By Hugh Carney
ABA Viewpoint
Much of the focus on the Basel III “endgame,” or B3E, has been on how the U.S. proposal would raise costs and limit credit availability for millions of Americans. Less attention has been given to the cumbersome and duplicative nature of a “dual stack” capital requirement, where larger banks must apply two different standardized approaches (that is, the regulator-approved methods for calculating minimum required capital, as opposed to calculations based on banks’ own models, used with supervisor approval).
In his dissenting vote on the 2023 Basel III proposal, FDIC Director Jonathan McKernan highlighted the inefficiencies of the current dual-stack capital requirement framework and proposed a compelling alternative: a streamlined, single-stack system. This approach not only addresses the duplicative nature of the existing regulations but also aligns with international standards, encouraging more risk sensitivity and efficiency. As it begins to outline new approaches to financial supervision, the incoming administration should give serious consideration to McKernan’s vision because it offers a pragmatic path toward simplicity, stability, and strengthened financial oversight. Embracing McKernan’s idea could modernize regulatory frameworks while maintaining a strong, resilient banking sector.
The origins of the endgame: From patchwork to overreach
The roots of B3E are difficult to trace, as it began as a patchwork of well-intended international proposals that were later merged into a single, ambitious framework. (At the time, some observers thought the changes were substantial enough to constitute “Basel IV.”) The term “endgame” was introduced to signal finality, inspired by the climactic allure of a popular Marvel franchise. Yet, much like the cinematic universe it sought to emulate, B3E has stretched credibility and purpose, continuing long past its natural conclusion. This effort has consumed the focus, time and resources of three consecutive U.S. administrations, with little to show for the effort.
The version of B3E proposed by U.S. regulators under the Biden administration layers punitive capital requirements in a way that undermines the original goals. The difficulty of U.S. adoption was driven by three competing priorities:
- Avoiding regulatory burdens for community banks.
- Preserving some semblance of Basel III compliance.
- Adhering to a misguided interpretation of the 2010 Collins Amendment.
These competing goals have produced a regulatory quagmire, satisfying no one. To reconcile them, regulators have proposed a “dual stack” capital regime. This system forces all banks to adhere to the U.S. standardized approach while requiring larger banks to calculate capital under a further revised international standardized approach. While this fulfills the stated priorities — shielding community banks, maintaining at least a semblance of Basel compliance, and establishing a risk-based capital “floor” under the Collins Amendment — it creates a cumbersome and redundant framework for large banks that doesn’t make sense.
The Collins Amendment: A shaky foundation for capital rules
At the heart of the dual stack problem lies misguided interpretation of the Collins Amendment, a provision of the 2010 Dodd-Frank Act. Under a rigid interpretation, the provision mandates two key constraints:
- A risk-based capital floor. All banks must calculate capital under “generally applicable” rules, and further requirements are “floored” by these generally applicable rules.
- A prohibition against quantitative reductions. Risk-based capital cannot be lower than what was required when Dodd-Frank was enacted.
Currently, and under the B3E proposal, all banks must calculate their capital requirements using “generally applicable” rules. For larger banks subject to more granular risk-sensitive calculations, these approaches are restricted by less nuanced standards. While intended as a safeguard, this rigidity creates perverse incentives by allowing risk sensitivity to increase capital requirements but never decrease them.
The case for optionality
The Collins Amendment should not constrain moving towards a simpler single stack approach. In his dissenting vote, McKernan proposed an alternative path to meeting these competing priorities. He suggested making the expanded risk-based approach of B3E the default system, while allowing smaller banks the option to retain the existing standardized rules. By redefining what the “generally applicable” rules are, the first constraint of the Collins Amendment is met. The second constraint is increasingly irrelevant. Over almost 15 years since Dodd-Frank’s passage, numerous rulemakings have already raised the capital bar, with higher minimums, higher risk weights, stricter definitions of Tier 1 capital, and increased regulatory deductions, to name a few changes. With this buffer, there is little risk that future capital requirements will drop below pre-Dodd-Frank levels.
A single stack offers several advantages:
- Efficiency. A single, streamlined framework would eliminate redundancies, reducing compliance costs and regulatory burdens.
- Optionality for smaller banks. While large banks would have to adhere to B3E, smaller banks could choose the approach that best suits their business model (for example, if they wanted to avail themselves of lower mortgage risk weights).
- Risk sensitivity. Larger banks could align capital requirements with their actual risk profiles, encouraging better risk management practices.
- Basel compliance. A simpler framework would align with international standards without imposing duplicative requirements.
A simpler, more balanced path forward
McKernan’s proposal for a more flexible system offers a pragmatic solution to these challenges. Allowing smaller banks to opt for the existing standardized rules while requiring larger banks to apply a single-stack framework under Basel III could harmonize competing priorities without sacrificing prudence or Basel compliance.
Repealing the Collins Amendment would be the most direct path to achieving a rational capital regime. But even without legislative change, regulators can act now to modernize the framework. By adopting a simpler, more balanced system, policymakers can strengthen the financial system, support economic growth, and align U.S. regulations with international best practices.
ABA Viewpoint is the source for analysis, commentary and perspective from the American Bankers Association on the policy issues shaping banking today and into the future. Click here to view all posts in this series.
