For more than a decade after the 2008 financial crisis, bank regulators pursued a noteworthy objective: make America’s banks safer by requiring them to allocate more capital to sustain unexpected losses. Those efforts transformed America’s banking industry, strengthening balance sheets, reducing leverage, and creating larger buffers against bank failures that could threaten depositors and taxpayers.
Unfortunately, that framework is beginning to change.
In March, federal banking regulators unveiled proposals that would reduce regulatory capital requirements for many U.S. banks by revising how risk-weighted assets are calculated and by modifying capital surcharge requirements for the nation’s largest banks. The proposals’ supporters argue the changes would eliminate unnecessary complexity, improve competitiveness, and free up capital for lending, especially for mortgages.
Yet, according to a recent report from Moody’s, the implications are far from straightforward. The rating agency’s message is clear: lower capital requirements are not necessarily a problem. The concern arises when banks use the resulting capital relief to increase shareholder payouts, expand risk-taking, or operate with thinner capital cushions. In that scenario, what appears to be regulatory efficiency could become a source of future financial vulnerability.
As I wrote in early May ‘Deregulate Banks Now, Downgrade Later,’ Moody’s has been the most explicit of the major rating agencies in characterizing the current deregulatory direction as a credit negative.
The Difference Between Capital Ratios and Capital Strength
At the center of Moody’s analysis is an important distinction that is often overlooked in discussions about bank regulation.
The proposed rules primarily reduce the denominator in regulatory capital ratios by lowering risk-weighted assets (RWAs). As a result, many banks would report higher Common Equity Tier 1 (CET1) capital ratios even if the actual amount of capital on their balance sheets remains unchanged.
In other words, the numbers may look stronger without banks becoming meaningfully safer.
Moody’s argues that creditor protection depends less on reported ratios than on a bank’s actual loss-absorbing capacity, earnings power, governance, and risk management practices. A higher ratio generated solely through revised calculations does not necessarily improve a bank’s ability to withstand a recession, credit losses, or market shocks.
This distinction matters because bank regulators, investors, and bank executives often focus on capital ratios as shorthand measures of financial strength. Moody’s is effectively warning that a change in measurement should not be mistaken for a change in substance.
Billions in Potential Capital Relief
The proposed changes, if implemented in their current state, could be significant.
For the largest banks, regulators have proposed replacing portions of the existing Basel III framework with an Expanded Risk-Based Approach that generally uses less conservative calibrations than previous proposals. At the same time, changes to the methodology used to calculate Global Systemically Important Bank (G-SIB) surcharges could reduce required capital buffers for many of the country’s largest banks.
For regional and super-regional institutions, revisions to the standardized approach would lower risk weights for many common asset categories.
Early disclosures from banks suggest that many institutions expect meaningful reductions in minimum capital requirements. According to Moody’s, some banks estimate that risk-weighted assets could decline by approximately 6% to 8%, translating into increases of roughly 70 to 100 basis points in reported CET1 ratios.
Those are material changes in a business where capital levels are measured in fractions of a percentage point.
The prospect of releasing billions of dollars in excess capital has already attracted significant attention from investors.
Governance Becomes More Important
Perhaps the most important insight in the report is not about capital ratios at all. It is about governance, and I certainly agree.
Under a more prescriptive regulatory framework, supervisors effectively limit how much risk banks can take by imposing higher capital requirements. If those requirements are relaxed, management teams gain greater discretion over capital allocation decisions.
As a result, differences in leadership quality, board oversight, risk culture, and strategic discipline become more important.
Some banks may choose to maintain substantial capital buffers and conservative risk profiles. Others may seek to maximize shareholder returns by operating closer to regulatory minimums.
Over time, Moody’s expects these decisions to create greater divergence across the banking sector.
Institutions with strong governance and disciplined capital management may preserve or even strengthen their credit profiles. Those that pursue aggressive capital distribution strategies or heightened risk-taking could face increased credit pressure. The implication is that investors may need to pay closer attention to management behavior rather than relying solely on regulatory metrics.
A Test for the Post-Crisis Regulatory Framework
The debate over bank capital ultimately reflects a broader question about the future of financial regulation. Since 2008, policymakers have generally favored a model built on higher capital requirements, enhanced supervision, and reduced tolerance for risk. Advocates argue that these reforms helped create a more resilient banking system capable of withstanding severe economic shocks.
Supporters of the new proposals contend that some post-crisis rules have become unnecessarily burdensome and may constrain economic growth. They argue that well-capitalized banks should have greater flexibility to deploy resources efficiently.
Moody’s does not take a position on whether regulatory requirements should be higher or lower. Instead, the agency focuses on the consequences of how banks respond.
If capital relief simply changes the way capital is measured while institutions continue to maintain prudent buffers, the impact may be limited. If it encourages larger payouts, thinner cushions, or more aggressive risk-taking, the long-term effects could be far more significant.
Concluding Thoughts
The proposed regulatory changes may boost reported capital ratios and unlock billions of dollars in flexibility across the banking industry. Investors are understandably enthusiastic about the possibility of higher dividends, larger share repurchases, and improved returns on equity.
But Moody’s is urging caution. The rating agency’s warning serves as a reminder that stronger-looking capital ratios do not automatically translate into stronger banks. What matters is how institutions use the freedom that lower requirements create. The next chapter of U.S. bank regulation may ultimately be determined not by the rules themselves, but by the choices bank executives make once those rules are relaxed.
Forbes Articles By Mayra Rodríguez Valladares
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Deregulate Banks Now, Downgrade Later
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Beyond Bank Runs: The OCC Warns Of A More Complex Financial Threat
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Weakening Bank Regulations Is A Risk Americans Can’t Afford
Well-Capitalized Banks, Stronger Ratings, Lower Borrowing Costs
Are Bank Regulations Being Weakened At The Worst Possible Moment?
America’s 8 Biggest Banks Are Returning Record Capital To Shareholders
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Congressional Testimonies By This Author
Prioritizing Main Street: Evaluating the Impact of Capital Proposals on Economic Growth and American Communities
Strengthening Accountability at the Federal Reserve: Lessons and Opportunities for Reform
A Holistic Review of Regulators: Regulatory Overreach and Economic Consequences
Addressing Climate as a Systemic Risk: The Need to Build Resilience within Our Banking and Financial System
