A Better Path Forward on Bank Capital: What the Federal Banking Agencies Should Do Next

This is the eighth and final post in our weekly series on the federal banking agencies’ March 2026 bank capital proposals. We conclude the series with Better Markets’ policy recommendations for what the agencies should do next.

Have questions about the proposals, our analysis, or our recommendations? Send them our way by commenting below or emailing us. Christopher Appel and Phillip Basil will host a Substack Live to answer readers’ questions and discuss where bank capital policy in the United States should go from here.

The Federal Reserve (Fed), Federal Deposit Insurance Corporation, and Office of the Comptroller of the Currency have proposed a sweeping set of changes to the nation’s bank capital rules. As Better Markets has detailed extensively, taken together, those proposals would substantially reduce capital requirements, with the largest reductions flowing to the eight biggest, riskiest U.S. globally systemically important banks (GSIBs).

The agencies should not finalize that package.

However, the agencies taking the prudent path to withdraw the current proposals does not mean abandoning capital reform going forward. There are important elements of the proposals that should move forward, and there are longstanding weaknesses in the capital framework that still need to be addressed. The agencies have an opportunity to replace the current reckless, deregulatory package with a more targeted, transparent, and evidence-based approach.

To that end, we outline below what they should do next.

1. Conduct a Real Impact Analysis Before Rewriting the Capital Rules

Before the agencies decide how much capital banks should be required to maintain, they need to understand what their proposed changes would actually do.

That sounds like common sense, but the agencies’ current estimates fail to adequately account for one of the most predictable consequences of changing capital requirements: banks will change their activities to both minimize their capital requirements and maximize their profitability.

That interaction effect matters enormously. The agencies estimated that their proposals would reduce capital requirements for the GSIBs by roughly 5 percent. Better Markets estimates a reduction closer to 15 percent—or approximately $130 billion—once foreseeable bank actions in response to the proposals are incorporated.

The agencies should therefore conduct and publicly release a comprehensive impact analysis that incorporates realistic behavioral responses by banks, as Better Markets did in our analysis (albeit at a high level). To credibly support policymaking, their analysis must show how each major component of the proposals would affect capital requirements, how banks can reasonably be expected to respond, how those bank actions flow through the capital framework, and the resulting capital levels at the largest banks.

The agencies should know the consequences of their rules before they finalize them—not discover them afterward. This issue is too important for a head-in-the-sand approach.

A thorough analysis must also consider the proposals’ impact on the broader economy. The agencies made unsupported claims in their proposals that lower capital requirements would result in greater lending activity by banks, but Better Markets has shown with robust academic research that, in fact, the agencies’ proposals would result in the Main Street economy being starved of critical financial resources.

2. Repropose a Framework Consistent with the International Minimum Basel Standards

The agencies should then repropose the capital framework using the internationally agreed Basel standards as the starting point.

The United States spent more than 15 years developing those standards with its international counterparts, a process that incorporated thorough analysis of bank operations and historical data as well as consultation with the largest banks from around the world. The standards were designed to establish credible minimum requirements across jurisdictions, strengthening the standards for risks that the pre-2008 financial crisis framework grossly underestimated, especially for financial markets activities. Strengthening the capital framework for those activities was the central purpose of the latest proposals.

Yet the current U.S. proposals deviate from the international standards in at least 20 areas, and those deviations overwhelmingly reduce capital requirements for the largest banks. Particularly consequential deviations affect market risk and operational risk—areas where the international standards were specifically intended to strengthen capital requirements.

The decision to deviate materially from international standards also has consequences beyond the United States. Even before the U.S. rules have been finalized, other jurisdictions have signaled that they plan to weaken their own requirements out of concern about the competitiveness of their banks relative to U.S. banks operating under weaker requirements. The agencies’ actions therefore risk fueling an international race to the bottom.

There may be limited circumstances in which a U.S. deviation from a Basel minimum is appropriate. But downward deviations should be based on evidence, not assumptions or guesses about how U.S. banks operate or how particular requirements might affect their businesses. Where the agencies believe the Basel framework produces an inappropriate result, they should first collect the data necessary to demonstrate it through targeted quantitative impact studies or other data collections. They should make that information public, explain precisely why the Basel treatment produces an inappropriate result for the U.S. banking system or economy, and propose a calibrated alternative based on that evidence.

After the 2008 financial crisis, the U.S. agencies frequently adopted standards above the Basel minimum, including the U.S. GSIB surcharge. Higher standards remain entirely appropriate where warranted by the risks of the U.S. financial system.

That is how evidence-based rulemaking should work: collect the data, analyze the impact, and then propose the rule. The agencies should repropose a framework consistent with the Basel standards and require compelling, evidence-based reasons for any material downward U.S. deviation.

3. Focus the Reproposal on the Biggest and Riskiest Banks

The agencies should also narrow the scope and focus of the proposals. The central unresolved problem in the U.S. capital framework is that the capital requirements applicable to large banks (particularly the largest, most complex, and most systemically important banks) simply do not adequately reflect the risks those institutions pose.

The agencies are changing the capital requirements for community banks and other smaller banks for no compelling reason. Community banks did not ask for sweeping changes to their capital requirements, nor have the agencies demonstrated a compelling need for such changes.

Community banks provide much more support to the Main Street economy than bigger banks. For example, community banks account for approximately 40 percent of bank lending to small businesses, despite holding only 15 percent of total banking assets. They also pose virtually no systemic risk. Yet the current and proposed capital framework can leave community banks facing capital requirements comparable to—or even higher than—those imposed on the country’s largest banks.

Better Markets has identified additional reforms in its comment letters that we recommend the Fed and the other agencies consider.

4. Redo the GSIB Surcharge Reference Bank Analysis to Account for the 2023 Banking Crisis

The GSIB surcharge capital requirement exists for a straightforward reason: the failure of a GSIB would impose costs on the financial system, economy, and Americans far beyond those caused by the failure of an ordinary bank. It is an extra capital requirement for GSIBs that is supposed to be strong enough to reflect those systemic consequences above and beyond the requirements that apply to other, less systemic banks.

However, instead of calibrating the GSIB surcharge so that those systemic consequences are captured by the requirement, the Fed entirely missed the mark. That is because it relied on an irrelevant hypothetical bank as a reference to anchor the calibration rather than grounding its analysis in an actual historical episode of systemic banking stress: the 2023 bank failures that required the U.S. government to use the “systemic risk exception” for Silicon Valley Bank and Signature Bank. Better Markets’ analysis has demonstrated that applying the Fed’s own framework to the experience of 2023 would result in significantly higher GSIB capital requirements, not lower requirements as proposed. A GSIB surcharge calibrated to actual historical experience would better align capital requirements with the relative systemic risks posed by large and small banks.

The Fed should redo its reference-bank analysis based on the 2023 bank failures to bring credibility to the GSIB surcharge and have it reflect actual systemic risk instead of working back from a desired outcome.

5. Finalize Targeted Reforms That Would Strengthen the Capital Framework

Our recommendation to withdraw and repropose the broader package does not prevent the agencies from immediately finalizing targeted changes that address known weaknesses in the existing capital framework. We outline the major changes the agencies should finalize below:

Accumulated Other Comprehensive Income (AOCI). AOCI reflects certain unrealized gains and losses that are recorded on a bank’s balance sheet but generally excluded from its earnings, including changes in the value of certain securities caused by movements in interest rates. The agencies should finalize reforms requiring appropriate recognition of AOCI (especially for large banks). Currently, most banks are not required to recognize these unrealized gains and losses in their regulatory capital, which can artificially make banks appear better capitalized in a higher interest rate environment.

The 2023 bank failures (particularly Silicon Valley Bank) demonstrated the dangers created when large, unrealized securities losses are excluded from regulatory capital measures. We recommend applying this change to all banks with more than $10 billion in total assets.

Improvements to the Credit Risk Framework. The agencies should also move forward with targeted changes that improve the accuracy and risk sensitivity of the credit risk capital framework. We support updating the definition of a “commitment” to provide greater clarity and better reflect the risks associated with different types of lending arrangements. We also support certain elements of the proposed credit risk framework, particularly changes that improve the treatment of traditional lending activities and better align capital requirements with the actual risks of those exposures.

GSIB Surcharge “Window Dressing.” Capital and systemic-risk measures must reflect banks’ actual risks throughout the year, not merely their activities on a single date at year-end. Yet that is exactly how the GSIB surcharge works and, as a previous Substack described, banks are gaming the surcharge. The agencies should strengthen and finalize the proposed changes to prevent the GSIBs from being able to temporarily shrink or rearrange exposures to reduce their reported systemic importance and resulting capital requirements. They should also coordinate with the Basel Committee to ensure the same improved standards apply to foreign GSIBs.

GSIB Surcharge Short-term Wholesale Funding. As shown in both the 2008 and 2023 banking crises, excessive reliance on short-term wholesale funding can make large banks more vulnerable to failure during periods of stress and amplify risks to the broader financial system. As our previous Substack explains in detail, the Fed should finalize its proposed change that appropriately captures a bank’s total amount of short-term wholesale funding rather than the current “scaling” approach.

Other improvements to GSIB measurement. The Fed should also update the scope of exposures captured by the GSIB surcharge to better reflect the channels through which the largest banks can transmit risk throughout the financial system. In particular, the framework should more comprehensively capture exposures to other financial institutions, including private credit funds and other nonbank financial institutions, where significant exposures can create channels for stress to be transmitted between the banking system and financial markets. Updating these measures would help ensure that the GSIB surcharge keeps pace with changes in the financial system and more accurately reflects the systemic risks posed by the largest banks.

These are targeted improvements to longstanding and known weaknesses in the capital framework. They should be addressed immediately.

A Better Capital Framework Is Still Achievable

As this Substack outlines, there is a much better path forward to a stronger capital framework if the agencies jettison their current reckless approach.

The agencies should conduct a credible impact analysis and repropose a capital framework focused on the largest and riskiest banks and anchored in the Basel standards. Any downward departures from those minimum standards should be supported by actual data rather than assumptions or guesses. The Fed should redo its GSIB surcharge reference-bank analysis using a methodology grounded in real-world evidence. The agencies should move forward with targeted reforms—including AOCI, window dressing, short-term wholesale funding, and other improvements to the measurement of credit risk and systemic risk—that would genuinely strengthen—as opposed to weaken—the capital framework.

The lessons of the 2008 financial crisis and the 2023 bank failures are clear: strong bank capital is essential to preventing large bank failures, protecting financial stability, and ensuring that banks can continue lending through economic downturns. For the Fed, maintaining financial stability is critical to ensuring it can effectively pursue its monetary policy objectives.

The agencies’ leadership should correct course and produce a capital framework that reflects those lessons, appropriately accounts for the enormous risks posed by the largest banks, and strengthens rather than weakens the resilience of the U.S. financial system.