Why Do the Differences Between U.S. Bank and Bank Holding Company Capital Requirements Drive the Issuance of Subordinated Debt?

All U.S. banking institutions are required to meet stringent capital and other requirements established by U.S. banking laws and regulations, and are regulated and supervised by the three primary federal banking agencies: the Federal Reserve Board (FRB), the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC). Compliance with bank and bank holding company (BHC) capital rules can impact the intensity of an agency’s supervision. Institutions that do not satisfy the regulatory capital requirements are subject to significant supervisory monitoring, including potential operating limitations on growth, dividends, mergers, and other activities of a bank, as well as capital restoration plans. Accordingly, banks are careful to stay in compliance.

For all but the largest banks, there are up to four distinct regulatory capital ratios, each composed of a measure of capital divided by a measure of adjusted assets. For regulatory purposes, capital components are categorized into tier 1 and tier 2 buckets, with components closer to true common equity in tier 1. Common equity tier 1 capital (CET1) is a subset of tier 1 capital that excludes components deemed to be somewhat less economically resilient. Tier 2 includes all capital that does not qualify as tier 1 capital. For instance, subordinated debt (sub debt) is a tier 2 instrument. 

Banks and BHCs must maintain capital levels in compliance with each requirement as outlined below.

BHC and Bank Capital Ratio Requirements

Sources: FDIC, FRB

The definitions of each ratio are the same for banks and BHCs, but the level of capital expected by the regulators does vary, with banks held to a higher standard than BHCs for certain of the ratios.

The same minimum capital standards apply to both banks and BHCs. For banks, the three federal banking regulators have adopted common definitions of “well capitalized,” which, in practice, operate as minimums at the bank level. However, the FRB, which supervises all BHCs, has taken a different approach, establishing a definition of well-capitalized for BHCs only with respect to two of the four regulatory ratios: total risk-based capital (RBC) and tier 1 RBC levels. The absence of “well-capitalized” expectations for two of the four regulatory ratios results in somewhat less onerous capital requirements for BHCs compared to banks. And the fact that the FRB has not set a “well capitalized” level for the leverage ratio means BHC capital requirements emphasize the risk-based ratios. 

As with any set of rules, the banking industry seeks to optimize what it takes to comply. In practice, the differences between the bank and BHC capital requirements provide BHCs greater flexibility to optimize their capital structure, including by taking advantage of the disparity between bank-level and BHC-level requirements. In particular, BHCs can utilize more sub debt (a tier 2 instrument) yet still satisfy the less stringent BHC-level requirements, given the lower thresholds for the leverage ratio (which excludes sub debt from capital). A BHC can take the proceeds from the sub debt and inject those funds into a subsidiary bank as common equity (CET1). The bank can use those funds as tier 1 capital to satisfy its higher capital requirements, namely the leverage ratio again. This is a common tactic known as “double leverage” used by over 500 BHCs.

Double leverage occurs when a BHC raises debt (including tier 2 sub debt capital) and downstreams the funds to a bank subsidiary as common equity (tier 1 capital). The double leverage ratio is calculated as follows:

Given their highly diversified business models, global systemically important banks (GSIBs) can justify double leverage ratios above 200% to regulators and investors.   In contrast, double leverage ratios above 130% for non-GSIBs may begin to raise additional supervisory scrutiny and investor concerns regarding debt service coverage. Additionally, BHCs with less than $3 billion in consolidated assets are generally exempt from certain requirements, including minimum capital levels. Bank subsidiaries of such smaller BHCs are not exempt from the capital ratios, creating even more incentive for the smaller institutions to issue sub debt at the BHC level.

From January 2010 to June 30, 2025, banks and BHCs issued over $200 billion of subordinated debt. A notable chunk of this—$45 billion—was concentrated in the short period from late 2020 through 2022 as these companies sought to take advantage of pandemic-era near-zero interest rates and a flood of investors seeking any meaningful yield. Is this a problem? Stay tuned for a deeper dive into bank sub debt.