GFC 2.0? Trump is taking a big risk with America’s banks

The US appears to be close to finalising a new set of prudential rules for its banks that could trigger a global reappraisal of the tough rules for capital and adequacy imposed after the global banking system’s near-death experience during the global financial crisis.

The US may have been the epicentre of that crisis – when the meltdown in the US subprime mortgage market triggered a global wave of banking stress – but the Trump administration has committed to rolling back, or at least lightening, some of the key regulations developed by the global standards-setter, the Basel Committee on Banking Supervision.

Late last week, the Federal Deposit Insurance Corporation and the Comptroller of the Currency submitted proposals to the US Office of Management and Budget for new rules for “Regulatory Capital and Standardised Approach for Risk-weighted Assets”.

While the agencies didn’t provide any details of their proposals, the Trump administration has made it clear it wants to lower capital and liquidity requirements and move away from the standard approach to risk-weighting bank assets that has progressively been adopted in the US since the crisis.

On Monday, Michelle Bowman, the vice chair of the US Federal Reserve Board and the Fed official who oversees banks and their regulation, unveiled a new approach to the regulatory capital requirements for mortgages, moving away from a standardised approach to one that takes the “risk sensitivity” of mortgage loans into account.

Late last year, US regulators lowered leverage requirements for the major US banks, reducing the amount of capital they were required to hold by about $US213 billion ($301 billion).

The “supplementary leverage ratio” required the biggest banks – those considered of global systemic importance – to hold capital equivalent to five per cent of their total assets, regardless of the riskiness of those assets. The ratio was reduced to a range of 3.5 per cent to 4.5 per cent.

Along with a recommendation that the banks should be allowed to reduce the amount of subordinated debt they need to absorb losses in a crisis, the new rules were designed to give banks more flexibility, lower their funding costs, hold more US Treasury securities and lend more.

So the thrust of the US approach to the prudential framework for its major banks is clear. It wants to reduce the amount of capital they are required to hold so that they can support the bond market, which has at times creaked under the strain of the deluge of government debt the administration is generating, and lend more to boost the economy.

After the 2023 regional banking crisis that saw several smaller banks fail, the Biden administration wanted to toughen prudential requirements, but didn’t act before Biden lost office. Now, the Trump administration wants to loosen them.

The new regulatory environment is expected to release trillions of dollars of big bank balance sheet capacity, whether for additional lending, capital markets activity or share buybacks and dividends.

With the interest rate cuts that Donald Trump wants from his nominee as the next Fed chair, Kevin Warsh, the big tax cuts in the One Big Beautiful Bill, the rollback of consumer finance and environmental protections, and continuing budget deficits that approach $US2 trillion a year, the administration is hoping to turbocharge US growth. Reduced bank capital requirements would add to growth.

US Treasury Secretary Scott Bessent has provided another strand to the explanation for the administration’s lightening of the regulation load on banks.

Apart from his insistence that it will cut tens of basis points from the $US1 trillion a year cost of government debt by increasing the banks’ capacity to buy treasuries, he believes that the Basel regime has prevented the banks from competing with non-banks.

A lot of bank activity before the 2008 crisis – whether supporting the Treasuries market or making leveraged loans – is now undertaken by less-regulated, or unregulated, non-bank institutions in what’s been broadly described as the “shadow banking” sector.

The US prudential framework, because of the severity of 2008 and the fact that it has more globally systemically important banks, is at the conservative end of the spectrum of global banking regulation. Its banks hold more capital, relative to their asset bases, than most of their international peers.

There is, therefore, an argument in favour of some reduction in requirements that restrict their ability to lend and compete.

The flip side of the argument, however, is that any reduction in the levels of capital they hold, or in how the risks within their asset bases are calculated, increases the risk levels within the US banking system.

The 2008 crisis is now a distant memory for politicians and bank regulators and there has been significant questioning of rules that do restrict the ability of banks to lend or to support capital market activity.

Perhaps that is at the margin, but the increasing (albeit still peripheral) exposures to the boom in data centres and artificial intelligence more broadly, the growing links between the banks and the private credit sector (where problems continue to surface) and the impact of Trump’s tariffs on smaller US businesses mean that there are latent risks within the US system.

Even the changes to mortgage risk-weightings could, given that low and middle-income households in the US are struggling, lead to a deterioration in credit quality.

There’s also the demonstration provided by the collapse of Silicon Valley Bank in March 2023 that showed that holding more supposedly risk-free US Treasury bonds isn’t actually free of risk.

That bank and others collapsed because, in responding to a run, it was forced to sell its government bonds rather than hold them to maturity. It crystallised substantial losses in the process.

In financial systems, any deregulation creates some level of increased risk. The magnitude of that increase is usually only known with hindsight.

The US changes to its banks’ regulations are being watched closely by other banking regulators, concerned that their banks will lose competitiveness if the previous broad consensus on the prudential approach is fragmented.

The European Commission last month started a review of the competitiveness of its banks relative to their international rivals, which could lead to some simplification of the complex rules and, perhaps, some weakening of the capital requirements if the Europeans want their banks to remain competitive with their US peers.

The 2008 crisis is now a distant memory for politicians and bank regulators, and there has been significant questioning of rules that restrict banks’ ability to lend or support capital market activity.

It’s probably not a bad thing that regulators in the US and elsewhere are considering the trade-offs involved in ensuring their major banks are crisis-proof.

It would be an unwelcome and potentially risk-enhancing development, however, if the global prudential regulation of banks were to be weakened significantly and fragmented, and regulatory arbitrage and competition between domestic banking regulators emerged. No one wants another financial crisis.

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