Image: Bloomberg
SOMETHING HAS CHANGED on Wall Street. Bank bosses who spent the past decade grumbling about stress tests and capital buffers now sound… cheerful. Share prices agree and so do bonus pools. After years of treating regulation like gravity, annoying but unavoidable, America’s biggest banks sense the pull easing.
It is not because the rules failed. Quite the opposite: by every standard banks are strong. Capital ratios sit near record highs. Liquidity is abundant and profits are fat. Even the 2023 wobble, when three small- to mid-sized banks went under, stayed contained. The fortress is solid. And once walls feel sturdy, it is human nature to wonder whether the gates might be opened a little wider.
Leading the rethink is Michelle Bowman, recently installed as the Federal Reserve’s vice-chair for supervision. She argues that rules introduced after the 2008 financial crisis have become rigid, even counterproductive. And once complementing each other, they now overlap. Stress tests tend to bind banks that are otherwise healthy. Banks, she laments, spend too much time gaming the rulebook and too little thinking about shocks that actually matter. The ambition, as she puts it, is to make them useful. Wall Street hears “freedom to act”.
Take the leverage ratio, for example. It ignores risk and caps the size of a bank’s balance sheet relative to its equity. And the metric treats Treasuries and speculative loans alike. That discourages banks from being dealers of last resort in government bonds—a role that proved crucial during the pandemic’s dash for cash. Loosening it frees tens of billions of dollars. Officials hope it will fortify a key market without inviting catastrophe.
Then there are the stress tests. Once revolutionary, they are now frustrating. Their models are opaque and their scenarios sometimes look implausible. Since they dictate capital levels, small tweaks matter. The Fed plans to make the models more transparent and the results more predictable. For banks, that is capital being freed for use rather than sitting idle.
And finally, Basel III: a decade in the making but never fully implemented in the United States. Previous proposals would have yanked up capital well above international norms. Industry lobbying killed that. The replacement will largely maintain current levels rather than pushing them higher. Wall Street counts that as a win.
Supporters see it as realism. The riskiest lending has migrated to hedge funds and private credit. Constraining banks further does not make the system safer: it just pushes risk into less visible corners. Strong, nimble banks absorb shocks better than locked-down, overcapitalised ones.
Critics, naturally, hear an old tune. Regulation loosens slowly, then imperceptibly. Stability breeds complacency and memory fades. Carmen Reinhart once noted that appetite for preventive measures weakens just when they appear to have worked. The cycle repeats.
And there is a geopolitical angle. American banks already dominate global markets. Looser rules only help tip the balance. European and Asian competitors, still burdened with stricter requirements, risk losing market share. Pressure on foreign regulators to relax, or watch activity flee, will grow. Regulatory divergence is increasingly becoming a talking point in boardrooms and ministries.
The test, then, is not whether America’s banks can handle the easing—they can. The headache is whether the global financial system can do the same without tipping into instability.
For the moment, the mood in New York is triumphant. Capital is being freed, and the regulatory burden is lifting. But banking has never escaped its cycle: confidence swells, constraints loosen and risks migrate into the shadows. The bill for today’s leniency, when it comes, is never presented during the boom that made it possible. ■
