Regulation U
What Is Regulation U?
Regulation U is a Federal Reserve Board regulation that governs loans by elements including 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 to purchase more securities. Securities included commonly incorporate stocks, mutual funds, and other market-exchanged securities.
Grasping Regulation U
Regulation U is intended to relieve the disciple risks that exist while utilizing margin leverage in securities trading, particularly when too much leverage is conceded to an individual or business. By limiting the margin amount, Regulation U plans to limit the potential losses that the two borrowers and banks or lenders can support in occurrences where leverage can lead to exceptionally large losses relative to the physical capital extended.
Regulation U explicitly centers around leverage extended with securities as collateral, for the purchase of extra securities. It applies to elements other than specialist dealers, for example, commercial banks, savings and loan associations, federal savings banks, credit unions, production credit associations, insurance endlessly companies that have employee stock option plans.
Regulation U puts down a boundary on the maximum loan amount an entity can issue to a borrower getting the loan against stock or other securities to purchase more securities. The maximum loan value that can be offered is half of the collateral securities' market value.
Regulation U is intended to put a floor on potential losses that borrowers and banks or lenders can experience in occasions where leverage can lead to big losses relative to the capital that was made accessible.
Bank Lender Requirements
Regulation U has two important requirements that bank lenders must conform to. Initial, a bank lender must get a purpose statement (Form U-1) for loans secured by collateral that surpass $100,000. Second, a bank lender can broaden credit for half of the value of the securities utilized as collateral on the loan on the off chance that the loan is to be utilized for securities purchases.
Regulation U explicitly applies to secured loans extended to purchase securities. For this reason purpose statements are important for following Regulation U. Purpose statements are all the more stringently upheld for loans surpassing $100,000. A bank lender doesn't have Federal Reserve Board limitations while giving a loan secured with securities that are not planned for the utilization of buying more securities.
1936
The year Regulation U initially started covering securities credit extended explicitly by commercial banks.
Illustration of Regulation U Limits
For instance, expect a borrower might want to borrow money from a bank to purchase securities and the borrower plans to utilize $400,000 in securities as collateral. The loan would require a Form U-1 revealing the purpose of the loan. Since the loan is to purchase more securities, the maximum amount of credit the bank can stretch out to the borrower is $200,000. On the off chance that the borrower increased the amount of collateral he was able to use to secure the loan to $500,000 then the bank could offer him a loan for $250,000.
Regulation U Exemptions
A few special cases for Regulation U might apply. Nonbank lenders are subject to marginally unique oversight while lending with securities as collateral. Moreover, loans offered against employee stock option plans might be exempt from Regulation U requirements.
Features
- The regulation applies to commercial banks, savings and loan associations, federal savings banks, credit unions, production credit associations, insurance endlessly companies with employee stock option plans.
- Margin stock incorporates equity security registered on a national exchange, like the NYSE, over-the-counter (OTC) security trading on the Nasdaq, debt security that can be changed over into a margin stock, and most mutual funds.
- Regulation U puts limits on elements that provide out credit for the motivation of buying or carrying margin stock, involving securities as collateral for the loans.
- Regulation U is a Federal Reserve requirement for lenders who broaden credit secured by margin stock — barring securities brokers and dealers.
