Washington, D.C. – Bank Policy Institute CEO Greg Baer issued the following statement on the Federal Reserve Board’s vote today to advance a proposal on the supplementary leverage ratio:
“Today’s proposal marks a first step toward a more rational capital framework that enables banks to perform their core purpose of intermediating markets and supporting economic growth. We are hopeful that this proposal begins the process of returning the SLR to its intended purpose: a backstop, not a binding constraint. A sensible recalibration of the requirement, as proposed today, will promote the banking system’s ability to provide critical liquidity to the U.S. Treasury market, a vital function under market stress. However, while this recalibration is a positive step, maximizing banks’ financing capacity requires comprehensive reform, and comprehensive reform needs further action.
Adjusting the eSLR would have a de minimis effect on large banks’ capital—just a 0.74% reduction based on the latest available data. Postulations that it materially lowers capital are misleading, as the proposal restores risk-based capital as the primary constraint. We look forward to commenting in detail on this measure.”
Background: The banking agencies are proposing changes to the enhanced supplementary leverage ratio, which applies to the U.S. GSIBs.
- Unlike risk-based capital requirements, which assign capital charges based on the relative risk level of each bank asset, the SLR and other leverage capital requirements treat all assets as having equal risk. Thus, a safe asset like a U.S. Treasury bond incurs the same capital charge as a higher-risk loan.
- The SLR was designed to be a backstop to risk-based capital requirements, not a binding constraint. For some banks it has become the latter. Binding leverage ratios incentivize banks to decrease low-risk activities like intermediating in the U.S. Treasury market.
What’s at stake: U.S. Treasury market intermediation faces mounting challenges that could exacerbate instability under stress.
- The U.S. Treasury market has been growing, but the capacity of banks’ balance sheets has not kept pace, partly because of leverage ratio constraints. Since 2007, outstanding Treasuries have grown nearly 4x relative to primary dealer balance sheets.
- Large banks have significantly increased their Treasury holdings to comply with liquidity regulations, yet their market-making capacity has decreased. This can be attributed to the dual impact of regulations on bank balance sheets – liquidity regulations requiring banks to hold a large stock of very low-risk tradable assets and leverage capital requirements constraining the ability to intermediate.
- Banks usually experience a major influx of deposits during market stress, which expands their balance sheets and can lead to leverage ratio constraints. This, in turn, may result in less lending activity. This dynamic could exacerbate a future economic downturn.
Bigger picture: A key question contemplated in the proposal is whether to deduct certain assets, such as central bank reserves or U.S. Treasury securities, from the denominator of the SLR (either narrowly — by excluding U.S. Treasuries held by broker-dealer subsidiaries from the denominator for their consolidated holding companies, or more broadly — by excluding reserves and U.S. Treasuries holdings from the denominator for all firms subject to the SLR). This is an important question that deserves thoughtful consideration. When the Fed temporarily removed reserves and Treasuries from the SLR calculation during the COVID pandemic, it provided space on bank balance sheets to support the Treasury market and the economy. Excluding reserves and Treasuries from the SLR denominator (composed not only of on-balance-sheet assets, but also of derivative and repo-style transaction exposures, and certain other off-balance-sheet exposures) would make the requirement less of an exacerbating factor during downturns as the Federal Reserve tends to increase reserve balances during times of stress.
- The eSLR is not the only leverage capital requirement warranting a second look. For example, the Tier 1 leverage ratio is also ripe for reform. When binding, a Tier 1 leverage requirement can inhibit banks from taking in new deposits.
- More broadly, the capital framework should be aligned with actual risk levels, and redundancies in capital requirements should be eliminated.
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About Bank Policy Institute.
The Bank Policy Institute is a nonpartisan public policy, research and advocacy group that represents universal banks, regional banks and the major foreign banks doing business in the United States. The Institute produces academic research and analysis on regulatory and monetary policy topics, analyzes and comments on proposed regulations, and represents the financial services industry with respect to cybersecurity, fraud, and other information security issues.
Media Contacts
- Tara Payne, Bank Policy Institute, tara.payne@bpi.com
