Bank Regulation: A New Season

Balancing Regulatory Relief with Financial Stability

The U.S. banking system is once again in a period of regulatory recalibration. After a long series of post-crisis reforms, policymakers and supervisors are signaling an intent to trim unnecessary burdens, simplify rules, and accelerate agency decision-making. But history counsels caution: Past efforts to ease bank regulation have often encouraged risk-taking and have sowed the seeds for future financial stress, crises, and costly bailouts.

By comparing recent proposals to ease capital requirements, improve the communication of examination findings, and clarify regulatory objectives with similar efforts from prior decades, we can better see both the potential gains and risks of deregulation, as well as the importance of proceeding at a deliberate pace.

Capital Requirements: The First Level of Regulatory Relief

Bank regulatory relief efforts nearly always begin with capital requirements. Banking is fundamentally a leveraged business: the greater the leverage, the more credit available to borrowers and the higher the potential returns to investors. It is therefore not surprising that current policy proposals aim to simplify the most intricate risk-weighted capital frameworks, reduce required bank capital levels, and allow capital to move more freely between insured banks and uninsured affiliate firms.

The goal is to accelerate and facilitate the deployment of capital to productive uses. Congress is also considering proposed legislation that would lower capital requirements for smaller banks in an effort to level the competitive playing field between small and large banks.

Rethinking the Bank Examination Process

Changes to the current bank examination regime are also underway. Regulators are more precisely defining “material findings” related to financial or operational weaknesses identified during on-site examinations, particularly in areas such as liquidity risk management, governance, and risk appetite frameworks. While material findings are meant to address matters of significant risk and consequence, some observers note that excessive procedural requirements have crowded out strategic risk management findings in favor of box-ticking compliance.

The goal is to preserve the discipline that prevents fragility while reducing processes and redundancies that inhibit performance and innovation.

Living Wills and the Limits of Procedural Resolvability

Living wills, or orderly wind-down plans, also feature prominently in the debate over regulatory burden reduction. The Dodd–Frank era vaulted these instruments into the regulatory toolkit as a cornerstone of bank and bank holding company “resolvability.” Yet critics—including academics, think tanks, and regulators themselves—argue that living wills have proven expensive to prepare and are rarely used in crises to execute orderly liquidations. In practice, crisis resolution still falls on government-backed remedies rather than market-driven wind-downs.

As a result, there is growing discussion about rethinking, or even trimming, living will requirements in favor of more credible bank resolution and bankruptcy processes, rather than procedural rituals that are never invoked.

What Past Banking Crises Continue to Teach

Against these reforms, however, it’s crucial to remember the structural lessons of past cycles. The literature on banking crises—bolstered by industry voices and policy analyses—emphasizes a persistent truth: Crises tend to expose policy missteps as much as bank misjudgments. The roots of instability are often macroeconomic and policy-driven and are shaped by inflationary dynamics, monetary policy stances, and fiscal impulses that distort risk perceptions and pricing.

When policy ignites asset price booms and is later followed by somber rate shocks, banks can accumulate portfolios that look resilient on paper, due to opaque asset valuation and related capital calculations, but are fragile in reality. No amount of deregulation can shield banks and the financial industry from these forces. It is the unexpected, no matter the source, that exposes bank weakness and triggers crises.

When Capital and Liquidity Fail Under Stress

From this history and research, a lesson too often ignored is that under sudden stress, institutions that appear to be on solid ground can suddenly fail. Capital foundations reveal themselves to be shallow. Liquidity that once seemed abundant becomes visceral. In crisis after crisis, heavy reliance on liquidity backstops—such as deposit guarantees and bailouts—undermined both market and policy discipline.

The most recent 2023 episode involving several mid-sized and large banks illustrated how a mismatch between perceived safety nets and actual capital and liquidity positions can trigger rapid runs by uninsured depositors when policy shifts abruptly and confidence in the market erodes. Subsequent government interventions, while stabilizing in the short term, underscored the unintended and unwanted socialization of losses and further blurred the line between private risk-taking, accountability, and public protection.

Too Big to Fail and Persistent Market Distortions

The case for simpler, more transparent safeguards is inseparable from concerns about Too Big to Fail. The TBTF dynamic remains a central policy concern: The implicit guarantee that the largest and most interconnected banks will be rescued in a crisis fosters moral hazard, distorts competition, and concentrates systemic risk. TBTF institutions have also been used to justify the extensive regulations imposed on the industry, as an off set to their exemption from the ultimate market test: failure.

Reducing regulatory distortions that shelter TBTF institutions, while preserving robust resolution mechanisms rather than paper exercises, would arguably strengthen market discipline and level the playing field for smaller banks that face disproportionate scrutiny despite posing less systemic risk.

A Prudent Path Forward for Regulatory Reform

So, what might a prudent path forward look like in practice? A balanced approach would pursue targeted regulatory relief while preserving core safety nets and strengthening capital in ways that are both transparent and testable under stress. That balance points to several practical steps:

• Simplify capital standards.

  Move away from overly complex risk-weighted assets toward a stronger, more straightforward leverage metric, supported by credible loss-absorbing buffers and well-calibrated stress-testing. Use targeted risk-based capital overlays only where they demonstrably improve resilience and transparency. The goal is to reduce complexity, improve comparability, and keep the focus on true loss-absorbing capacity. In short: simplify where possible, but do not weaken the spine of capital that underwrites resilience.

• Demand credible resolution capabilities.

  Rather than relying on living wills that have not once been used for crisis response, insist on transparent FDIC resolution procedures for all banks and bankruptcy procedures for bank holding companies. Any reduction in regulatory burden should not undermine the system’s ability to unwind failing firms in an orderly and predictable manner.

• Align liquidity with bank and industry solvency.

  Liquidity runs are driven by fears about solvency. Effective reform should combine meaningful liquidity measures—not brittle rules—with transparent and credible capital standards, ensuring that banks cannot merely rely on backstops to mask underlying liquidity and capital weakness.

• Reduce redundancy, not oversight.

  Streamline regulatory structures by consolidating data within a single agency while ensuring access by all agencies. Apply consistent, cross-cutting standards to bank risk management, governance, and accountability.

• Seek a more market driven and level playing field.

  Propose reforms that curb subsidies and implicit guarantees that distort competition. A more explicit, credible resolution framework, paired with some degree of loss-sharing for uninsured creditors, would help restore market discipline across the banking landscape.

• Ground reforms in economic fundamentals.

  Recognize that macroeconomic policy—fiscal trajectories, inflation, and monetary regimes—shapes risk-taking as much as micro-prudential rules do. The consumer and investor communities respond to policy signals, capital costs, and perceptions of the financial system’s safety, and, thus, the degree of regulatory reform must account for those realities.

Why Deregulation Alone Cannot Deliver Stability

A note of caution should accompany any effort to reduce regulatory burden. Deregulation, while often productive, does not eliminate risk or neutralize policy mistakes. History and academic literature tell us that if carried out carelessly, deregulation, however attractive for efficiency and growth, can lead to larger and more costly crises down the line.

Five decades of banking crises repeatedly show that systemic stability hinges not on predicting every shock but on understanding that market and policy failures create fragility, and stability rests on the industry’s ability to absorb the unexpected. The rolling recessions of the 1980s, the financial and economic crisis of 2008, and the banking panic of 2023 all illustrate the same pattern: Easing regulations and enabling greater risk-taking without reinforcing the industry’s underlying infrastructure—capital, credible resolution, and accountable risk-taking—creates fragility.

Policy accommodation without market and regulatory guardrails may invite a repeat of past cycles that deliver short-term gains often at the cost of higher medium-term losses.

Stability as the Foundation for Sustainable Growth

Finally, the current enthusiasm for regulatory relief presents an opportunity. Bank supervisors have signaled openness to modernizing and streamlining the regulatory framework. Yet the enduring lesson of decades of financial crises remains: The system’s durability rests on a disciplined alignment of capital, credible resolution, and transparent incentives.

Regulating for stability is not anti-growth; it is pro-growth, preserving confidence, channeling capital to productive uses, and avoiding or mitigating the boom-and-bust cycles that hollow out the real economy. As policymakers, practitioners, and observers move forward, their efforts should focus on how reforms will strengthen the market’s infrastructure—not simply repaint its façade.