New regulation: A jogger in front of the Fed building in Washington. The central bank’s board has voted five-to-two to propose changes to the enhanced supplementary leverage ratio which applies to some of the largest US banks including Bank of America Corp. — AFP
WASHINGTON: The Federal Reserve (Fed) has unveiled plans to roll back an important capital rule that big banks say limits their ability to hold more Treasuries and act as intermediaries in the US$29 trillion market.
The Fed board voted five-to-two to propose changes to what’s known as the enhanced supplementary leverage ratio (eSLR), which applies to the largest US banks like Bank of America Corp, JPMorgan Chase & Co and Goldman Sachs Group Inc.
The revisions would reduce holding companies’ capital requirement under the ratio to a range of 3.5% to 4.5%, from the current 5%. Their banking subsidiaries would see that requirement lowered to the same range from 6%.
“The proposal will help to build resilience in US Treasury markets, reducing the likelihood of market dysfunction and the need for the Fed to intervene in a future stress event,” Michelle Bowman, the central bank’s new vice-chair for supervision, said in a statement accompanying the draft rule.
“We should be proactive in addressing the unintended consequences of bank regulation.”
The Fed’s announcement confirmed proposed changes to the rule first reported by Bloomberg News last week.
Bowman’s predecessor, governor Michael Barr, objected to the plan, which he said would weaken the eSLR and reduce bank-level capital by US$210bil for the US global systemically important banks.
“Taken together, these changes would significantly increase the risk that a G-SIB bank would fail, orderly resolution would not be possible, and the deposit insurance fund would incur higher losses,” Barr said.
Governor Adriana Kugler joined Barr in objecting to the draft rule.
Both said it’s unlikely to help the Treasury market, especially in times of stress.
Wednesday’s proposal is a partial win for the banks, which had called for the Fed to exclude certain assets like Treasuries from the ratio calculation. The industry, which has pushed for lighter regulation under the Trump administration, is likely to fight for the carve-out during the planned 60-day public comment period. The Fed is asking for weigh-in on the exclusion.
“This is an important question that deserves thoughtful conside0ration,” said Greg Baer, president of the Washington-based Bank Policy Institute, referring to the carve-out.
The leverage ratio, which went into effect in 2018 and treats all assets equally, was meant as a backstop to other capital rules that give different loans and bonds varied weightings based on their perceived risk.
Policymakers have said the eSLR has become stricter for some banks than those risk-weighted regulations, meaning it could constrain their ability to add to Treasury holdings in stressful times.
Critics of changing the eSLR rules question whether banks will actually use the increased flexibility to buy Treasuries.
“The challenge for regulators is how they can address the narrow issue of ensuring banks can support the Treasury market without jeopardising financial stability or allowing banks to distribute the excess capital to their shareholders,” said Graham Steele, a Fed alumnus who served as a Biden-era Treasury official.
He said regulators should consider more targeted solutions that could mitigate issues in the market.
The Federal Deposit Insurance Corp will follow the Fed with its own meeting.
Rodney Hood, acting head of the office of the comptroller of the currency, said in a statement Wednesday that he supported the planned revisions to the rule.
The Fed’s staff said the proposal would reduce the aggregate capital requirements for the eight big banks by US$13bil.
Although more than US$200bil of capital would be freed up for the firms’ banking subsidiaries, the restrictions at the holding company level would prevent that from being paid out to shareholders, agency said.
Under the Fed’s proposal, total loss absorbing capacity (TLAC) requirements for big banks would decline 5%.
TLAC forces lenders to hold a certain amount of debt – at the holding-company level – that can be converted to equity under stress. The plan would lower firms’ long-term debt requirements by 16%, the central bank said.
The Fed temporarily relaxed the leverage ratios in 2020 in response to the economic and financial turmoil triggered by the Covid-19 crisis, with the goal of freeing up lending to consumers and businesses.
The exemption, which expired in March 2021, allowed banks to hold more Treasuries without those assets affecting their leverage ratios.
In April, the Trump administration’s tariffs rattled the markets, increasing focus on the SLR standards.
“We do not know exactly what circumstances may lead to a future stress event or how it will manifest, and continuing to impose unwarranted limits on dealers’ intermediation capacity could exacerbate a future stress event in this critical market,” Bowman said in a speech earlier this week.
“But we do know that these events have raised concerns about the resilience of US Treasury markets.”
Fed chair Jerome Powell has supported revisions to SLR standards to help bolster banks’ roles as intermediaries in the Treasury market.
“When the leverage ratio is binding, it discourages banks from undertaking low-margin, fairly safe activities, such as mediation in Treasury markets,” he told members of the House Financial Services Committee on Tuesday.
Some of the sharpest criticism of the Fed’s proposal to reduce the enhanced version of the SLR has come from senator Elizabeth Warren, a Massachusetts Democrat who recently wrote a letter to bank regulators.
She called the leverage rule a “critical safeguard” that promotes financial stability and warned that the economy already faces risks from President Donald Trump’s tariff policies. — Bloomberg
