Washington is in a lenient mood toward banks. In March, federal regulators announced a sweeping overhaul of capital requirements – the financial cushion banks must maintain to absorb losses during difficult times – and the headline read itself: billions of dollars freed up for deregulation, bailouts, loans and stock buybacks. The proposal would reduce capital requirements for Wall Street’s biggest companies by nearly 5%.
The Fed estimates that the eight largest banks alone could release about $20 billion in capital. Former Fed Vice Chairman Michael Barr pushed the number even higher, warning that the total could reach $60 billion when all related changes are factored in.
Why this is important: Bank stability depends more on the capital that the market believes actually exists than on its reported capital. If unrealized losses still remain on the balance sheet, confidence can erode faster than regulations can respond, turning a technical accounting problem into a liquidity crisis.
But when you read the fine print, something unexpected emerges. Regulators have made one specific exception. Some major regional banks will have to start recording unrealized losses on their books, a change that is directly related to the Silicon Valley bank failure in 2023. This provision has been largely overlooked in widespread rollback coverage, but it amounts to an admission by regulators.
To understand why, you need to understand what “unrealized losses” actually mean to banks. Imagine you buy a 10-year Treasury bond for $100. Then, if interest rates rise rapidly, the new bond becomes more expensive to pay, and the market value drops to, say, $80, your bond becomes less attractive.
Even if you didn’t sell anything and didn’t lose any cash, this means you now have a loss of $20, which is unrealized and doesn’t show up on most financial scorecards.
Mid-sized banks have long been allowed to exclude these losses from the capital figures they report to regulators, as if there were no gap between market value and book value.
How Silicon Valley Bank’s unrealized losses led to a bank run in 2023
The Silicon Valley bank’s failure was caused by something far more mundane than fraud or reckless lending: a portfolio of perfectly legal long-term bond investments that lost much of its value as interest rates rose.
The first signs of crisis began to appear in early March 2023. At that time, SVB announced a $1.8 billion loss on securities sales, a direct result of these unrealized losses, alongside plans to raise $2 billion in new capital.
The stock price fell 60% the next day as uninsured depositors began withdrawing their assets en masse. By that night, $42 billion had left the banks, and another $100 billion was scheduled to be withdrawn by the morning.
Almost 30% of the sediment evaporated within a few hours. SVB died from panic, but panic was caused by losses that had existed for quite some time suddenly becoming visible.
Given that most regulators, depositors, and investors were unable to measure the true magnitude of unrealized losses on securities, banks appeared to be much better capitalized than they actually were.
Under the rules in force at the time, SVB exercised a legal and widely available option and simply opted out of including these losses in its reported capital figures, but this decision proved fatal.
Meanwhile, banks, which were required to reflect unrealized losses in their regulatory capital, managed their interest rate risk quite carefully. The lesson for SVB is that if you hide losses of this magnitude, no one will take action until it’s too late.
Why new bank capital regulations will still require local banks to report unrealized losses
So back to the current proposal. The change, which will require large regional banks to record unrealized losses, will increase capital requirements for regional banks by 3.1%, but total capital is still expected to decline by 5.2% after all pending changes are taken into account.
Banks with less than $100 billion in assets have no such requirement, and their capitalization is expected to decline further. The message here is clear. The problem was real, and it was real on a certain scale. The carve-out was when Washington, in its characteristic bloody bureaucratic language, said that the collapse of the SVB was due to inadequate regulation.
Barr resigned as vice chairman earlier this year rather than being ostensibly fired by the Trump administration, but he remained on the Fed’s board, although he has been vocal about his concerns about it. In his formal dissent, he warned that capital requirements have been significantly lowered and liquidity requirements could also be lowered, that the Federal Reserve’s supervisory staff has been cut by more than 30%, and that banking is built on trust.
The last phrase is noteworthy. A bank can withstand accounting deterioration until the moment the people who entrust their money to it no longer believe in it.
Proponents of a broader rewrite have reasonable arguments. The original 2023 Basel proposals were widely seen as over-calibrated and a blunt instrument to push risks out of the regulatory system into the shadows, rather than actually mitigating them. Federal Reserve President Michelle Bowman said capital remains strong and the new framework better aligns with requirements and actual risks.
However, the unrealized loss carve-out will persist even in a relaxed framework. If the problem were indeed resolved, and duration risk and depositor confidence were no longer a market concern, there would be no reason to maintain this provision. Regulators don’t impose expensive requirements out of nostalgia.
It is tempting to view the new proposals as simple deregulation. But a more accurate interpretation is also more interesting. Even as the US government bails out banks, it is quietly heeding one hard lesson learned from SVB. That means when interest rates soar and losses pile up, what banks actually think still matters, whether the rules say so or not.
