What is Regulation Q?
Regulation Q is a Federal Reserve Board rule that sets minimum capital requirements and capital adequacy standards for board regulated institutions in the United States. Regulation Q was most recently 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. The purpose of this was to limit speculative behavior by banks competing for customer deposits as it led to banks seeking risky means of income to be able to pay the interest. 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In 2011, Regulation Q was repealed by the Dodd-Frank Wall Street Reform and Consumer Protection Act, allowing banks that are members of the Federal Reserve System to pay interest on demand deposits. The reason to repeal was done to increase a bank's capital reserves, thereby mitigating any credit illiquidity, one of the causes of the 2007-2008 Credit Crisis.
The repeal was met by both supporters and detractors, with detractors primarily stating that the repeal would result in increased competition for customer deposits. 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 argued that this would result in more innovative products, greater transparency and a stable source of capital.
Understanding Regulation Q
In updating Regulation Q, the Federal Reserve implemented rules to ensure banks maintain sufficient capital that will allow them to continue lending despite losses or economic downturns.
These rules include 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%. It also includes a ratio of tier 1 capital to risk weighted assets of 6% and total capital to risk weighted assets of 8%. For large banks that are internationally active, there is a supplementary leverage ratio of 3%, which takes into consideration off-balance sheet exposure.
Certain institutions are exempt from having to meet the capital requirements. Bank holding companies with less than $500 million in total consolidated assets typically do not need to meet the stated requirements.