Bank Regulation Rollbacks in the U.S. and UK Could Increase Financial Risks, Study Warns

Efforts to simplify bank regulation in the United States and the United Kingdom could unintentionally weaken the financial system by making it easier for banks to bypass key safeguards, according to new research. The study challenges the growing push to reduce regulatory burdens, arguing that complex financial rules often provide stronger protection against excessive risk-taking.

The research, which will be presented to leading central bankers at the European Central Bank’s Sintra conference, suggests that regulatory complexity serves an important purpose. While simpler rules may appear just as strict on paper, they are often easier for financial institutions to exploit by shifting risks to less regulated parts of the financial system.

The paper, co-authored by Mariassunta Giannetti, a professor at the Stockholm School of Economics, warns that recent moves by U.S. regulators to relax oversight and capital requirements could go too far. The authors also noted that Britain is gradually adopting a similar approach as policymakers seek to encourage lending, investment, and financial innovation.

According to the researchers, reducing regulatory complexity may have unintended consequences because straightforward rules are generally easier for lenders to circumvent. This could increase vulnerabilities within the banking sector and create risks that may not become apparent until periods of financial stress.

In contrast, the European Union is attempting to simplify its banking rulebook without lowering overall capital standards. Researchers believe this strategy aligns with their findings, provided that policymakers preserve the critical components of regulation they describe as "load-bearing" elements. These provisions help prevent loopholes and maintain the effectiveness of financial oversight.

The study also points to Switzerland’s tougher banking regulations following the 2023 collapse of Credit Suisse as an example of balancing strict capital requirements with detailed rules that limit opportunities for regulatory arbitrage.

However, the authors acknowledged that their analysis focuses primarily on listed financial institutions. As a result, the findings may not fully capture risks developing in less-regulated sectors, including private credit, private equity-backed lending, and other alternative finance markets.

The researchers conclude that while simplifying financial regulations may improve efficiency, policymakers should ensure that essential safeguards remain in place to preserve financial stability, prevent regulatory loopholes, and reduce the likelihood of future banking crises.