What is Regulation U?

Regulation U is a United States Federal Reserve Board regulation that pertains to loans made by banks for the purchase of margin stock. It applies to investments such as equity stocks, over-the-counter securities and most mutual funds. First adopted in 1936, this regulation specifies the maximum amount that a bank can lend for margin stock.

The amount that can be loaned according to Regulation U has changed numerous times since the policy was first adopted. As of 2010, the maximum value for a loan to purchase margin stock is set at 50 percent of a margin stock’s value at the time the loan is made. The maximum loan is not affected if the value of margin stock falls after the initial loan is issued. This regulation applies to banks and all other lenders that give credit secured by margin stock.

Regulation U also requires transaction participants to register and fill out documentation. When loans exceed $100,000 US Dollars (USD), banks are responsible for submitting U-1, a form issued by the Federal Reserve Board. This form contains a “purpose statement” that outlines the purpose for which the loan will be used. Non-bank lenders are always required to obtain purpose statements.

The regulation lists several exceptions to its maximum credit stipulation. For example, margin stock used exclusively for collateral isn’t covered by Regulation U. Banks aren’t required to conform when they issue loans to other banks, employee stock ownership plans, or plan-lenders. The regulation also allows banks to issue greater amounts of credit if loans are used only for the temporary purchase of securities or to allow customers to cover unforeseeable emergency expenses. Non-bank lenders are exempt if they issue less than $200,000 USD in loans secured by margin stock in a given quarter or have less than $500,000 USD worth of loans of this type outstanding in a given quarter.

Regulation U is designed to minimize the risk taken on by customers whose loans are secured in margin stock. In particular, the regulation aims to regulate use of a technique called “leverage,” in which borrowed capital is used to finance investments. This regulation emerged in the aftermath of the adoption of Regulation T, which governs credit issued by brokerage firms and dealers and was issued to secure loopholes left open by the prior regulation.