Regulation Q: Definition, Impact, and Recent Changes

Regulation q, a federal reserve board (FRB) rule, sets minimum capital requirements and standards for board-regulated institutions in the United States. Initially established in 1933 as part of the Glass-Steagall act, its primary objective was to restrict banks from paying interest on deposits in checking accounts. Additionally, it imposed limits on the interest rates payable on other account types to curb speculative behavior among banks.

The genesis of regulation q can be traced back to 1933, coinciding with the enactment of the Glass-Steagall act. The legislation aimed to address the instability in the banking sector during the great depression. One of its key provisions was the prohibition of interest payments on checking deposits. By imposing ceilings on interest rates for various accounts, regulation q sought to deter banks from engaging in risky practices to fund interest payments, a phenomenon commonly known as financial repression.

Regulation q’s prohibition on interest payments led to unintended consequences, notably the emergence of money market funds. These funds provided investors with alternatives to traditional bank deposits by offering higher yields, thereby circumventing regulation q’s restrictions. Over time, as financial markets evolved, regulation q underwent revisions to adapt to changing economic conditions and banking practices.

The repeal of regulation q came about with the passage of the Dodd-Frank wall street reform and consumer protection act in 2011. This legislative action aimed to enhance the resilience of the banking system in the aftermath of the 2007–2008 financial crisis. By allowing banks to pay interest on demand deposits, the repeal sought to bolster banks’ capital reserves and mitigate credit illiquidity, a contributing factor to the crisis.

In 2013, the federal reserve issued an updated version of regulation q to ensure banks maintain adequate capital reserves, irrespective of economic conditions. These requirements include a minimum ratio of common equity tier 1 capital to risk-weighted assets and a common equity tier 1 capital conservation buffer. Large banks that are internationally active must also adhere to a supplementary leverage ratio, accounting for off-balance sheet exposure.

In 2020, the federal reserve introduced a final rule to determine a company’s capital buffer requirement. This rule employs the results of supervisory stress tests to assess capital adequacy, replacing the static component based on risk-weighted assets.

Regulation q aimed to prohibit banks from paying interest on checking deposits and imposed limits on interest rates for other types of accounts to curb speculative behavior among banks.

The repeal of regulation q was enacted through the Dodd-Frank act in 2011 to allow banks to pay interest on demand deposits. This action was intended to bolster banks’ capital reserves and mitigate credit illiquidity following the 2007–2008 financial crisis.

Certain institutions, such as bank holding companies with less than $100 billion in total consolidated assets, are exempt from meeting regulation q’s capital requirements.

The repeal of regulation q led to increased competition among banks for customer deposits. Larger banks were better positioned to offer higher interest rates, potentially disadvantaging smaller community banks. However, it also fostered innovation and transparency in banking products and practices.