Correcting the Record: The Supplementary Leverage Ratio Is Not a ‘Central Pillar’ of Dodd-Frank

The NY Times yesterday reported that banks were pushing for changes to post-crisis regulation that “would undermine a central pillar of the Dodd-Frank law.”  Because the basic premise of the article is factually inaccurate, we correct the record here.

At issue is a provision of the bill (Section 402 of S. 2155) that would make changes to a leverage ratio adopted by the Federal banking agencies. This particular ratio, the Supplementary Leverage Ratio (SLR), is a regulatory standard that was initially developed by an international organization, the Basel Committee on Banking Supervision in 2011 and implemented in the U.S. by the banking agencies in 2014 at their own discretion. Nowhere in the Dodd-Frank Act’s more than 800 pages is any requirement that banks adhere to the SLR. Thus, it is incorrect to call it a part (let alone a key part) of the Dodd-Frank Act enacted by Congress.

Incidentally, there is a leverage ratio that was enshrined by the Dodd-Frank Act — specifically, the so-called “tier one leverage ratio.” Under section 171 of Dodd-Frank, that leverage ratio applies to all banks, whatever the size.  No aspect of the pending Senate reform bill would make any change to that part of Dodd-Frank.

A leverage ratio acts as a backstop to risk-based measurements and requires banks to hold a specified amount of capital against their total assets, regardless of the risk of those assets. Leverage ratios should only be used as a backstop, because they are a poor measure of risk, as we have noted here, here, and here.

The proposed revision to the agencies’ SLR (the leverage ratio not in Dodd-Frank, though asserted otherwise by the New York Times) would exclude from the denominator cash held on deposit with the Federal Reserve by three custody banks.  The rationale, of course, is that these are risk-free assets that do not require capital to insure against unexpected losses.

So, it is hard to see how treating cash as riskless in a backstop provision that did not originate in the Dodd-Frank Act could be portrayed as weakening a “crucial requirement” and “central” provision of that Act.