Regulation U: Overview, definition, and example
What is Regulation U?
Regulation U is a rule issued by the Federal Reserve that limits how much credit banks and other lenders can extend for the purpose of buying or carrying margin stock (i.e., publicly traded stocks). It applies to non-broker lenders, such as commercial banks, that provide loans secured by margin stock. Regulation U sets margin requirements and reporting obligations to prevent excessive borrowing against stocks, helping to manage risk in the financial system.
Why is Regulation U important?
Regulation U is important because it keeps banks and other non-broker lenders from fueling too much leverage in the stock market. By capping the amount of credit that can be extended when margin stock is used as collateral, it protects lenders, investors, and the broader economy from the risks of market overexposure. It also ensures consistency with related regulations—like Regulation T (for broker-dealers) and Regulation X (for borrowers)—creating a comprehensive margin lending framework.
Understanding Regulation U through an example
If a bank lends $1 million to a borrower to finance the purchase of publicly traded stock, Regulation U may require that no more than 50% of the value of the margin stock be used as collateral. So if the borrower pledges $1 million in margin stock, the bank can only lend up to $500,000 under Regulation U. This limits how much the borrower can leverage stock holdings for credit.
Example of how Regulation U may be referenced in a loan agreement
Here’s how Regulation U may appear in a credit facility or lending document:
"The Lender and Borrower agree that any extension of credit secured by margin stock shall comply with the margin requirements set forth in Regulation U of the Board of Governors of the Federal Reserve System."
Conclusion
Regulation U controls how much credit banks can extend for stock-based transactions, helping to prevent excessive leverage backed by publicly traded securities. It plays a key role in maintaining financial stability and works alongside other Federal Reserve regulations to monitor and restrict margin lending. Lenders and borrowers must understand its requirements when structuring loans secured by margin stock.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.