120% Rule Drives Deposits Away, Banks Shield Risk

A regulatory requirement known as the 120% rule forced banks to hold collateral or capital equal to 120% of certain exposures. The requirement coincided with measurable withdrawals of retail and wholesale deposits at institutions subject to the rule and prompted lenders to reduce reliance on third parties for funding and risk protection.

Banks operating where the rule applies reported customers and counterparties adjusted to higher collateral demands, leading to deposit outflows and shifts in funding patterns. After the rule took effect, affected lenders rebalanced balance sheets, increased liquidity buffers and curtailed borrowing that had depended on shared or third-party protections.

Under the 120% rule, banks must secure specified exposures with posted assets or capital that exceed the face value of the exposure by 20 percentage points. The extra collateral raised the cost of trades and financing that previously relied on unsecured funding or risk transfers. Several counterparties scaled back credit lines and reduced unsecured funding, leaving banks to cover shortfalls internally and prompting depositors and short-term funders to move funds to firms with lighter collateral burdens.

Balance sheets shifted toward higher holdings of cash and government securities. Some banks narrowed their product and trading activity to lower collateral needs. Client-facing changes included tighter lending standards, more requests for upfront collateral and longer-term client commitments in transactions that now carry higher collateral costs.

Industry participants reported operational and pricing effects. Treasury and risk teams updated systems to track new collateral ratios, adjusted funding strategies, and in some cases raised prices on products with higher collateral costs. Several firms pulled back from business lines where added collateral requirements made returns unattractive.

Regulators designed the 120% requirement to reduce interconnectedness by ensuring potential shortfalls are covered without relying on unpredictable third-party support. Regulators expect the rule to lower systemic exposure over time. In the near term, banks subject to the rule experienced deposit declines and altered how they allocate credit and manage liquidity and capital.