Regulation U: Bank Requirements and FAQs

By
James Chen
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James Chen, CMT is an expert trader, investment adviser, and global market strategist.

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Updated July 31, 2024
Reviewed by Eric Estevez
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Vikki Velasquez
Vikkie Velasquez
Fact checked by Vikki Velasquez
Full Bio
Vikki Velasquez is a researcher and writer who has managed, coordinated, and directed various community and nonprofit organizations. She has conducted in-depth research on social and economic issues and has also revised and edited educational materials for the Greater Richmond area.
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A photo of Federal Reserve headquarters in Washington.

 

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What Is Regulation U?

Regulation U is a Federal Reserve Board regulation that governs loans by entities involving securities as collateral and the purchase of securities on margin. Regulation U limits the amount of leverage that can be extended for loans secured by securities for the purpose of buying more securities. Securities involved typically include stocks, mutual funds, and other market-traded securities.

Key Takeaways

  • Regulation U is a Federal Reserve requirement for lenders who extend credit secured by margin stock—excluding securities brokers and dealers.
  • Margin stock includes equity security registered on a national exchange, such as the NYSE, over-the-counter (OTC) security trading on the Nasdaq, debt security that can be converted into a margin stock, and most mutual funds.
  • The regulation applies to commercial banks, savings and loan associations, federal savings banks, credit unions, production credit associations, insurance companies, and companies with employee stock option plans.
  • Regulation U puts limits on entities that give out credit for the purpose of buying or carrying margin stock, using securities as collateral for the loans.

Understanding Regulation U

Regulation U is designed to mitigate the adherent risks that exist when using margin leverage in securities trading, especially when too much leverage is granted to an individual or business. By limiting the margin amount, Regulation U aims to limit the potential losses that both borrowers and banks or lenders can sustain in instances where leverage can lead to very large losses relative to the physical capital extended.

Regulation U specifically focuses on leverage extended with securities as collateral, for the purchase of additional securities. It applies to entities other than broker-dealers such as commercial banks, savings and loan associations, federal savings banks, credit unions, production credit associations, insurance companies and companies that have employee stock option plans.

Regulation U sets a limit on the maximum loan amount an entity can issue to a borrower securing the loan against stock or other securities for the purpose of buying more securities. The maximum loan value that can be offered is 50% of the collateral securities’ market value.

Regulation U is designed to put a floor on potential losses that borrowers and banks or lenders can suffer in instances where leverage can lead to big losses relative to the capital that was made available.

Bank Lender Requirements

Regulation U has two important requirements that bank lenders must comply with. First, a bank lender must obtain a purpose statement (Form U-1) for loans secured by collateral that exceed $100,000. Second, a bank lender can only extend credit for 50% of the value of the securities used as collateral on the loan if the loan is to be used for securities purchases.

Regulation U specifically applies to secured loans extended for the purpose of buying securities. This is why purpose statements are important for complying with Regulation U. Purpose statements are more strictly enforced for loans exceeding $100,000. A bank lender does not have Federal Reserve Board restrictions when issuing a loan secured with securities that are not intended for the use of buying more securities.

1936

The year Regulation U first began covering securities credit extended specifically by commercial banks.

Example of Regulation U Limits

For example, assume a borrower would like to borrow money from a bank for the purpose of buying securities and the borrower plans to use $400,000 in securities as collateral. The loan would require a Form U-1 disclosing the purpose of the loan. Since the loan is for the purpose of buying more securities, the maximum amount of credit the bank can extend to the borrower is $200,000. If the borrower increased the amount of collateral he was willing to use to secure the loan to $500,000 then the bank could offer him a loan for $250,000.

Regulation U Exemptions

Some exceptions to Regulation U may apply. Nonbank lenders are subject to slightly different oversight when lending with securities as collateral. Additionally, loans offered against employee stock option plans may be exempt from Regulation U requirements.

Article Sources
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  1. Board of Governors of the Federal Reserve System. "Regulation U: Credit by Banks or Persons other than Brokers or Dealers for the Purpose of Purchasing or Carrying Margin Stocks."