How Quantitative Balancing Helps Banks Meet CET1 Requirements

Quantitative Balancing (QB) introduces a novel framework that can significantly impact banks' Common Equity Tier 1 (CET1) requirements, offering both direct and indirect benefits. CET1 is the highest-quality component of a bank’s capital structure, designed to absorb losses without external support. It serves as a buffer against risks and ensures financial stability. By redefining the treatment of deposits and seigniorage payments, QB aligns with the principles of robust regulatory frameworks like Basel III, potentially easing pressures on banks while maintaining or even enhancing systemic resilience.

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How Quantitative Balancing Helps Banks Meet CET1 Requirements

1. Segregation of Deposits Reduces Risk-Weighted Assets (RWA)

Under traditional accounting practices, deposits are treated as liabilities directly borne by banks. This increases their Risk-Weighted Assets (RWA) , which in turn raises the amount of CET1 capital required to maintain regulatory compliance. With QB, deposits are reclassified as liabilities to the State Treasury rather than direct liabilities of the bank. This shift effectively reduces the bank's RWA because it acknowledges that depositors retain ownership of their funds, thereby reducing the perceived risk associated with these liabilities.

For example, consider a scenario where a bank has €1 billion in deposits. Under current rules, this amount contributes to the bank's RWA, increasing its CET1 requirement. However, under QB, since deposits are segregated and recorded as liabilities to the Treasury, they no longer count toward RWAs. Consequently, the bank’s CET1 ratio improves automatically, as the denominator (RWA) shrinks without requiring additional capital infusion.

2. Enhanced Transparency Facilitates Regulatory Trust

One of the core principles of QB is enhanced transparency through explicit recognition of seigniorage payments and clear segregation of monetary policy effects from commercial banking activities. This increased clarity allows regulators to better assess a bank's true risk profile and operational health. When regulators have greater confidence in the accuracy of financial statements, they may be more willing to adopt flexible interpretations of CET1 requirements during periods of stress.

Moreover, by explicitly recording seigniorage payments as operating expenses, QB provides a more accurate reflection of a bank's profitability. This transparency could reduce the need for excessive capital buffers, enabling banks to operate closer to minimum requirements without compromising safety.

3. Reduction in Need for Excessive Capital Buffers

Banks often hold excess capital beyond the mandated 4.5% CET1 ratio to total risk-weighted assets (RWA), partly due to uncertainties in accounting practices and regulatory scrutiny. QB addresses this issue by standardizing the treatment of deposits and ensuring consistent reporting across jurisdictions. As a result, banks may feel less compelled to maintain oversized buffers, freeing up capital for lending and other productive uses.

Additionally, the explicit guarantee of depositor funds by the State Treasury under QB reduces the likelihood of panic-driven withdrawals, which are a major source of liquidity risk. With lower liquidity risk, banks may face reduced demands for additional capital buffers, further alleviating pressure on CET1 requirements .

4. Realignment of Incentives Promotes Responsible Lending

QB fosters a stable Nash Equilibrium among banks, the State, and depositors by aligning incentives for responsible behavior. Banks are incentivized to lend prudently, knowing that underreporting M2 liabilities or engaging in reckless practices could lead to penalties or reputational damage. At the same time, the State ensures regulatory oversight and uses seigniorage revenues for public welfare, indirectly benefiting depositors .

This alignment of incentives encourages banks to focus on sustainable lending practices rather than aggressive expansion driven by short-term profits. Such prudence naturally lowers risk exposure, allowing banks to maintain healthier CET1 ratios without needing to accumulate excessive capital reserves.

5. Potential Adjustment to Capital Adequacy Rules

To fully realize the benefits of QB, regulatory frameworks such as the Capital Requirements Regulation (CRR) could be adjusted to exclude deposits from CET1 calculations altogether. Currently, deposits are included in RWAs, even though they do not represent actual cash inflows but rather claims on the bank. By excluding deposits from RWAs, QB simplifies capital adequacy assessments and ensures that CET1 requirements reflect only genuine risks .

Furthermore, the introduction of "Credits from Bank Seigniorage" as an asset on the State’s balance sheet creates symmetry between private and public financial statements. This harmonization enhances fiscal transparency and accountability, reinforcing trust in the overall system and potentially relaxing stringent capital requirements for banks.

6. Long-Term Stability Reduces Recapitalization Needs

By addressing fundamental issues in the current banking model—such as ambiguous definitions of money and opaque accounting practices—QB promotes long-term stability. A more stable banking system reduces the frequency and severity of crises, minimizing the need for emergency recapitalizations. For instance, during the 2008 Financial Crisis, many banks were forced to raise capital urgently to meet heightened CET1 requirements. Under QB, such situations could be mitigated by clearer risk assessment and stronger depositor confidence, reducing the burden on banks to constantly bolster their capital positions.

Conclusion

Quantitative Balancing offers a transformative approach to managing CET1 requirements by fundamentally altering how deposits and seigniorage are treated in financial reporting. Through the segregation of deposits, enhanced transparency, realignment of incentives, and potential adjustments to regulatory frameworks, QB enables banks to achieve higher levels of efficiency and stability while meeting capital adequacy standards. Ultimately, this reform not only supports individual institutions but also strengthens the broader financial ecosystem, paving the way for a more resilient and equitable banking sector.

By embracing QB, policymakers and regulators can ensure that banks remain well-capitalized, transparent, and focused on sustainable growth—all while fostering trust among depositors and stakeholders alike. This holistic approach underscores the importance of innovation in financial regulation and highlights QB as a promising solution to longstanding challenges in the banking industry.