lower
bank funding costs. In addition to increased resilience for banks, Basel III reforms are expected to increase euro area
banking sector leverage ratios by over 1 percentage point.
Limitations
While the ECB study takes a unique perspective to measuring the benefits of Basel III implementation, there are key
limitations that can lead to model uncertainty. Each of these factors has the potential to impact the study’s conclusions
regarding the overall net benefits of capital requirements. Some of the factors are based on model assumptions that may,
in reality, be slightly different. Others are factors not considered by the study that could change the outcomes if their
impacts were taken into account.
considered these regulations, the marginal benefit from increasing capital requirements would be reduced, potentially
3. Impact to bank trading books and market liquidity: Similar to other studies, the framework applied by ECB (2021)
253

higher liquidity premium on corporate bonds, raising corporate borrowing costs and reducing investment and GDP.
On the other hand, the model does not consider the fact that corporate bonds are a substitute for bank debt. The
The Table below provides a summary of the expected impact that each of the factors or assumptions would have on the
overall net benefits.
Table 38: ECB 2021, Factors not Considered and Potential Impact to Net Benefits
# Factor Potential Impact on Net Benefits, Under Increased Capital Requirements
Positive
Enhanced regulation and
1 bank balance sheet Existing liquidity and recovery and resolution requirements aim to reduce the risk of bank assets overall
composition and enhance the resolvability of firms during a crisis. Consideration of both of these factors could have a
positive impact on Net Benefits..
Migration of financial Mixed

2 intermediation to
non-banks Non-bank lending share may increase, enhancing competition, but potentially increasing risk in stress
Mixed
Bank trading books and
3 market liquidity is not Without considering trading book, the marginal cost of increased capital requirements may be overstated
considered or understated, as corporate bonds act as a substitute funding source, but increased capital requirements may
reduce market liquidity.
The Table above highlights the directional impact of the factors not considered and assumptions of the model framework.
While the lack of consideration for enhanced regulation and bank balance sheet composition may overstate the model’s
estimates for benefits, resulting in the net benefit being overstated, the lack of consideration for trading book has a mixed
effect on the model's outputs. Additionally, the incorporation of a migration of financial intermediation to non-bank
financing has the potential to have a positive or negative impact on the net benefits of capital requirements by enhancing
competitiveness and increasing risk in stress. Greater positive net benefits could be realized through a consideration of a
transition period for banks and banks’ use of capital markets for raising equity capital.
In addition to the factors not considered listed above, the model assumes that any change in the capital requirements is
treated as an instantaneous impact to bank balance sheets. In reality, when new requirements are announced, banks tend
to slowly adjust their balance sheets to avoid shocks. Allowing for this transition period should enable banks to reduce
transition costs associated with complying. Furthermore, the model assumes that banks cannot access the capital
markets, and as such are not able to raise capital by issuing new shares. This can be a major source of funding for banks,
and would allow banks to increase their capital ratios without reducing the supply of credit.
2.3.8 Financial Regulation in a Quantitative Model of the Modern Banking System (2022)
Juliane Begenau and Tim Landvoigt
Begenau and Landvoigt build upon the methodology set forth in Begenau (2020) by incorporating the effects of an
unregulated non-bank financial sector on household welfare and the optimal capital level for commercial banks. This study
presents a quantitative dynamic stochastic general equilibrium (DSGE) model to identify the impacts of capital
requirements on a competitive financial market that consists of regulated commercial banks as well as non-bank financial
intermediaries. In the model, the banks provide liquidity services to households and compete for funding from households.
Starting with a base tier 1 equity ratio of 10%, the authors analyze the impacts of capital requirements on capital stock,
cost of lending, loan volumes, and welfare. The authors simulate a pre- and post-crisis scenario involving an aggregate
productivity shock and a run on the non-bank financial sector, followed by a post-crisis period of increasing capital
requirements and a decrease in implicit government support. The model results indicate that an optimal capital ratio of
~16% maximizes household welfare.

Methodology
This section discusses the models methodology, beginning with a description of the four agents in the model, the
relationships between these agents, and the two different model simulations used to draw conclusions. The four agents
are households, commercial banks, non-bank financial intermediaries, and government. The primary model simulation is a
comparative equilibrium simulation of different capital ratios, and the second simulation is an attempt to mimic features of
the 2008 financial crisis.
The first agents in the model are households who gain utility from liquidity services offered by banks and consumption
over time. Households demand bank deposits due to the liquidity services and interest payments received from banks.
Households also demand equity investments in banks due to their future payoffs, which increases future wealth and
consumption opportunities. Households maximize utility by striking a balance between future payoffs from equity
investments, and current consumption and liquidity services. Households own all debt and equity claims of banks.
The next agents in the model are commercial banks and non-bank financial intermediaries, which both have a similar
production process. Both types of banks have revenue derived from a combination of labor inputs and capital goods
purchased by the bank. Banks choose at the beginning of each period how much capital and deposits they issue in the
next period. Payoffs from production are a result of the productivity of capital goods, the price of capital goods, and the
labor-capital ratio. The production process is the same for both banks, but the crucial difference between the two is that
the commercial banks deposits are insured and are constrained by the capital requirements, whereas deposits with non
bank financial intermediaries are not insured and they are not constrained by the capital requirements. The impacts of
these differences will be discussed below, as part of the discussion on the relationships between the agents.
The fourth agent is the government, whose primary impact in the model is providing deposit insurance to commercial bank
deposits, making them risk-free, and bailing out NBFI deposits at random. The government gets revenue from taxes and
deposit insurance fees from commercial banks.
In addition to descriptions of the agents, the relationships between them need to be explained. As stated, government
sponsored deposit insurance makes commercial bank deposits risk-free, while NBFI deposits still carry some risk. From
the household’s perspective this gives an advantage to commercial banks, although both types of banks can offer liquidity
services. Thus, commercial bank and NBFI deposits are modeled as imperfect substitutes. Due to the lack of insurance, a
certain portion of households may withdraw deposits early from NBFIs, causing a bank run. This bank run will require
NBFIs to sell their productive capital goods to redeem deposits, and in some cases lead to default. While commercial
banks do not face early withdrawals from households, they can still default based on the severity of productivity shocks
that occur each period. In the case of commercial bank default, the government will use revenues from taxes and deposit
insurance fees to make depositors whole. When a non-bank financial intermediary defaults, the recovery value of assets
are used to pay back depositors, and the government will provide a bailout to make them whole at random.
The primary model interactions that still need to be discussed are those between households and banks when there is an
increase in capital ratios. Commercial banks have an advantage with insured deposits that are risk-free, but a
disadvantage with capital requirements limiting their possible leverage. Increasing capital ratios changes the liability
structure and subsequent size of commercial banks and NBFIs in equilibrium. The two competing forces driving these
changes in the model are the competition effect and the demand effect. The competition effect refers to the diminished
competitive advantage of commercial banks when capital ratios increase. Commercial banks becoming less profitable
from higher capital requirements incentivizes households to shift towards NBFI equity, causing an expansion of NBFIs and
a decrease in their leverage. At the same time there is a “demand effect”, where the liquidity supply (in the form of
deposits offered by banks) decreases because commercial banks have shifted their liability structure towards equity.
Since households demand liquidity services, and there is lower supply of liquid deposits available to them, there is
downward pressure on interest rates on deposits. This lowers the cost of debt for banks and incentivizes NBFIs to
increase their size and leverage, whereas commercial banks leverage is constrained from the capital requirement. Both
effects cause expansion in non-bank financing, however the net change in leverage in the non-bank financial sector will
be determined in the model by the offsetting effects.
Next are the two different modeling simulations. The primary modeling simulation is an infinite time-horizon model with
discrete time periods, with a simulation for different capital ratios ranging from 10% to 30%. After running each iteration,
the resulting equilibria at these different capital ratios are analyzed. The measures analyzed include market share and

leverage between commercial banks and NBFIs, deposit rates for both banks, default rates, GDP, volatility, and household
welfare. Each time-period of the model is broken down into seven steps as follows:
1. Productivity shocks and household early withdrawal decisions are made.
2. Non-bank financial intermediaries sell assets in proportion to the number of early withdrawals.
3. Production of banks and households occurs, and banks make investment decisions.
4. Idiosyncratic payoffs from production processes occur, potentially triggering default.
5. Banks make funding decisions, choosing how much capital to purchase and how many deposits to issue in the next
period to maximize shareholder value over time. Surviving banks pay dividends and new banks emerge to replace
banks that defaulted.
6. Bailouts occur as needed, including government bails out of commercial bank deposits, and randomly occurring
NBFI bailouts.
7. Households consume goods produced by the bank-dependent and non-bank dependent sectors.
The second modeling scenario involves the same model agents and decision-making process in each time-period but is
structured to mimic the 2008 financial crisis. The pre-crisis period is viewed as one of relaxed capital requirements and
large implicit bailout guarantees for NBFIs, followed by a post-crisis period of greater regulatory requirement and lower
bailout probability. The model begins with a capital requirement of 8% and NBFI bailout probability of 87%. The model
then has a large NBFI run (early withdrawal on NBFI deposits) and a large negative productivity shock. Over the next
three years following the shock and bank run, capital requirements are increased from 8% to 11%. The new equilibrium is
then analyzed to identify the changes in the banking sector and economy compared to a baseline without increased
capital requirements. The primary goal of this simulation is to see how well the model is able to capture aspects of the
2008 financial crisis. This simulation finds that, although the increasing capital requirement does cause an expansion in
non-bank financing, this effect is offset by much larger effects that lead to an overall decline in non-bank financing.
Calibration
Model parameters are calibrated using data from a period of 1991 Q1 to 2019 Q4 from sources including
Compustat/CRSP, Flow of Funds, NIPA, FRED, FR-Y9C and the FDIC.
Conclusions
The results of the comparative equilibria model are that increases in the required capital ratio for commercial banks lead
to an expansion of the non-bank financial sector and a higher leverage ratio in the non-bank financial sector, due to
demand effect dominance. The increase in NBFI leverage is only modest, however, due to the countervailing competition
effect. Despite this increase in non-bank financial sector size and leverage, the significant decrease in the default rates of
commercial banks leads to a more stable financial system overall. The welfare measure, calculated in terms of household
value, is optimized at a capital ratio of 16%. At this level, GDP increases by 0.03%, consumption increases by 0.086%,
and overall welfare increases by 0.054%.
The 2008 financial crisis simulation results in a bank run that triggers a sharp contraction in output for the bank-dependent
sector and a drop in household consumption and liquidity services. In this simulation, there is a sharp decline in the
non-bank financial sector’s share of the debt market and leverage, eventually resettling at a new and lower equilibrium in
the post-crisis period. The effect of raising capital requirements (from 8% to 11%), over a three-year period post-crisis,
and a decrease in the probability of government bailout of NBFIs, is to have consumption recover to a higher level than
pre-crisis, while liquidity production declines. The primary takeaway from this simulation is that the model was able to
capture aspects of the 2008 financial crisis. The increased capital ratio post-crisis does increase the NBFI debt share
relative to the alternative scenario, where there is no change in the capital requirement, consistent with the standard
model above. However, this effect is offset by quantitatively larger changes that lead to a decline in non-bank financing in
the post-crisis period, as seen in the real data.
Limitations

Begenau and Landvoigt (2022) builds upon the framework of the Begenau (2020) study, incorporating the non-bank
financial sector as an additional agent in the model. Although the study incorporates NBFIs, the consideration of the
non-bank financial sector is somewhat limited. Moreover, the model’s framework does not consider certain, other
potentially material factors. The limitations associated with factors not considered by the model could also adjust the
paper’s conclusion.
considered these regulations, the marginal benefit from increasing capital requirements could be reduced, potentially
2. Narrow definition of non-bank financial intermediaries: The paper leverages the definition of non-bank financial
intermediaries identified in Gallin (2013). This definition does not include other non-bank lenders, asset-backed
securities and investment vehicles. Under the current definition, Beganau and Landvoigt assume the non-bank
financial sector provides roughly 33% of the credit supply to the US economy; however, Michael S. Barr, Vice Chair
for Supervision at the Federal Reserve in his December 2022 speech notes that the non-bank financial sector
produces roughly 60% of the credit supply.254 Beganau and Landvoigt show that increasing the share of financing
supplied by the non-bank financial sector from 33% to 42% reduces the optimal capital level from 16% to 14%. Thus,
leveraging a broader definition of non-bank financial intermediaries may reduce Begenau and Landvoigt’s calculated
optimal capital level further.
3. Uninsured commercial bank deposits: As a simplifying assumption, the paper treats all commercial bank deposits
as insured by the FDIC, while in reality, only half of commercial bank deposits are insured. By assuming full deposit
insurance, the model overstates the competitive advantage commercial banks have over NBFIs. Moreover, within the
model, increased capital requirements reduce the competitive advantage of commercial banks, promoting effective
competition in the financial sector. This is considered a marginal benefit in the model, as effective competition results
in favorable deposit and lending rates for households. However, because the model overstates the competitive
advantage of commercial banks, there may be less marginal benefit to be achieved from increasing capital
requirements, as the market may be closer to effective competition. Consequently, the optimal capital level may be
overstated as well.
higher liquidity premium on corporate bonds, raising corporate borrowing costs and reducing investment and GDP.
254
Michael S. Barr December 1, 2022y, Why Bank Capital Matters:
https://www.federalreserve.gov/newsevents/speech/barr20221201a.htm

Table 39: Begenau and Landvoigt 2022, Factors Not Considered and Potential Impact on Welfare and Optimal Capital Level Estimates
# Factor Not Considered Potential Impact on Household Welfare Potential Impact on Optimal Capital Level Estimate
Positive
Negative
Enhanced regulation and Existing liquidity and recovery and resolution
1 bank balance sheet requirements aim to reduce the risk of bank assets
balance sheet composition, the model may overstate
composition overall and enhance the resolvability of firms during a
the marginal benefit of capital requirements, resulting in
crisis. Consideration of both of these factors could have
an overstated optimal capital level
a positive impact on Household Welfare.
Negative
Positive
The narrow definition of non-bank financial
intermediaries may result in the marginal benefit being
Broadening the definition of non-bank financial
Narrow definition of overstated, as the model may currently underestimate
intermediaries increases the model’s initial
2 non-bank financial the risk in the financial sector derived from non-bank
estimate of NBFI lending share, potentially
intermediaries financial sector size. Increased capital requirements
overestimating the benefits of increased capital
may further increase the risk embedded in the financial
requirements on effective competition and household
sector by increasing the portion of credit provided by
welfare.
NBFIs.
Negative
Positive
Without considering that some commercial
The presence of uninsured commercial deposits
Uninsured Commercial deposits are uninsured, the model may overstate the
3 may overstate the competitive advantage held by
Deposits competitive advantage commercial banks have over
commercial banks, potentially overestimating the
NBFIs. As such, the marginal benefit of increased
benefits of increased capital requirements on effective
capital requirements, resulting from promoting effective
competition and household welfare.
competition in the banking sector, may be overstated.
Mixed Mixed
Bank trading books and Consideration for trading book and market Without considering trading book, the marginal cost
4 market liquidity are not liquidity, introduces a substitution effect where of increased capital requirements may be overstated or
considered corporate bonds may mitigate the impact of lending on understated, as corporate bonds act as a substitute
The Table above highlights that the directional impact of the unconsidered factors would be somewhat difficult to
determine in aggregate. However, the majority of factors not considered would potentially have a positive impact on
household welfare, resulting in a reduction in the marginal benefits from increased capital requirements. If the paper
assumed a lower marginal benefit from increased capital requirements, the optimal capital level would be lower. That
being said, the potential impact of considering trading book and market liquidity, is mixed. As such, these additional
considerations would have to be incorporated in the model to understand which channel would dominate under increased
capital requirements and ultimately, how this would impact the model’s existing estimates for optimal capital levels.
2.3.9 Federal Reserve Board - The Welfare Effects of Bank Liquidity and Capital Requirements (2022)
Skander J. Van den Heuvel
Skander J. Van den Heuvel of the Federal Reserve Board explores the impact of increasing bank liquidity and capital
requirements on overall welfare in his 2022 paper. By utilizing a general equilibrium model, this research measures
welfare costs and evaluates how banks' capacity to generate net liquidity influences investments. Van den Heuvel
expands on his 2008 study', which integrates liquidity-creating banks into a standard general equilibrium growth model.
This paper has two main contributions. Firstly, it establishes a framework for assessing the welfare effects of liquidity and
capital requirements. Secondly, it develops two straightforward formulas for determining welfare cost magnitude, based
solely on observable variables, thus avoiding full-model calibration and estimation complications.
The model ultimately finds that the increases in capital and liquidity requirements as a part of Basel III result in net welfare
gains, but capital requirements are more costly than liquidity requirements. Van den Heuvel examines the costs and

benefits of capital and liquidity individually, an approach not commonly used in other studies. The study concludes that a
10% increase in liquidity requirements leads to a permanent consumption loss of 0.02%. Meanwhile, a 10% increase in
capital requirements results in a 0.2% permanent consumption loss, a ten-fold difference in magnitude.
Methodology
The objective of the model is to measure the welfare costs of increasing capital and liquidity requirements under a general
equilibrium growth model framework. This quantitative approach is commonly used amongst academics in the analysis of
optimal capital levels. In this study, Van den Heuvel extends upon the framework he established in his 2008 paper titled
“The Welfare Costs of Bank Capital Requirements.”
Van den Heuvel’s 2022 model builds upon his 2008 model by adding two key features. First, the model considers that
households have a need for liquidity. Second, the model considers that banks are able to create liquidity services through
bank deposits. Additionally, Van den Heuvel recognizes other studies, such as Begenau (2020), Begenau and Landvoigt
(2022), Clerc at al. (2015), Elenev, Landvoigt, and Van Nieuwerburgh (2021), Martinez-Miera and Suarez (2014), and
Nguyen (2015), that present quantitative macroeconomic models of optimal bank capital regulation and identifies three
main differences between this study and those. These three differences are described below:
• Liquidity requirements: In contrast to past studies, Van den Heuvel focuses on the impact of liquidity requirements as
opposed to strictly capital requirements. As such, the model provides a separate estimate for the impacts of increased
liquidity requirements on welfare.
• Endogenous Modigliani-Miller theorem failure: Modigliani-Miller fails in the paper as an endogenous result of banks’
role in providing liquidity, meaning that bank capital structure affects the equilibrium. The capital requirement for banks
is binding, meaning that banks will always hold the minimum capital requirement and any deviation from this level will
result in suboptimal welfare.
• Full model calibration: Van den Heuvel derives closed-form formulas that only use observable, historical values as
inputs to calculate the marginal effects of capital and liquidity requirements. This advance avoids the need to calibrate
unobservable parameters such as borrower preferences.
In terms of the model’s construction, it is composed of four agents, each with their own decision problems. The decision
problems are solved to determine a general equilibrium estimate for welfare costs, given an increase in capital or liquidity
requirements.
In the model, the first agents are households which are considered to be infinitely lived dynasties that value consumption
and liquidity services. Households obtain liquidity services through bank deposits. Households also receive a convenience
yield on government bonds. Households are equivalent to non-bank financial firms, such as money market funds, bond
funds, or pension funds. In the household’s decision problem, there is no distinction between bank and non-bank equity,
as they have the same return.
Banks are the next agents in the model, providing loans to financial institutions, holding government bonds, and financing
assets via deposits from households or equity issuance. Banks are assumed to operate under perfect competition. Under
this assumption, all banks operate under the same conditions regarding risk taking and costs and no bank has a
competitive advantage over another bank. Additionally, banks must adhere to capital and liquidity regulations. To meet
capital requirements, banks need to maintain a specific ratio of equity to assets, while liquidity requirements stipulate
holding a minimum amount of government bonds relative to deposits. The model's analysis of capital and liquidity
requirement benefits accounts for certain features, such as deposit insurance, credit risk, and liquidity risk, which
contribute to the moral hazard of excessive risk-taking.
Nonfinancial firms are the third agents in the model. Although they cannot create liquidity through deposits, they can
generate output using capital and labor. If bank loans offer more favorable terms than equity financing, firms opt for bank
loans to fund their capital.
Lastly, the government’s responsibilities include managing fiscal policy, overseeing the deposit insurance fund, setting
capital and liquidity requirements, and supervising banks. In regulating banks, the government enforces rules and
monitors excessive risk-taking. However, the model assumes imperfect observability of risk-taking since the government

cannot detect all instances of excessive risk. If the government were able to identify all excessive risk-taking by banks,
moral hazard problems would not exist.
Given the agents described above, Van den Heuvel provides a qualitative overview of the welfare implications of
increased bank regulations. The analysis evaluates the trade-off between the costs and benefits and increased capital
and liquidity requirements. The costs of regulations are reduced asset valuations and market liquidity. Meanwhile, the
benefits of capital requirements include discouraging banks from engaging in excessive risk-taking, such as lending to
high-risk borrowers. Liquidity requirements also reduce risk-taking by encouraging banks to hold sufficient liquid asset
buffers.
Excessive risk-taking by banks can lead to a high rate of bank failures, potentially resulting in a financial crisis. In such
instances, losses are transferred to the deposit insurance fund and taxpayers, while also generating deadweight losses. If
the costs of bank failures due to excessive risk-taking are significant enough, it becomes socially optimal to deter banks
from taking these risks, despite the welfare costs associated with the regulations. Van den Heuvel provides evidence that
preventing financial crises and excessive risk-taking is socially desirable.
Within the context of the qualitative overview and agents described above, Van den Heuvel defines a quantitative general
equilibrium model to assess the costs of increased regulation. The equilibrium is defined as a path of consumption,
capital, employment, financial quantities, and returns such that households, banks, and firms all solve their maximization
problems. Van den Heuvel focuses on a policy that deters excessive risk taking by banks by setting capital and liquidity
requirements sufficiently high. There are five key features of the equilibrium as described below
1. Banks always hold the minimum capital requirement, because equity is more expensive than deposits.
2. The liquidity requirement may or may not bind depending on the convenience yield of government bonds relative
to bank deposits. It binds when the convenience yield of Treasuries exceeds the convenience yield of bank deposits.
In this case, as is the case with the capital requirement, banks will choose to hold as many bank deposits as the
liquidity requirement will allow. If the convenience yield on Treasuries is below that of bank deposits, then banks will
likely hold a level of Treasuries above the minimum requirement.
3. Capital and liquidity requirements impact investment. If binding, then the capital and liquidity requirement cannot
be changed while still realizing optimal welfare. As explained in 1 and 2 above, the capital requirement binds because
the convenience yield on deposits makes it a cheaper source of funding than equity, and the liquidity requirement
binds when the convenience yield on Treasuries exceeds that of deposits. If both requirements are binding, then the
cheap deposit financing results in banks lowering lending rates. The low lending rates can lead to firms exclusively
using bank financing for investments.
4. Firms finance investments with a mix of bank and non-bank funding in equilibrium, also referred to as “mixed
financing” in the model.
5. Disintermediation or a shift to non-bank financing can be the result of stringent regulation. Increasing capital and
liquidity requirements can cause migration toward non-bank finance. For the liquidity requirement, this is more likely to
happen if the convenience yield on government bonds is high. This is because in the case of high demand and low
supply of government bonds or close substitutes, firms will be forced to look for other sources of investment.
The following subsections describe the analysis performed to estimate the costs and benefits of increased capital and
liquidity requirements.
Costs Channel
As a key purpose of this study is to quantify the welfare costs of raised capital and liquidity requirements, Van den Heuvel
derives formulas for welfare costs which only use observables as inputs. The first formula, for determining the impact of
liquidity requirements, relies on asset yields to reveal the strength of the household’s preference for liquidity.The formula
shows that there is a positive welfare cost associated with bank liquidity regulation when the interest rate on deposits, plus
the marginal cost of servicing deposits, exceeds the interest rate on government bonds. This is due to the liquidity
requirement forcing banks to transform some government bonds into deposits. The second formula considers the welfare
costs of permanently increasing the capital requirements. This formula is valid whether the equilibrium uses pure bank

finance or mixed finance. Van den Heuvel shows that an increase in capital requirements beyond what is necessary for
financial stability, lowers welfare due to constraints on banks’ ability to issue deposit-type liabilities..
Leveraging the formulas described above and annual aggregate balance sheet and income statement data for all
FDIC-insured commercial banks in the United States from 1986 to 2019, Van den Heuvel calculates the gross welfare
costs of capital and liquidity requirements. The analysis evaluates capital and liquidity requirements individually before
offering a comparative assessment.
Van den Heuvel employs data from two distinct periods to evaluate the costs of liquidity regulations. The first period,
2001-2007, had no liquidity regulation. As such, introducing liquidity regulations during this time would likely have been
the binding constraint in the model. In other words, banks would have to adjust their portfolios to meet the minimum
requirement. The second period, 2016-2019, covers the implementation of the Liquidity Coverage Ratio (LCR) as part of
Basel III. To estimate the welfare costs of a 10 percentage point increase in liquidity requirements, the equation utilizes
several key inputs over two periods. The first is the existing liquidity requirement for each period, which is 0% for the first
period and 17% for the second period. The author arrives at 17% by taking the average ratio of depository institutions'
holdings of Treasuries, plus excess reserves, to total deposits. Both equations also consider the historical spread of
Treasuries to deposits, and the deposit to consumption ratio. In the model, as banks are required to hold higher levels of
liquidity, they must transfer government bonds into bank deposits. The bank deposits command a convenience yield,
which reduces liquidity services by the bank. The reduction in liquidity services leads to a reduction in investment and in
turn, consumption. The results for each period can be found in the Table below.
Table 40: Estimating welfare costs of a 10% increase in liquidity requirements255
Permanent loss in Permanent loss in

consumption (%) consumption ($ based on
Existing Liquidity New Liquidity 2019)
Data Period
Requirement Requirement
Following 10% liquidity requirements increase
2001-2007 0 10% 0.031% $4.5 billion
2016-2019 17% 27% 0.046% $6.6 billion
To quantify the welfare costs of increasing capital regulations, Van den Heuvel uses data from two periods, one pre- and
one post-Basel III implementation. The first period spans 1993-2010 and the second period spans 2016-2019. The key
inputs for this equation are the average spread of nominal interest rates on subordinated debt and deposits, mean loan to
consumption ratio, the net non-interest cost of servicing deposits, and the liquidity requirement of the period. The results
assume a 10 percentage point increase in capital requirements. As the capital requirements increase, there is a reduction
in the banks’ supply of deposits as banks replace those deposits with equity. When banks have a need for greater equity
and lesser deposits, there is a reduction in loan volume, leading to a reduction in investment and consumption. The
results can be found in the Table below.
Table 41: Estimating welfare costs of a 10% increase in capital requirements256
Permanent loss in
Nominal interest rates consumption (%)
Loan to consumption Net non-interest cost
Data Period Liquidity Requirement on debt and deposits
ratio of servicing deposits
spread Following 10% capital
requirements increase
1993-2010 0 302 bp 0.95 122 bp 0.17%
255
Source: Van den Heuvel, Skander J. (2022). “The Welfare Effects of Bank Liquidity and Capital Requirements,”
Finance and Economics Discussion Series 2022-072. Washington: Board of Governors of the Federal Reserve System,
https://doi.org/10.17016/FEDS.2022.072, 36-37.
256
https://doi.org/10.17016/FEDS.2022.072, 39-40.
2016-2019 17% 336 bp 1.07 206 bp 0.22%
The results in the Table below compare the average welfare cost of a 10% increase in each requirement in a pre- and
post-Basel III implementation. The numbers in parentheses below display the range that was observed under the various
cost estimates.
Table 42: Comparative assessment of 10% increase in requirements across periods257
Welfare Cost Pre-Basel III (%) Post Basel III (%)
10% Liquidity Requirement 0.017 0.023

(0.003-0.031) (0.001-0.046)
10% Capital Requirement 0.191 0.245

(0.171-0.210) (0.219-0.272)
Benefits Channel
Van den Heuvel's analysis does not contribute to the literature on the welfare benefits of increased capital and liquidity
requirements. According to Van den Heuvel, utilizing a sufficient statistics approach is not ideal for measuring these
benefits. To compare welfare benefits to the costs calculated in this study, Van den Heuvel relies on the results of previous
impact studies, specifically the Basel Committee on Banking Supervision (BCBS) 2010 report.
The author uses the BCBS 2010 report because of its assessment of the gross benefits of an LCR-style liquidity
requirement. For capital requirements, the report finds that raising the requirement from 7% to 15% results in a benefit
ranging from 0.8% to 2.64% of GDP. In terms of liquidity requirements, the report shows a 0.23% to 0.76% increase in
GDP. These liquidity requirement results assume a 7% capital requirement, and the impact on GDP decreases as the
capital requirement rises.
Conclusion
Van den Heuvel's equilibrium model reveals that both capital and liquidity requirements result in welfare costs to
consumption. The author estimates that the costs associated with capital requirements are approximately ten times
greater than those for liquidity requirements. However, when considering the benefits of these requirements, there is a net
positive welfare impact for both capital and liquidity requirements. Moreover, the benefits of capital requirements
significantly outweigh those of liquidity requirements, resulting in a larger net benefit for capital requirements as well.
Although costs are measured as a decline in consumption and benefits are expressed as a percentage of GDP, making
direct comparison difficult, the overall results are evident. The Table below presents a comprehensive quantitative
evaluation of these requirements.
Table 43: Overall Net Impact on Welfare258
Requirement Welfare Benefit on GDP Welfare Cost on consumption Welfare Net Impact
(Increasing from 7% to 15%) (Increasing from 7% to 15%)
Capital 0.8% to 2.64% 0.15% Largely positive
Liquidity 0.23% to 0.76% 0.02% Positive
257
https://doi.org/10.17016/FEDS.2022.072, 41.
258
https://doi.org/10.17016/FEDS.2022.072, 45.
Additionally, Van den Heuvel finds that liquidity requirements are not a substitute for capital requirements in regards to
credit risk. The optimal policy relies on both capital and liquidity requirements for financial stability.
Limitations
Van den Heuvel’s study includes some limitations in regards to factors not considered in the model framework. The
absence of these considerations leads to a possibility of different model outcomes and have the potential to alter the
study’s conclusions.
1. Assessment of welfare benefits: The framework does not complete its own assessment of the welfare benefits of
capital and liquidity requirements. The paper instead relies on previous studies, mainly a study conducted 12 years
prior. Conclusions regarding higher or lower welfare benefits based on the model framework could result in different
results regarding the net benefits.
2. Lender of last resort: The lack of consideration for central bank intervention for commercial banks with liquidity
problems may overstate the impact of liquidity requirements. The consideration of government bail out in the model
would likely result in reduced liquidity requirement welfare benefits.
The Table below provides a summary of the anticipated impacts that the consideration of each factor may have on the
model’s estimated impact to overall welfare under capital and liquidity requirements.
Table 44: FRB 2022, Factors Not Considered and Potential Impact on Welfare
# Factor Not Considered Potential Impact on net welfare, Under Increased Capital and Liquidity Requirements
Mixed
1 Assessment of Welfare Benefits
An independent review of the welfare benefits using the model framework and recent
data could result in higher or lower benefits which would impact the overall net impact
Negative
2 Lender of Last Resort
Government intervention for liquidity stressed banks would reduce liquidity requirement
benefits, leading to a net decrease in overall welfare of the requirements
Mixed
Bank trading books and market liquidity is
3 Without considering trading book, the marginal cost of increased capital requirements
not considered
may be overstated or understated, as corporate bonds act as a substitute funding source,
but increased capital requirements may reduce market liquidity.
The Table above highlights the directional impact of the factors not considered in the model framework. While an
independent assessment of welfare benefits could lead to mixed effects on the study’s conclusions, inclusion of a lender
of last resort or different approximations of cost estimates would result in lower net welfare. Additionally, the lack of
consideration for trading book and market liquidity potentially has a mixed effect on the model's outputs. The inclusion of
these factors could potentially have large implications on the outcome of the study and may increase or decrease the
overall welfare of the capital and liquidity requirements.

2.3.10 Bank of England - Implementation of the Basel 3.1 Standards (2022)
Multiple Authors
In 2022, The Bank of England (BOE) released its Consultation Paper, "Implementation of the Basel 3.1 Standards." This
paper evaluates the impact of the Prudential Regulatory Authority's (PRA) proposal for implementing Basel III reforms on
the UK financial system and broader UK economy. Building on the BOE's 2015 paper, the study assesses the
macroeconomic impacts of higher capital requirements on the UK economy, under a cost benefit analysis framework and
leveraging a large-scale, multi-country econometric model, called the National Institute Global Econometric Model
(NIGEM).
The BOE concludes that the benefits of increased capital from Basel III reforms substantially outweigh the costs. BOE
defines the benefits of increased capital as a reduction in the probability and cost of a future financial crisis, and the costs
of increased capital requirements as a reduction in loan volume and an increase in regulatory compliance costs. The
regulator estimates that the reforms will result in a 3.1% increase in CET1 capital ratios, with a net benefit of £10.3Bn
Pounds (or 0.5%) added per year to the UK’s annual GDP.
The BOE's initial stance is that "higher and better-quality capital promotes both firm safety and soundness and financial
stability by reducing the likelihood of another financial crisis." The BOE contends that known weaknesses in risk
measurement and RWA calculation variability cast doubt on the pre-reform adequacy of a firm’s capital levels. Absent the
Basel III reforms, these weaknesses could have costly implications for the U.K.'s GDP and increase the risk of contagion
due to the interconnectedness between the U.K.’s financial system and global financial markets.
Methodology
To evaluate the expected impact of the Basel 3.1 reforms, the BOE performs scenario analysis, leveraging three distinct
models, and running two distinct scenarios through the framework. In the first scenario, Basel III reforms are not
implemented, and in the second scenario Basel III reforms are implemented. The approach compares the results between
the two, first on the cost side, and then on the benefit side, summing up the differences to generate an estimate for the net
benefits of implementing the Basel III reforms. Figure 44 below displays the model flow, including the three distinct
models, the inputs and outputs, and the connection points between the three models:
Figure 44: Illustration of the modeling approach259
The modeling framework takes the changes to banks measures of risk-weighted assets under the Basel III standards to
generate individual bank responses as an input, and provides an output in terms of long-term GDP levels and growth, and
the expected GDP losses from a crisis.
A brief description is provided below of each of the three models that comprise the framework:
259
Source: "CP16/22 - Implementation of the Basel 3.1 standards," Appendix 7, “Aggregated cost benefit analysis (CBA),”
Bank of England, 28.

• Model 1: The first model is a model of the banking system that estimates how individual firms adjust their balance
sheets, including assets and liabilities, as a result of changes in regulations.
• Model 2: The second model represents NIGEM, a macroeconomic model that translates the proposed changes in
aggregate banking sector risk-based capital ratios into average lending spreads and economic output.
• Model 3: The third model estimates the probability of a crisis under different banking sector leverage ratios, with higher
leverage ratios corresponding to an increased likelihood of a crisis.
The following subsections provide more detailed information regarding the approach and assumptions of each model.
Model 1
The first model estimates how each firm would adjust its balance sheet to meet capital requirements under the Basel III
regulatory framework. The model uses bank-level data, including firm-specific calculations for RWA, collected through
quantitative impact study (QIS) templates provided by individual banks.260 The model uses the data to estimate how each
each firm would respond to the reforms, making the following key assumptions:
1. Capital requirements maintained: Each firm maintains a capital ratio that aligns with the supervisor’s prudential
requirements and systematic and unsystematic risk requirements.
2. Capital surplus maintained: Under the assumption that there are no changes to macroeconomic and market risk
drivers, each firm maintains their pre-reform capital surplus.
3. Dynamic assets and liabilities: Each firm adjusts both their assets and liabilities to meet post-reform capital
requirements.
Because the impact data from the QIS templates only covered a subset of impacted firms, and certain factors are left
unconsidered in the original 2019 QIS template submission, Model 1 attempts to extrapolate the results from the
submission to all impacted firms while resolving data issues and certain factors not considered within with the QIS data.
At a high level, the model process is executed in three distinct steps:
1. Data cleansing: As a first step, the model process begins with data cleansing. The model uses the 2019 QIS
submission, because the 2019 submissions were collected from a wider range of banks than the traditional
semi-annual QIS exercises run by the BIS. In addition, an earlier QIS submission affords the model the opportunity to
capture the entire impact of the Basel III reforms, as forward-looking firms may have begun to adjust their balance
sheets in anticipation of Basel III reforms, and this may be reflected in later submissions. However, the 2019 QIS
Template includes some errors by individual firms, and the input data is adjusted to reflect instances in which firms
acknowledged errors in the submission.
2. Extrapolation across sector: To extrapolate the impacts across the sector, Model 1 first calculates the change in
RWAs for each firm that submitted QIS data to the PRA in 2019. The PRA then estimated the average change in
RWA by the following categories:
a. Size: Large Firms vs. Small and Medium Firms
b. Business model: Banks vs. Building Societies
c. Approach to risk measurements: Internal Ratings-Based vs. Standardized Approach
The model then applied the average changes across cohorts to the firms not included in the QIS 2019 impact study.
This step results in a comprehensive set of results across firms in the sector.
260
The sample of bank respondents represent 20 percent of all U.K. banks affected by the Basel III reforms.

3. Adjustments for additional considerations: Adjustments to the model output are made to account for the
interaction between Basel III reforms and Pillar 2A requirements, and the implementation time of the reform:
a. Basel III and Pillar 2A Requirements interaction: Model 1 was adjusted to consider the interaction with the
PRA's Pillar 2 framework and avoid double counting. The PRA used regulatory reporting and supervisory data to
gauge the likely reduction in Pillar 2A requirements and adjust the RWAs impact accordingly.
b. Implementation timeline: Model 1 assumes firms would start adjusting to the proposals from the proposed
implementation date of 1 January 2025, with the output floor phased in until 2030. The long transitional period
allows firms more time to adjust, and the estimate of total capital costs is likely conservative, overestimating the
overall impact on capital.
Based on the key assumptions and the process described above, the model provides two key outputs. First, the model
provides an estimate for the aggregate change in capital across the banking sector in response to the reforms. Second,
the model provides aggregate changes in risk-based and leverage-based capital ratios, based on changes at the
individual firm level.
Model 2
The second model uses NIGEM to generate paths for UK GDP under two distinct scenarios, one in which Basel III
reforms are implemented, and one in which the reforms are not implemented.
To generate the paths for UK GDP, the NiGEM model is modified to include a UK-banking sector sub-model that
demonstrates how lending is repriced over time in response to the changes in the aggregate risk-based capital ratio
calculated in Model 1. This sub-model translates the changes in aggregate banking sector capital ratios into impacts to
average lending spreads, and further sub-models translate the impact to lending spreads to impacts to consumption,
investment growth, and GDP.
The assumptions made in the translation of changes in risk-based capital ratios to lending rates are provided below:
Table 45: Model 2 Assumptions Associated with the UK Bank Sub-Model
# Assumption Name Description
1 Capital Structure Impacts Funding Costs The change in the aggregate capital ratio affects the capital-debt mix of firms’
liabilities and hence firms’ average funding cost
2 Lending Spreads are Adjustable by Banks Firms use lending spreads over base rates to recover the increase in higher
funding costs
3 The ‘Modigliani-Miller’ offset Changes in average funding costs are partly offset as firms’ equity (capital) and
debt investors respond to changes in firms’ balance sheet structure (the
‘Modigliani-Miller’ offset)
4 Short-Term Impacts to Household and Corporate Lending The average spread charged to households adjusts more slowly than to
Spreads corporates in the short-term, as household loans are dominated by long-term
mortgages that cannot be repriced quickly
5 Long-Term Impacts to Household and Corporate Lending Spreads charged to both the household and corporate lending sectors adjust by
Spreads the same amount after approximately three years.
In addition, to the assumptions listed above, the model makes further assumptions outside of the UK-sub model to
translate an impact in lending rates to an impact to GDP:
Table 46: Additional Model 2 Assumptions

# Assumption Name Description
1 No Arbitrage in Funding Costs The cost of other forms of finance (e.g., corporate debt issuance) move in line
with changes in credit spreads over base rates ensuring there is no arbitrage in
the model from non-bank finance sources
2 Small, Open Economy The UK is a small, open economy with capital mobility–household consumption
and the savings rates change, but after an adjustment period, any lasting effects
are offset by the current account, foreign assets, and incomes from abroad –the
savings rate does not affect the productive potential of the economy
Based on the assumptions outlined above, the model estimates two paths of UK GDP, one considering the impact of
Basel III reforms, and one not. The difference between the two paths quantifies the macroeconomic cost of increased
capital requirements under the Basel III regulatory framework.
Model 3
The third model estimates the reduction in the probability and cost of a future financial crisis, based on the impact to
leverage ratios, provided by Model 1. As the Basel III reforms reduce banking sector leverage in aggregate, Model 3
generates an expected decrease in the probability of a crisis, which can be used to evaluate the expected costs if a crisis
were to occur. The assumptions of Model 3 are displayed in the Table below:
Table 47: Model 3 Assumptions
# Assumption Description
1 OECD Country Averages Determine Frequency of Crisis The frequency of crises and associated GDP costs are based on Organisation
and GDP costs for Economic Co-operation and Development (OECD) country averages (see
Barrel et al., 2009)
2 Financial Crisis Drivers The drivers of financial crises are high banking sector leverage (i.e., low equity
to asset ratios), low banking sector liquidity, and fast house-price growth
From the OECD average country estimates of financial crisis frequency and costs, and the leverage ratio impacts
provided by Model 1, Model 3 estimates the benefit of Basel III reforms with respect to the reduction in likelihood and
severity of a financial crisis.
Conclusions
Through the use of these models, there are several benefits, costs, and overall impacts that are identified and derived.
The Figure below lists the key benefits, costs, and overall impacts.
Table 48: Costs, Benefits, and Overall impacts of the regulations
Benefits Costs
Safety and soundness Affected firms and markets
Facilitating effective competition Operational compliance costs to firms
Competitiveness and growth Capital and balance sheet costs to firms
Direct costs to the PRA
Overall Impacts
Macroeconomic opportunity costs

Macroeconomic net benefits
As indicated in the above Table, the models suggest benefits in the form of an increase in the security of banks and
increased competition among banks. Although it is not quantified, the study suggests that banks will no longer be able to
gain a competitive advantage through credit risk, thus promoting competition. Overall, the risk levels of firms most at risk
of default is reduced when competition is more intense. The identified costs are most directly related to firms needing to
make changes to their operations and balance sheets to meet the new requirements. The PRA also incurs costs related to
changes in its supervision function adjusting to proposed changes in regulations. The study concludes that the net
benefits do outweigh the costs. The BOE calculates the net economic benefit to be £10.3 billion per year.261 The Table
below provides an overview of the final model outputs:
Table 49: Summary of the expected impact of the proposals in CP 16/22 based on PRA estimates262, 263
£ Billions264 % of Total
Macroeconomic Benefits 21.0 100%
Proposals in CP 16/22 1.8 9%
Other relevant prudential requirements 19.2 91%
Macroeconomic Costs 10.8 100%
Proposals in CP 16/22 1.3 11%
Other relevant prudential standards265 9.5 89%
Net benefits of relevant prudential policy266 10.3 -
The BOE estimates the benefit of higher capital levels and reduced probability of financial crises to be equivalent to £21B
per year, or roughly 1 percent of the U.K.’s 2021 GDP. Offsetting the benefits are higher costs to firms, which the BOE
estimates to be £10.8B or approximately 0.5% of the U.K.’s 2021 GDP. To arrive at a net present value of ongoing costs,
the BOE assumes a discount rate of 3.5 percent (in line with the current guidelines for 2022). Higher costs at the firm-level
are realized through the increased cost of operational compliance and raising of capital. For firms, the largest compliance
cost stems from the change in the market risk framework. The PRA estimates an increase of approximately £14.2B in
additional CET1 capital will be raised across all firms, with large firms driving much of the additional capital needs.
Increased macroeconomic costs appear in the form of increased borrowing costs. In particular, the BOE estimates that for
every increase in the sector-wide RBC ratios of 100 basis points there is a subsequent increase in borrowing costs that
reduces the UK’s annual GDP by roughly £1.3B per year. To estimate firm-specific costs, the BOE relies on initial and
ongoing cost estimates from affected firms collected through the QIS responses.
261
The net economic benefit is £10.3 billion rather than £10.2 billion per year due to rounding in the estimates.
262
Costs and benefits are calculated against a baseline where the proposals in CP 16/22 would not be implemented.
263
"CP16/22 - Implementation of the Basel 3.1 standards," Appendix 7, “Aggregated cost benefit analysis (CBA),” Bank of
England, 35.
264
Annual annuity estimate of the present value of the chained volume measure (2021) of GDP.
265
Other relevant prudential requirements include the initial phase of implementation of the Basel III standards in the UK.
266
The size of the net benefits should be considered in the context of annual GDP for the UK economy, which was £2.1
trillion in 2021

Limitations
Like other methodologies, the BOE’s study is limited by the uncertainty and sensitivity of model assumptions. These
limitations also include factors not considered in the study which may impact the overall conclusions. The limitations can
change the degree to which costs and/or benefits are measured and thus affect the overall net benefits.
considered these regulations, the marginal benefit from increasing capital requirements could be reduced, potentially
The Table below provides a summary of the expected impacts of each of the limitations or excluded factors. Each factor
can have positive or negative impacts on the overall net benefits of the capital requirements.
Table 50: BoE 2022, Factors Not Considered and Potential Impact on Net Benefits
# Factor Potential Impact on Net Benefits, Under Increased Capital Requirements
Positive
Enhanced regulation and bank balance sheet
1 Existing liquidity and recovery and resolution requirements aim to reduce the risk of
composition
bank assets overall and enhance the resolvability of firms during a crisis. Consideration of
both of these factors could have a positive impact on Net Benefits.
Mixed
Migration of financial intermediation to
2
non-banks Non-bank lending share may increase, enhancing competition, but potentially
increasing risk in stress.
Mixed
Bank trading books and market liquidity is not
considered
In the Table, the directional impact of each factor not included in the framework, is outlined. Accounting for a transition
period for banks and avoiding shocks will reduce transition costs and increase the overall net benefits. Adjustments in the
discount rate sensitivity, operational cost estimates, and the migration to non-bank financing all have the possibility of
positive or negative impacts to net benefits based on the direction in which the adjustments take place.

In addition to the factors not considered listed above, the model assumes that any change in the capital requirement is
treated as an instantaneous impact to bank balance sheets. In reality, when new requirements are announced, banks tend
to slowly adjust their balance sheets to avoid shocks. Allowing for this transition period should enable banks to reduce
transition costs associated with complying.
2.3.11 Basel Committee on Banking Supervision - Evaluation of the Impact and Efficacy of the Basel III
Reforms (2022)
Multiple Authors
The Basel Committee on Banking Supervision (BCBS) has published two studies focused on analyzing the impacts of the
Basel III reforms. The first paper was conducted in 2010 and analyzed the likelihood of a crisis and its potential impact on
GDP, assuming the adoption of the proposed capital and liquidity reforms. The BCBS concluded that there would be
considerable room to tighten capital and liquidity requirements while still realizing positive net benefits. The second paper,
conducted in 2022 following the implementation of the majority of Basel III reforms, evaluated the effects that the reforms
had on the banking sector.
The BCBS' 2022 paper was the first comprehensive evaluation following the implementation of the majority of Basel III
reforms, and is the focus of this literature review. The Committee concluded that the reforms led to overall increased
resilience in the global banking sector. The implementation of reforms, including revised definitions of capital and
minimum risk-based capital requirements, a minimum leverage ratio requirement, LCR, and NSFR, allowed the BCBS to
conduct a holistic assessment of their impact. The analysis showed that the banking sector’s cost of capital was not
compromised. The analysis concluded that there was not compelling evidence of the potential negative side effects of the
reforms.
Methodology
To better understand the methodology used by the BCBS to analyze the impact of Basel III reforms, this section describes
the general approach applied in the empirical analysis to assess bank resilience, lending, and cost of capital. Then, this
section explains the approach to assessing each of these elements in more detail and provides the results of each
analysis.
The general methodology used in the empirical analysis of the impact of the Basel III reforms primarily employs panel
fixed-effects regressions. These regressions relate the outcome variable, such as resilience measures, lending growth, or
cost of capital to the bank-specific impact of the reforms. The analysis aims to rule out macroeconomic trends and other
exogenous factors as an explanation for the association between the reforms and the outcome variable by including
additional explanatory variables to mitigate omitted variable bias in the regression estimates. The formula below presents
the general structure of the regression models used to analyze bank resilience, lending and cost of capital:
Figure 45: General Equation
The definition for the variables in the equation are provided in the Table below:

Table 51: Variable Definitions
Variable Symbol Variable Definition
y Outcome variable of interest, such as resilience measures, lending growth, or cost of capital
i bank
t time
αi bank -specific regression intercepts
θt Time dummy variables, meant to filter out time period-specific effects unrelated to Basel III reforms (optional)
Macro Lagged country-specific (or global) macroeconomic control variables to account for the influence of macroeconomic
dynamics such as GDP and interest rates
c Country
βτ Time-specific event window coefficient, aimed to reveal any time patterns in the outcome variables’s response to the impact
of the reform event
Dt Impacti Sets of regressors that capture the effect per each unit of Basel reform impact at time t relative to the jurisdictional
announcement date
εi,t Regression error terms
The general equation estimates the impact of the Basel III reforms using the following three terms: βτ, Dt, and Impacti. βτ
is the impact coefficient and will be estimated as part of the regression, taking a positive or negative value that will reveal
the direction and magnitude the impact the reform has had on the output variable, Y. Dt is a dummy variable input, taking
either a value of 1 or 0. Dt only takes a value of 1 during the relevant time window for a given jurisdiction and reform. For
instance, D1 is equal to 1 only in the year that is 1 year after the specific reform announcement year in the relevant
jurisdiction. Finally, Impacti is an input and defined as the reform-related key regulatory ratio (e.g., CET1 ratio) at the time
of the reform event (i.e., for τ = 0), multiplied by negative 1, as the impact of imposing these requirements on banks’
requirements on bank’s behavior is greater when the banks’ ratios are lower.
To specify the regressions, three primary sources of data are used:
1. BCBS-specific data collection and Basel III implementation progress updates
2. External data that included vendor and country-specific macroeconomic data
3. Internal survey conducted by Committee member and observer organizations
The time-series of the data collection covered 2011-2019 as this allowed for pre-pandemic analysis as well as only
evaluating data on reforms that had already been implemented.
The following sections describe the methodologies and results in more detail regarding the areas of study that leverage
the general framework described above:
Impact of the Basel III reforms on bank resilience
The BCBS leveraged the general framework above to assess the impact of the introduction of the reforms on the
resilience of individual banks. Resilience of individual banks was investigated through two separate lenses: regulatory
measures of bank resilience, and market-based measures of bank resilience. In each case, BCBS analyzes a historical
time series of each measure, noting that the measures have improved over time, and attempts to attribute changes in the
measure to the announcement of regulatory reforms, while controlling for macro factors, and bank and time fixed effects.

In the analysis of the impact of the Basel III reforms on regulatory measures of bank resilience, BCBS used four panel
regression models to evaluate the impact of the reforms on CET1 ratio, Leverage ratio, Liquidity Coverage Ratio, and
NSFR. Each regression focused on a single resilience measure as the dependent variable and controlled for the same
macroeconomic indicators. The macroeconomic indicators considered were lagged GDP growth, lagged implied volatility
(VIX/V2X), and lagged policy rate.
The coefficient, βτ, is assessed to determine the impact the announcement of a reform had, within a given time window,
on the dependent variable. The regression results, highlighting the βτ value and its statistical significance, for each of the
4 regressions and time windows, are shown below:
Figure 46: Bank Resilience - Regulatory Measures: Regression Results267
Dependent Variable Regulatory Ratio
(1) (2) (3) (4)

Reform considered
CET1 Leverage LCR NSFR
One year after 0.081*** -0.008 0.086*** -0.016

(τ = 1) (0.028) (0.016) (0.028) (0.011)
Two years after 0.095** -0.041** 0.227*** -0.020

(τ = 2) (0.044) (0.021) (0.046) (0.018)
Three years after 0.149*** -0.049* 0.308*** -0.048*

(τ = 3) (0.056) (0.026) (0.056) (0.026)
Four years after 0.158** -0.040 0.363*** -0.050

(τ = 4) (0.061) (0.031) (0.067) (0.036)
Five years after 0.176*** -0.029 0.420*** -0.074

(τ = 5) (0.061) (0.038) (0.070) (0.047)
R2 (within) 0.304 0.350 0.106 0.272

Observations 2,714 2,767 2,265 2,565
Number of banks 197 202 195 192
The symbols *, ** and *** denote significance at the 10%, 5%, and 1% level.
The regression results show that a lower CET1 ratio at the time of the jurisdictional announcement date leads to a larger
increase in the CET1 ratio over the following five years. This effect is statistically significant and adds up to about 18 basis
points after 5 years. Because the model used controls for the positive trend of CET1 ratios over time, the impact of 18 bps
of a lower initial CET1 ratio is in addition to the general trend.
Similarly, the results show that a lower LCR ratio at the time of the jurisdictional announcement date leads to a larger
increase in the LCR over the following five years. This effect is statistically significant and adds up to about 42 bps after 6
years.
The results indicate that the reforms have not only improved resilience at the system-wide, aggregate level, but have had
a particularly strong impact on banks with relatively weak initial CET1 ratios and LCRs.
On the other hand, the Leverage Ratio and NSFR do not show the same relationship. Although both ratios have improved
significantly since 2011, the regression analysis indicates that this trend did not differ much between banks with weak
leverage ratios and NSFRs and those with strong ratios. It is important to note that the Leverage Ratio and the NSFR
were planned to go into effect at later dates than were the CET1 ratio and LCR requirements.
In the analysis of the impact of the Basel III reforms on market-based measures of bank resilience, BCBS used 8 panel
fixed effects regression models to evaluate the impact of the reforms on CDS (senior) spreads and EDF, while assessing
267
Source: "Evaluation of the impact and efficacy of the Basel III reforms,” Basel Committee on Banking Supervision, 15.

each reform individually (i.e., CET1 ratio, Leverage ratio, Liquidity Coverage Ratio, and NSFR). The dependent variable in
each regression is either CDS (senior) spreads or EDF and controlled for the same macroeconomic indicators as the
regulatory-based resilience measures.
Figure 47: Bank Resilience - Market-based Measures: Regression Results268
Dependent
CDS (senior) EDF
Variable
Reform (1) (2) (3) (4) (5) (6) (7) (8)

considered CET1 Leverage LCR NSFR CET1 Leverage LCR NSFR
One year after -1.604 0.098 -0.115 0.013 -0.236 -0.429 0.004 0.063
(τ = 1) (1.074) (1.610) (0.093) (0.078) (0.590) (0.805) (0.033) (0.042)
Two years after -4.596*** -2.986 -0.159 -0.074 -0.532 -0.296 0.075 -0.030
(τ = 2) (1.690) (2.176) (0.154) (0.133) (1.140) (0.940) (0.065) (0.070)
Three years after -5.238** -2.862 -0.120 -0.020 -0.488 0.594 0.118 -0.048
(τ = 3) (2.097) (2.859) (0.202) (0.161) (1.474) (1.236) (0.090) (0.108)
Four years after -5.819** -1.614 -0.281 -0.164 -0.619 1.744 0.056 -0.148
(τ = 4) (2.494) (4.106) (0.256) (0.209) (1.718) (1.403) (0.110) (0.176)
Five years after -7.127** -5.006 -0.328 -0.152 -2.048 -1.096 0.066 -0.354***
(τ = 5) (2.835) (4.729) (0.304) (0.296) (2.155) (1.584) (0.127) (0.131)
R2 (within) 0.760 0.745 0.752 0.750 0.342 0.371 0.347 0.347

Observations 685 613 664 667 1,251 1,179 1,197 1,233
Number of banks 46 42 44 45 72 68 69 71
The results across the market-based resilience measures are less compelling than that across the regulatory-based
measures. Specifically, only column (1) shows that the impact of a jurisdictions’ announcements of the associated reform
is associated with a statistically significant decline in the market-based measure. In this case, it shows that for each
percentage point lower a bank’s CET1 ratio is at the time of the jurisdictional announcement date, the bank CDS spreads
fall by around 7 bps after five years, in addition to the general trend of decreasing CDS spreads over the time period. For
other measures, except for the case of NSFR after five years, the results are not statistically significant. The reader can
interpret this as stating that although CDS spreads have generally decreased over time, the regression analysis attributes
part of the trend to increased the higher CET1 ratios associated with the Basel III reforms.
Impact to Lending Volume
BCBS uses a similar approach to assess the effects of the Basel III reforms on lending volume. The reason Basel III
reforms may unintentionally reduce lending volume is that banks with lower capital ratios that lack the ability to raise new
capital to meet requirements may reduce RWA and exposures by cutting back on lending. Moreover, LCR and NSFR
requirements, which require banks to hold more high quality liquid assets and use more stable funding, may also limit the
amount of loans banks can hold on their balance sheet.
To perform this analysis, BCBS used four panel regression models to evaluate the impact of the reforms on lending
volumes. The dependent variable in each regression is total lending, and each regression is controlled for the same
macroeconomic indicators as in the approaches described earlier.
268

Figure 48: Total Lending: Regression Results269
Dependent Variable Total lending
(1) (2) (3) (4)

Reform considered
CET1 ratio Leverage ratio LCR NSFR
One year after 0.0028 0.0047* -0.0002* 0.0004

(τ = 1) (0.0022) (0.0026) (0.0001) (0.0004)
Two years after -0.0031 0.0125 -0.0004* 0.0011

(τ = 2) (0.0039) (0.0079) (0.0002) (0.0008)
Three years after -0.0034 0.0218* -0.0006 0.0021

(τ = 3) (0.0058) (0.0130) (0.0004) (0.0016)
Four years after 0.0001 0.0434 -0.0008 0.0052

(τ = 4) (0.0097) (0.0282) (0.0006) (0.0045)
Five years after 0.0028 0.0574 -0.0004 0.0121*

(τ = 5) (0.0136) (0.0393) (0.0006) (0.0072)
Coeff. for τ < 0 Yes Yes Yes Yes

2
R (within) 0.0880 0.0983 0.0804 0.1490
Observations 2,535 2,579 2,484 2,551
Number of banks 196 199 193 191
The mostly statistically insignificant coefficients suggest that, in general, loan growth by banks with weaker regulatory
ratios does not differ from that for other banks. The weakly significant, positive coefficients after the introduction of the
leverage ratio point to higher credit growth for these banks. However, on the other hand, a one percentage point lower
LCR at the event date is associated with a 0.02 percentage point lower lending one year later and 0.04 percentage point
lower lending two years later. Thus, the regression results above do not imply that banks with initially lower regulatory
ratios reduced their lending after the Basel III reforms.
Impact on Cost of Capital
BCBS uses a similar approach to assess the effects of the Basel III reforms on Cost of Capital. If no management actions
on capital ratios are taken, an increase in regulatory requirements due to the introduction of a new requirement can
reduce a bank’s distance from its regulatory minimum, which may drive an increase in the cost of capital. This is further
supported by an incomplete Modigliani-Miller effect suggesting that the weighted average cost of capital may rise during
the transition to a new regulatory regime. That being said, available evidence suggests that complying with stricter
regulation may, beyond the short-run increase, reduces average funding costs over the medium term.
To perform this analysis, BCBS used eight panel regression models to evaluate the impact of the reforms on Cost of
Equity and Cost of Debt. The dependent variable in each regression is either Cost of Equity or Cost of Debt, while
considering one of the four reforms in scope (i.e.,CET1 Ratio, Leverage Ratio, LCR, and NSFR). Each regression is
controlled for the same macroeconomic indicators as in the approaches described earlier.
eight regressions and time windows, are shown below:
269

Figure 49: Cost of Equity and Cost of Debt: Regression Results270
Dependent
Cost of equity Cost of debt
Variable
(2) (6)
Reform (1) (3) (4) (5) (7) (8)
Leverage Leverage
considered CET1 ratio LCR NSFR CET1 ratio LCR NSFR
ratio ratio
One year after -0.0133 -0.0572 -0.0018 0.0031 -0.0252*** 0.0142 0.0004 -0.0014
(τ = 1) (0.0263) (0.0451) (0.0021) (0.0031) (0.0090) (0.0114) (0.0004) (0.0009)
Two years after -0.0785 -0.0298 -0.0056 0.0003 -0.0462** 0.0137 0.0009 -0.0016
(τ = 2) (0.0584) (0.0780) (0.0042) (0.0070) (0.0176) (0.0193) (0.0009) (0.0018)
Three years after -0.1104 -0.2190** -0.0050 -0.0023 -0.0578** 0.0102 -0.0003 -0.0021
(τ = 3) (0.0878) (0.1090) (0.0054) (0.0104) (0.0244) (0.0294) (0.0013) (0.0027)
Four years after -0.0674 -0.2500** -0.0112 0.0031 -0.0543* -0.0116 -0.0028 -0.0016
(τ = 4) (0.1006) (0.1387) (0.0067) (0.0144) (0.0276) (0.0368) (0.0018) (0.0041)
Five years after -0.0144 -0.3518** -0.0201** 0.0026 -0.0393 -0.0704 -0.0065** 0.0045
(τ = 5) (0.1189) (0.1652) (0.0078) (0.0207) (0.0295) (0.0463) (0.0026) (0.0055)
Coeff. for τ < 0 Yes Yes Yes Yes Yes Yes Yes Yes
2
R (within) 0.3331 0.3469 0.3446 0.3412 0.4715 0.4354 0.5320 0.4468
Observations 1,229 1,157 1,184 1,211 1,229 1,157 1,184 1,211
Number of banks 69 65 66 68 69 65 66 68
The regression results indicate that banks with weaker leverage and/or LCR ratios saw a greater decrease in their cost of
equity after the Basel III reforms compared to other banks. On the other hand, banks most affected by either the
risk-based capital reform or the LCR reform saw a greater decrease in their cost of debt after the reforms relative to other
banks. The analysis of the weighted average cost of capital (WACC) suggests that after the proposal of the reforms,
WACC is lower for banks with a lower initial CET1 ratio or lower initial LCR relative to other banks. These results indicate
that the Basel III reforms reduced the relative risk of banks that entered the reforms with weaker regulatory requirements
and improved their relative cost of funding.
Conclusions
BCBS concludes that the analysis in this report demonstrates that the implementation of the Basel III reforms has led to
improvements in the capital and liquidity positions of banks, especially for those banks with weaker capital and liquidity
ratios. Moreover, the banking sector's systemic risk, as measured by regulatory-based and market-based indicators, has
also significantly improved, making the financial system less vulnerable to individual banks' distress. While the analysis in
the study is able to attribute improvements in regulatory-based measures to the announcement of the reforms, the
analysis was only able to attribute a reduction in CDS (senior) spreads to the announcement of the CET1 ratio, and not
other Basel III reforms. The study found no evidence of negative side effects from the Basel III reforms, as banks typically
lowered their costs of debt and equity, and bank lending expanded in most jurisdictions. Overall, the BCBS concluded that
the Basel III reforms brought significant benefits with little to no costs, resulting in a more secure financial system.
Limitations
The BCBS (2022) performs a retrospective analysis on the impacts on the Basel III reforms on bank resiliency, cost of
capital and lending volume, standard impact channels used by other researchers to estimate the impact of higher capital
requirements. Although the study is comprehensive in its consideration of relevant regulations, the study does not
consider non-bank financing and trading book and market liquidity in its assessment of the impacts of Basel III:
270

banks may reduce their trading inventories, thereby lowering market liquidity. This translates into a higher liquidity
The Table below provides a summary of the anticipated impacts to overall welfare that each of the factors not considered
may have had. The inclusion of these factors has the potential to alter the conclusions of this study through higher costs
or benefits of the regulations.
Table 52: BCBS 2022, Factors Not Considered and Potential Impact on Welfare
# Factor Not Considered Potential Impact on Welfare, Under Increased Capital Requirements
Mixed
Migration of financial intermediation to
1
non-banks
Non-bank lending share increases, enhancing competition, but increasing risk in stress
Mixed
Bank trading books and market liquidity is
not considered
Without considering non-bank financing and trading book and market liquidity, the BCBS study is not comprehensive in its
consideration of the potential impacts of Basel III reforms. As such, this paper is unable to make a conclusive statement
regarding the net benefits (or net costs) of increased capital requirements.
Additionally, another limitation to note is one associated with the model structure and use of fixed-effects panel regression
models. With regards to estimating the impact of reforms on outcome variables, it is difficult to control for all relevant
factors in the fixed effects model. The paper attempts to control for all relevant variables by controlling for time effects,
bank-specific effects, and the macroeconomy. However, there may be other factors left unconsidered, resulting in spurious
relationships in the regression models. Consequently, the results and conclusions drawn from the model may not be
reliable.
Moreover, the report relies heavily on comparing results before and after national announcement dates. The dates are not
randomly assigned. For example, regulators may delay announcements when their banking systems are stressed or the
economy as a whole is facing other macroeconomic concerns. Such choices might also explain why bank funding costs
fall after the announcement.
The report also appears to include data from many banks domiciled in Saudi Arabia, Mexico, Turkey, and Argentina.
These banks are much smaller than US G-SIBs and have different business models, typically focusing on domestic
markets. The markets for their debt and equity also likely differ greatly from that for US banks. It is unclear how these
substantive differences might affect results in the US.

2.4 Conclusion
This section analyzed a broad range of literature produced by leading academics, regulatory institutions and standard
setting bodies to determine an optimal capital ratio and assess the impact that increasing capital requirements may have
on financial stability and economic output.
Despite variations in key papers' estimates, an average optimal tier 1 capital ratio of around 15.5% emerges. This
figure aligns closely with the actual average tier 1 bank capital ratios of 15.5% and 15.2%, as of the fourth quarter
of 2021 and 2022, respectively, for bank holding companies that are expected to be subject to Basel III Endgame capital
requirements.271, 272
Although optimal bank capital ratios and actual recent ratios are both above current regulatory capital requirements,
banks tend to maintain capital buffers above regulatory mandated minimum levels to prevent breaches of regulatory
requirements and to accommodate their risk profile and capital strategy, which are determined through internal analysis.273
While many papers account for post-GFC regulatory reforms reducing risk in the financial system, none assess the
combined effect of all reforms. These include increased financial resources at large banks, stress testing implementation,
counterparty and trading risk reduction, supervisory programs, and supplemental enhancements to risk management. The
net effect of these reforms is complex and difficult to model. Existing models may overstate marginal benefits and optimal
capital level estimates might be lower than those published across the key papers.
In addition, few papers address the impact of the non-bank financial sector's growth on the probability and cost of a
financial crisis. Higher bank capital requirements could lead to reduced lending activity, with non-bank lenders filling the
gap. These entities have a fiduciary responsibility to maximize returns for their clients and, as such, some act as
opportunistic buyers of financial assets in stress, but research suggests that a subset of non-bank financial intermediaries
reduce syndicated lending more than commercial banks during crises.274 This could partially offset higher capital
requirements' benefits, implying an overstated marginal benefit in the literature.
On the other hand, while the predominant view is that increasing capital requirements results in increased cost of funds,
impacting lending rates and reducing loan volumes, some of the literature considers offsetting effects that may limit the
impact of increasing capital requirements on funding costs. For instance, the FRB (2019) paper notes that current models
do not consider the reduction in risk premia on bank equity and debt that may result from a safer banking system brought
about by higher capital requirements. In addition, the same paper notes that increased competition from non-bank lenders
may limit the extent to which an increase in cost of funds can be passed on to borrowers. However, not all papers
consider these factors, and as such, the outcomes across some papers may be derived assuming an overstated increase
in lending rate stemming from higher capital requirements.
In conclusion, the existing body of literature on optimal capital levels is vast, and conclusions regarding what is optimal
vary due to differences in approach and assumptions. Therefore, when policymakers consider increases in capital levels
271
Estimates for 4Q2021 actual tier 1 and CET1 capital ratios cover the 33 banks participating in the 2022 CCAR
submission, which aligns with Category I - IV banks, and represent simple averages across all firms. The estimates were
sourced from 2022 CCAR submission data: “Stress Test Results, 2013-2021 (CSV)”,
https://www.federalreserve.gov/supervisionreg/dfa-stress-tests.htm. Estimates for 4Q2022 actual tier 1 and CET1 capital
ratios were sourced using the FR Y-9C reported figures for the same 33 firms and represent simple averages across all
firms.
272
The papers tend to take a global view regarding applicability of capital rules, whereas in the U.S., Basel III Endgame is
only expected to be applicable to large banks. Whether the NPR or final rule will include all Category I - IV banks is
uncertain at this time. This comparison to average actual tier 1 capital ratios at large banks assumes that all Category I -
IV banks would be subject to the final rule. The average tier 1 ratio is computed as a simple average across the banks.
273
The minimum regulatory capital requirements for CET1 and tier 1 Capital, range from 7% to 13.3% and 8.5% to 14.8%,
respectively, for large banks. Data Source:
https://www.federalreserve.gov/publications/files/large-bank-capital-requirements-20220804.pdf. Ranges for tier 1 are
derived using the official Minimum tier 1 capital ratio requirement of 6.0%.
274
that could stem from the implementation of Basel III Endgame, it is important to not only examine the optimal levels of
capital discussed in the literature but also to consider the limitations of the analysis presented, such as the partial
inclusion of post-crisis regulatory reforms and the complex interactions between bank capital requirements, the size of the
non-bank financing sector, the cost of credit and financial stability.
Section 3: Recent Turmoil in the Banking Sector

A few banks with assets over $100 billion, which are subject to some, but not all, of the post-GFC enhanced regulatory
requirements, have recently been taken into receivership by the FDIC. While the academic literature suggests that current
capital levels at the largest firms are near optimal levels, real-world events suggest that some capital adequacy
regulations will likely be evaluated, specifically whether weaknesses in capital requirements and capital management
played a significant role in the demise of these firms. The final assessment as to the causes of recent bank stress is still
being determined, but the proximate causes appear to be a failure to manage banks’ interest rate risk and a resulting
liquidity crisis in the form of a quintessential bank run. That being said, it is worth investigating the extent to which
adjustments to certain components of bank capital regulation could have contributed to preventing recent bank failures.
1. Financial resource definition: At the largest firms (i.e. Category I and II), gains and losses on available-for-sale
(AFS) securities are included in regulatory capital through accumulated other comprehensive income (AOCI). All other
banks are given the option to opt-out of including AOCI when calculating their regulatory capital. The primary rationale
for the opt-out is to reduce volatility in banks’ capital levels as a result of changes in benchmark interest rates.
However, the opt-out also removes the immediate impact of interest rate risk in banks’ AFS securities portfolios from
capital.
2. Capital stress testing: Capital stress testing previously included multiple downside scenarios, often including
scenarios with rising interest rates coupled with an economic downturn. If a scenario with rising interest rates had
been included and the AOCI opt-out was removed for all banks included in the stress test, losses on the AFS
securities portfolio would have reflected the level of interest rate risk under the scenario rate paths. In addition, the
requirement to publicly share this information would have created another consideration for management when
evaluating the level of interest rate risk in the AFS securities portfolio.275
While capital was not the proximate cause of these firms’ failure, policymakers will likely consider the intersection of
capital and interest rate risk management when formulating their response. A host of options will be considered, including
modifications to the calculation of capital that may remove the AOCI opt-out for a greater number of banks, which is
reportedly already under consideration.276 Scenario analysis to better evaluate interest rate risk in securities portfolios is
also likely to be on the agenda, although it is still an open question as to whether this would be accomplished through
examinations specifically for interest rate risk in securities portfolios; or whether this would be rolled into the capital
stress-testing framework, which is substantially broader in scope than just interest rate risk.
275
Daniel K. Tarullo, “Stress Testing after Five Years.” Federal Reserve Third Annual Stress Test Modeling Symposium,
Boston, Massachusetts, June 25, 2014
276
Andrew Ackerman and Rachel Louise Ensign, “Fed Rethinks Loophole That Masked Losses on SVB’s Securities,” Wall
Street Journal (New York City), April 21, 2023
Contact our specialists
For additional information about this Our Take Special Edition, and how we can help you, please contact:
Adam Gilbert Vikas Agarwal

Principal, Global and US Senior Regulatory Leader Financial Services Risk & Regulatory Leader
914 882 2851 216 789 0314
adam.gilbert@pwc.com vikas.a.agarwal@pwc.com
Charles von Althann Alejandro Johnston

Principal Principal
202 674 8548 917 715 6594
charles.vonalthann@pwc.com alejandro.johnston@pwc.com
Contributing authors: Matthew Jacobson, Lindsay Steedman, Joe Ferguson, Brad Kelly, Evan Sklansky

Basel III Endgame 1682938205

Uploaded by

Copyright:

Available Formats

You might also like

Basel III Endgame 1682938205

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Basel III Endgame 1682938205

Uploaded by

Copyright:

Available Formats

1

2 Basel III Endgame | The next generation of capital requirements

3 Basel III Endgame | The next generation of capital requirements

The remainder of the paper is organized as follows:

5 Basel III Endgame | The next generation of capital requirements

A brief review of the effect of these five reforms is provided below.

6 Basel III Endgame | The next generation of capital requirements

8 Basel III Endgame | The next generation of capital requirements

Figure 2: HQLA Amounts for US G-SIBs12

9 Basel III Endgame | The next generation of capital requirements

Figure 3: Increase in Total Usable TLAC13

10 Basel III Endgame | The next generation of capital requirements

International Standard Setting

11 Basel III Endgame | The next generation of capital requirements

• liquidity requirements for short-term and longer-term funding needs

• additional requirements for systemically important banks

• Capital requirements for central counterparties (CCPs)

• Margin requirements for non-centrally cleared derivatives

• A standardized approach for counterparty credit risk (SA-CCR)17

• A revised market risk framework (Basel 2.5)

• Enhanced disclosure requirements

Table 1: Basel Framework

Capital • Risk-based capital • Equity investments in funds

Leverage • Leverage exposure (2014 definition) • Leverage exposure (2017 definition)

Systemic Importance • Global Systemically Important Bank (G-SIB) Surcharge N/A

12 Basel III Endgame | The next generation of capital requirements

Large Exposure • Large Exposure Framework (Single Counterparty Credit N/A

Regulatory and Supervisory Tailoring

Table 2: Tailored Financial and Supervisory Requirements

Tailored Financial and Supervisory Requirements

Category IV Category III Category II Category I

Capital No AOCI Opt-out ✓ ✓

13 Basel III Endgame | The next generation of capital requirements

1.3 Financial Resources

• Common equity tier 1

• Additional tier 123

14 Basel III Endgame | The next generation of capital requirements

15 Basel III Endgame | The next generation of capital requirements

• increase the level of capital requirements to absorb losses in stress;

Table 3: Going concern financial resources

Category Requirement Regulation Description33 Ratio

16 Basel III Endgame | The next generation of capital requirements

Supplementary Leverage Regulation Q (Subpart B) Non-risk-based "backstop" measure designed Tier 1

17 Basel III Endgame | The next generation of capital requirements

18 Basel III Endgame | The next generation of capital requirements

19 Basel III Endgame | The next generation of capital requirements

1.3.1.1 Minimum capital requirements

20 Basel III Endgame | The next generation of capital requirements

Minimum Regulatory Capital Requirements

Common Equity Tier 1 (CET1) 4.5%

Supplementary Leverage Ratio 3%

4. Investments in own shares, including treasury stock, must be deducted.

21 Basel III Endgame | The next generation of capital requirements

Figure 7: Average Leverage Ratio of US G-SIBs48

Supplementary Leverage Ratio

22 Basel III Endgame | The next generation of capital requirements

Figure 8: Average Supplementary Leverage Ratio of US G-SIBs54

23 Basel III Endgame | The next generation of capital requirements