Regulation T: Overview, definition, and example
What is Regulation T?
Regulation T is a rule issued by the Federal Reserve that governs how much credit brokers and dealers can extend to customers for purchasing securities. It primarily sets the initial margin requirement, which is the percentage of a security’s purchase price that must be paid with cash or fully paid securities when buying on margin. The rest can be borrowed from the brokerage firm. Regulation T applies to transactions involving stocks, bonds, and other securities traded on U.S. exchanges.
Why is Regulation T important?
Regulation T is important because it helps limit excessive borrowing in the securities markets and reduces systemic financial risk. By requiring investors to provide a minimum amount of capital upfront, the rule prevents over-leveraging, which can lead to large losses and instability in financial markets. It also creates a consistent framework for how brokers handle margin accounts, protecting both investors and the financial system.
Understanding Regulation T through an example
If an investor wants to buy $10,000 worth of stock on margin, Regulation T requires them to deposit at least 50%—or $5,000—of the purchase price. The broker can loan the remaining $5,000. If the investor doesn't meet the margin requirement, the broker cannot complete the trade on credit. This rule keeps the investor from taking on more risk than allowed under federal law.
Example of how Regulation T may be referenced in a contract
Here’s how Regulation T may appear in a brokerage or margin agreement:
"All margin transactions executed under this Agreement shall be subject to Regulation T of the Board of Governors of the Federal Reserve System, and the Customer agrees to maintain margin levels in compliance with applicable requirements."
Conclusion
Regulation T plays a key role in keeping financial markets stable by controlling how much credit investors can use when trading on margin. It ensures brokers follow uniform standards and helps investors avoid excessive risk. Any party trading on margin should understand how Regulation T affects their buying power and account obligations.
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.