What Is Regulation Q?
Regulation Q is a Federal Reserve Board (FRB) rule that sets "minimum capital requirements and capital adequacy standards for board regulated institutions" in the United States. Regulation Q was updated in 2013 in the aftermath of the 2007–2008 financial crisis and continues to go through changes.
- The original rule was created in 1933, in accordance with the Glass-Steagall Act, with the goal of prohibiting banks from paying interest on deposits in checking accounts.
- Regulation Q eventually led to the emergence of money market funds as a workaround to the prohibition of paying interest.
- The Fed later updated Regulation Q, implementing rules to ensure banks maintain sufficient capital to continue lending, despite losses or any downturns in the economy.
Understanding Regulation Q
The original rule was created in 1933, in accordance with the Glass-Steagall Act, with the goal of prohibiting banks from paying interest on deposits in checking accounts. It also enacted ceilings on the interest rates that could be paid in other types of accounts.
The purpose of these measures was to limit speculative behavior by banks competing for customer deposits as it led to banks seeking risky means of profit to be able to pay the interest on these deposits. This was later commonly regarded as a means of financial repression.
Regulation Q eventually led to the emergence of money market funds as a workaround to the prohibition of paying interest.
Repealing Regulation Q
In 2011, Regulation Q was repealed by the Dodd-Frank Wall Street Reform and Consumer Protection Act, allowing banks that are members of the Federal Reserve System (FRS) to pay interest on demand deposits. This action was taken to increase a bank's capital reserves and, subsequently, mitigate any credit illiquidity—one of the causes of the 2007–2008 credit crisis.
Response to the repeal was mixed. Detractors claimed it would result in increased competition for customer deposits and that larger banks would be in a better position to offer higher interest rates, thereby hurting smaller community banks. They also cited increased costs of funding and higher expenses.
Supporters, on the other hand, argued that the repeal would result in more innovative products, greater transparency, and a stable source of capital.
Current Regulation Q Requirements
In 2013, the Federal Reserve (Fed) issued an updated Regulation Q, designed to ensure banks maintain sufficient capital to be able to continue lending, regardless of losses or any downturns in the economy.
Certain institutions are exempt from having to meet the capital requirements, including bank holding companies with less than $100 billion in total consolidated assets.
These rules included a minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5%, and a common equity Tier 1 capital conservation buffer to risk-weighted assets of 2.5%, as well as a supplementary leverage ratio of 3% for large banks that are internationally active, which takes into consideration off-balance sheet exposure.
In 2020, the Fed then adopted a final rule to determine a company's capital buffer requirement, opting to use the results of a supervisory stress test, rather than the static 2.5% of risk-weighted assets component.