What’s New with the Enhanced Supplementary Leverage Ratio
The Federal Reserve, FDIC and OCC this week proposed changes to the enhanced supplementary leverage ratio, a capital requirement that has constrained banks’ capacity to intermediate in the U.S. Treasury market. The proposal would recalibrate the ratio for both the bank parent company and the bank subsidiary.
Context: The composition and interaction of different types of capital requirements matter more in this case than the raw numbers. The proposed changes aim to make the eSLR less of a binding constraint and more of a backstop to risk-based capital, as it was intended to be. This shift would encourage banks to engage in more low-risk activities like intermediating in the U.S. Treasury market. The Treasury market faces mounting intermediation challenges that could exacerbate instability under stress.
- The proposal contemplates 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.
BPI’s view: “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,” BPI’s Greg Baer said in a statement on the day of the Fed’s vote. “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.”
Get the facts on how the proposal would affect bank capital.
Five Key Things
1. What’s New and What’s Ahead for Stress Tests
The Federal Reserve on Friday released the results of this year’s bank stress tests. In response to the release of the results, BPI President and CEO Greg Baer issued the following statement. BPI will publish a detailed analysis next week.
“Today’s stress test results reaffirm the strength of the nation’s largest banks, but they also serve as an annual reminder of persistent flaws in the framework. Banks continue to hold excess capital not because of risk, but to hedge against uncertainty and year-to-year volatility in the Fed’s modeled results, now openly acknowledged by the Fed.
Much of the public focus remains on whether a bank ‘passed’ or ‘failed,’ but that misses the point. The stress test produces a binding, additive charge unique to the United States. The Fed still has not confirmed whether the averaging proposal, when finalized, would apply only prospectively; it is thus not clear whether final SCBs for 2025 will be determined under new or existing rules.
By this time next year, we are optimistic the Federal Reserve will have instituted a stress testing framework that is transparent, subject to public comment, consistent with the law and, therefore, a more accurate and less volatile assessment of banks’ capital needs under stress.”
Reducing uncertainty: Also in stress testing, BPI and the U.S. Chamber of Commerce filed a letter on Monday urging the Federal Reserve to resolve uncertainty and prevent volatility from certain calculation and timing issues in the stress tests and the resulting capital buffers. Read more here.
2. The 3 Letters at the Heart of Bank Supervision Dysfunction
A crucial issue in bank regulators’ efforts to reform the bank examination process is the role of bank examiners’ most important tool to control banks’ practices – a tool that has escalated to become a weapon: the MRA. This cornerstone of the bank examination process has little to no grounding in law and warrants a thorough rethink.
What is an MRA? MRAs, or Matters Requiring Attention, are written communications from bank examiners to a bank’s management or board requiring a change in practice. They’re typically conveyed in a formal exam report or supervisory letter.
Why do they matter? MRAs can lead to ratings downgrades, or impose significant penalties on banks’ expansion, such as bans on mergers and acquisitions.
What’s the legal foundation justifying MRAs? Because MRAs are not optional suggestions but rather mandatory commands, the legal basis of agencies’ issuance of MRAs is a crucial question.
- While MRAs are a product of the examination process, the examination power granted to the agencies by Congress does not authorize them to mandate changes in bank practices.
- The only such power is the agencies’ enforcement authority, but that authority is limited to unsafe or unsound practices or violations of law, and is subject to mandatory procedural safeguards, including notice and a hearing.
- Thus, and in stark contrast to current agency practice, the only basis for an MRA would appear to be as a non-binding request that the bank address a specific violation of law or unsafe or unsound practice that the agency can otherwise bring an enforcement action to correct, if left unaddressed.
What should be done? The agencies should conform the use of MRAs to their statutory authorization and purpose, tying them to a specific material violation or unsafe or unsound banking practice.
- The banking agencies should clarify that an MRA is not a binding order but a warning of potential enforcement action if the practice or violation is not corrected within a specified time.
- They should also make clear that MRAs should not be used as a means to communicate (and demand conformance with) supervisory recommendations, preferences or best practices, or to enforce non-binding guidance or “supervisory expectations,” as has become increasingly common.
3. Capital, FedNow and More: Highlights from Powell’s Hill Testimony
Federal Reserve Chair Jerome Powell testified on Capitol Hill this week at regular semiannual hearings. Here are some key highlights. For further takeaways, click here and here.
- Capital: Several lawmakers asked questions about the supplementary leverage ratio proposal. Powell noted the constraining effects of a binding leverage ratio on bank intermediation in low-risk assets. “We always thought that it would be better if we had a leverage ratio that was a backstop rather than the binding thing, and that’s what this proposal is going to do,” he said at the House hearing. At the Senate hearing, Powell said the proposal “will not in any way diminish the safety and soundness of the financial system and it will allow for banks to undertake lower risk.” Leverage ratio reform and Basel III Endgame are two significant elements of the capital framework that “fit together” on the Fed’s near-term agenda, Powell said. “[T]he leverage ratio was always supposed to be a backstop. We want risk-based capital to be the binding capital requirement. So that’s how those two pieces work together.”
- Stress tests: Powell previewed steps the Fed is taking to increase transparency in stress testing. “Later this year, we’ve said that we’re going to fully disclose the models,” he said. “If you’re going to set it like it’s the IRS, you know, if you’re going to charge people taxes, you have to have the transparency about what that is. It’s going to be the same as that. We’re going to show how the calculations are made, and we’re working on all that right now.” He also said: “We have a proposal out to sort of smooth the results of the tests from year to year.”
- FedNow: Sen. Thom Tillis (R-NC) questioned Powell about the costs and profitability of its FedNow instant payments program. The law “requires the Fed to cover all the direct and indirect costs actually incurred,” Tillis said. “So can you give me an idea of what we’re going to see a fee structure that’s going to generate, and actually pay for this implementation, including the expected ongoing operational costs?” Powell agreed about the Fed’s legal obligation for the program to fund itself. “And we have a period during which that’s supposed to happen. Uptake has been steady, but not rapid,” he said. Tillis asked whether cost recovery “is going to be achievable?” Powell responded: “I think it’s probably still achievable. I’m not 100% clear that we’re going to achieve it very soon.”
- Supervision: Powell acknowledged the Fed’s departure from the use of reputational risk in supervision and said banks should be making their own lending decisions. “We’re very conscious of the fact that we shouldn’t be telling banks who they can lend to. That’s a decision for them,” he said. That applies to legal crypto activities as well, he said: “Our view is that banks get to decide who their customers are. That’s not our decision. And so banks are free to provide banking services to the crypto industry, to crypto companies, and banks are also free to conduct crypto activities as long as they do so in a way that is protective of safety and soundness.”
4. Fed Ends Use of Reputational Risk in Supervision
The Federal Reserve this week announced that it will remove reputational risk as a component of its examination programs in bank supervision. “The Board has started the process of reviewing and removing references to reputation and reputational risk from its supervisory materials, including examination manuals, and, where appropriate, replacing those references with more specific discussions of financial risk,” the Fed said in a statement. “The Board will train examiners to help ensure this change is implemented consistently across Board-supervised banks and will work with the other federal bank regulatory agencies to promote consistent practices, as necessary.” BPI has criticized the nebulous nature of “reputational risk” in supervision, which can ultimately lead to customer account closures.
5. Bowman: Regulators Should Take Stock of Evolving Shifts, Unintended Consequences
Federal Reserve Vice Chair for Supervision Michelle Bowman called in a speech Monday for policymakers to reevaluate unintended consequences in regulations based on shifts in the environment over time. She gave the example of the supplementary leverage ratio, which has increasingly become a binding constraint rather than a backstop, and the effects of this dynamic on Treasury market intermediation. Bowman described the shifting backdrop that has developed over time and led to unintended consequences of this rule – for example, expanding bank balance sheets amid deposit inflows. Shifts that made the SLR more binding offer a lesson for other regulatory considerations, she said. “The unintended shift over time in the eSLR increasingly becoming a binding capital constraint demonstrates that we need to think about regulatory policies in a dynamic way based on the evolution in the banking and financial systems, and the broader economy.”
- Digging into the data: Throughout the remarks, Bowman emphasized the need to look closely at what the data indicates about regulatory trends. “The fact of leverage ratios becoming increasingly binding is evident in simple metrics like the ratio of risk-weighted assets to total leverage exposure,” she said. “Shortly after the SLR was adopted … this ratio stood at 48 percent in the aggregate for the eight largest U.S. banks, the global systemically important banks (G-SIBs). Since then, the ratio of risk-weighted assets to total leverage exposure has declined and currently stands at 40 percent, primarily due to higher reserves and other types of high-quality liquid assets on bank balance sheets. This downward trend results in the SLR increasingly becoming the binding constraint and reflects banks’ growing holdings of high-quality liquid assets, most of which carry a risk weight of zero under risk-based capital ratios but have a 100 percent weighting under leverage capital ratios.”
- Other potential changes: Other reforms could include reconsideration of the GSIB surcharge. Indexing the GSIB surcharge coefficients and the regulatory thresholds that define the broader categories of banks to nominal GDP could prevent “the original calibration from becoming divorced from the foundational policy decisions over time,” she suggested.
- Bottom line: “Regulations should not be created in a static world of ‘set it and forget it,’” Bowman said. “The economy evolves over time, as do the banking and financial systems and the needs of businesses and consumers.” She concluded: “Maintenance of the regulatory system should include reviewing the basis for earlier policy decisions, considering whether the policies embedded in regulations have been distorted over time through market developments, and examining whether emerging issues in the market should lead to further review and revision.”
In Case You Missed It
Faulkender Calls to ‘Americanize’ Basel Proposal
U.S. Deputy Treasury Secretary Michael Faulkender called for ensuring capital requirements do not stifle financing for American businesses. “Capital is the ultimate kind of shock absorber when it comes to the financial system,” Faulkender said in a Q&A with the Council on Foreign Relations. “On the other hand, to the extent that the capital requirements are excessive, that is capital that is off the table and not being used to facilitate Main Street activity.” He noted that the banking agencies are working with Treasury to revisit the Basel capital proposal, emphasizing the need to harmonize and “Americanize” the standards. “If we lose one of the important strengths of our economic system by moving more toward financing government and inadvertently decrease the funding availability to individuals and businesses, that would be detrimental … so there are important strides that Basel made, but there are other areas where we just don’t think that it’s going to be appropriate,” he said. He noted the prospect of financial intermediation migrating outside of the regulated space, suggesting that the optimal solution would be to “make the regulated space work better, such that the capital doesn’t flee in the first place,” rather than expanding the regulatory dragnet.
- AML: Faulkender also touched on the U.S. anti-money laundering framework, saying the $10,000 currency transaction report threshold is out of date and calling for a risk-based approach to compliance. He also indicated that effective AML reform would address the underlying rules as well as the examination process.
The Crypto Ledger
Here’s the latest in crypto.
- Market structure hearing: The Senate Banking Committee’s Digital Assets Subcommittee held a hearing this week to examine potential market structure legislation for digital assets. The committee released a set of principles for market structure legislation for the hearing. Both chambers of Congress are considering bills that would establish a division of responsibility between the SEC and CFTC over crypto in an effort to provide regulatory clarity. The hearing featured witnesses from academia and the crypto industry as well as former CFTC Chair Rostin Behnam. Sen. Cynthia Lummis (R-WY) emphasized the need for clear lines between securities and commodities and between regulatory oversight. Other topics of discussion at the hearing included the need for anti-money laundering and security safeguards for digital assets.
- Stablecoin bill vote timing: House Republicans are considering a floor vote on stablecoin legislation as soon as the week of July 7, according to POLITICO this week. Several factors are in flux, however – negotiations on the budget reconciliation bill; whether crypto market structure legislation is combined with a stablecoin regulation bill; and if the House passes the Senate’s GENIUS Act stablecoin bill without changes or advances its own version. The President has advocated for the House to pass the GENIUS Act as soon as possible without changes, adding to the dynamic of how the House proceeds.
Traversing the Pond
Here’s the latest in international banking policy.
- BIS on tokenization: The Bank for International Settlements published a “special chapter” of its Annual Economic Report entitled “The next-generation monetary and financial system,” focusing on tokenization and innovation. The chapter, written by BIS Head of Research Hyun Shin, offers insights on how tokenized platforms can pave the way for future efficiency in the monetary and financial system. It cautions that stablecoins offer some promise, but fall short of requirements to be the mainstay of the monetary system when evaluated on singleness, integrity and elasticity. While stablecoins’ future role remains uncertain, their poor performance on these three tests suggests they may at best serve a subsidiary role, the report says.
- EC stablecoin guidance: The European Commission plans to issue formal guidance indicating that stablecoins issued outside the EU are treated as interchangeable with same-branded versions on EU markets, according to the Financial Times. The development follows a warning from ECB President Christine Lagarde that “stablecoins … pose risks for monetary policy and financial stability [and] must therefore be governed by sound rules, especially when they operate across international borders.”
Vince Elected Chairman of BNY Board of Directors
Bank of New York Mellon announced recently that CEO Robin Vince has been unanimously elected by the Board of Directors to Chairman of the Board. Joe Echevarria, the current chairman, was elected lead independent director, effective Sept. 1, 2025.
