The U.S. Treasury market faces increasing intermediation challenges that could threaten its stability and resilience. Since 2007, outstanding Treasury securities have grown nearly fourfold relative to primary dealer balance sheets, as post-crisis regulatory capital requirements have constrained dealers’ ability to make markets effectively and reduced market depth.
The decline in intermediation capacity is evident in some of the changes seen in the composition of bank balance sheets. Large banks, which usually include a primary dealer entity, have significantly increased their Treasury holdings. Data from regulatory reports shows that the share of U.S. Treasuries relative to total assets has expanded from 3 percent in 2013 to 11 percent in 2024. Other high-quality liquid assets such as deposits at Federal Reserve banks and agency mortgage-backed securities have also increased materially in recent years.
This seemingly contradictory situation—where dealers’ market-making capacity has decreased while banks’ Treasury holdings have increased—can be explained by the dual impact of post-crisis regulations on bank balance sheets. While capital requirements have constrained dealers’ ability to actively intermediate in the Treasury market, liquidity regulations have simultaneously incentivized banks to hold more high-quality liquid assets, including Treasuries. As a result, although large banks hold more Treasuries, their capacity to provide liquidity and depth to the market has not kept pace with the growth in outstanding Treasury securities.
The expansion in holdings of Treasuries and other low-risk assets has not affected risk-based capital ratios, but has driven down banks’ leverage ratios, particularly the enhanced supplementary leverage ratio (eSLR). Currently, three of the six largest bank holding companies are bound by the eSLR, preventing further Treasury purchases unless they reduce other assets or raise capital. When leverage ratios become binding, banks have the incentive to decrease low-risk activities, such as intermediating in Treasury and Treasury repo markets.
Furthermore, during periods of market stress, banks typically experience a significant influx of deposits, which can lead to capital constraints imposed by the SLR and the Tier 1 leverage ratio. If it is costly for banks to raise new external capital during these stress times, they will be further incentivized to reduce their lending activities and other financial intermediation services to economize capital. This contraction in banking activity would worsen the effect of the initial market stress, amplifying damage to the broader financial system.
The resulting decline in intermediation capacity of banks raises significant financial stability concerns, as evidenced by multiple market disruptions. As capital constraints limit traditional intermediaries, Treasury market intermediation increasingly relies on principal trading firms (PTFs).[1] However, PTFs operate with short-term strategies and, unlike primary dealers, are less willing to make markets during stress periods. Furthermore, PTFs principally provide liquidity for on-the-run Treasury issues and liquidity for off-the-run issues remains dependent on dealer intermediation.
Assuming Treasury issuance continues to expand due to fiscal deficits, banks will be disincentivized to support that market. To preserve market functioning, bank regulators could simply recalibrate the eSLR — something they proposed to do in 2018 but never did for political reasons — and modify the Tier 1 leverage ratio. These adjustments are critical for enabling banks to accommodate the growing supply of Treasuries.
The Role of Primary Dealers in the U.S. Treasury Market
The U.S. Treasury market, where $28 trillion of outstanding securities are currently bought and sold, is considered the world’s deepest and most liquid securities market. However, it has experienced periods of dysfunction, including notable disruptions in March 2020, September 2019 and October 2014.
In the Treasury market, dealers serve as important intermediaries, facilitating trades with a broad range of clients, including foreign central banks, asset managers, pension funds and hedge funds. These dealers maintain significant balance sheets to support longer-term positions and larger trades, often warehousing securities when there is no immediate offsetting interest. The role of dealers is especially important in the off-the-run securities market (any Treasury security that has been issued), where their ability to hold positions until matching buyers or sellers emerge is necessary for market functioning.
However, while dealers remain essential liquidity providers, their intermediation capacity has not kept pace with the growing Treasury market size. Since 2007, the total amount of Treasuries outstanding has grown nearly fourfold relative to primary dealer balance sheets. This trend continues due to large U.S. fiscal deficits and regulatory capital constraints. All of the largest dealers operate within bank holding company subsidiaries, making their balance sheets subject to both capital and liquidity regulations. More specifically, the eSLR introduced in 2014, along with other post-crisis capital requirements like global systemically important bank (GSIB) capital surcharge, have significantly constrained dealers’ willingness and ability to intermediate trades.
Figure 1 shows that the primary dealers’ share of longer-term Treasuries at auctions has been declining since the introduction of these banking regulations, a trend that appears to have intensified in the post-pandemic period.
Evolution of Large Banks’ Holdings of U.S. Treasury Securities
Analyzing the trends in large banks’ Treasury holdings provides insights into why their capacity to make markets efficiently has declined. The data show that post-crisis rules have materially changed the balance sheet composition of large banks. While the largest banks’ total assets grew modestly at 3.8 percent during the 2013-2014 period, holdings of U.S. Treasury securities surged at more than 16 percent annually, as shown in Figure 2. The sizable shift toward U.S. Treasury securities reflects a fundamental shift in the asset allocation strategies of the largest banks. In terms of balance sheet share, the share of USTs in total assets has gone from 3 percent of total assets in 2013 to 11 percent of total assets in the third quarter of 2024.
According to some recent academic papers, large banks have increased their holdings of Treasury securities post-Global Financial Crisis for several key reasons:[2]
- Increased capital requirements following the global financial crisis (namely Basel III, GSIB surcharge and stress testing), particularly for the largest banks, have reduced banks’ incentives to make loans. Since larger banks face higher capital requirements for loans than smaller banks, they have shifted their portfolio toward liquid assets such as Treasury securities and away from loans.
- The introduction of liquidity requirements has forced large banks to increase their holdings of high-quality liquid assets, which include Treasury securities, in place of loans.[3]
- Growing competition from nonbank lenders in traditional corporate lending markets has pushed banks to reallocate their assets toward securities.
An important consequence of the largest banks’ increased holdings of U.S. Treasury securities has been to make leverage ratios, particularly the supplementary leverage ratio, more binding on these institutions.
For this purpose, it is crucial to note that securities held by bank holding companies at the insured depository institution for compliance with liquidity regulation or as investment assets are not typically available for use in broker-dealer intermediation. Thus, it is possible for the holding company to be awash in Treasury securities while its broker-dealer subsidiary simultaneously experiences a shortage of them.
Banks’ Balance Sheet Capacity to Hold Low-Risk Assets Has Been Declining
The SLR is defined as the ratio of Tier 1 capital to total leverage exposure. Total leverage exposure includes on-balance-sheet assets and certain off-balance-sheet exposures, such as derivatives and securities financing transaction exposures, and credit-equivalent amounts of loan commitments. Under the eSLR framework, the largest banks must maintain a three percent minimum requirement plus an additional two percent eSLR buffer, while their insured depository institution subsidiaries must maintain a 6 percent eSLR to be considered “well capitalized.”
To determine what factors have made the eSLR increasingly binding over time, we examine banks’ capacity to absorb securities that have a zero risk weight under risk-based requirements, such as U.S. Treasuries, without triggering the eSLR as the binding requirement. Specifically, we calculate the additional amount of Treasury securities a bank could hold without increasing its overall Tier 1 capital requirements. For example, a bank holding company for which the eSLR currently generates the highest Tier 1 capital requirement has no remaining balance sheet capacity for additional Treasury securities.
To determine balance sheet capacity, we first calculate the Tier 1 capital banks must hold to meet risk-based requirements. These are determined by Basel III risk-weighted assets, the stress capital buffer and the GSIB surcharge.[4] We also assume that banks maintain buffers over these requirements of 50 basis points for their Tier 1 risk-based requirement and 25 basis points for their eSLR requirement. Table 1 presents the balance sheet capacity calculations for each of the largest banks as of the third quarter of 2024. The results show that three of the six banks are bound by the eSLR, indicated by zero balance sheet capacity. This means these banks cannot increase their Treasury holdings without needing to fund themselves with additional Tier 1 capital.
Table 1: Current Balance Sheet Capacity to Hold US Treasuries
Note: The table assumes management buffers of 50 basis points for Tier 1 risk-based requirement and 25 basis points for the SLR requirement.
Figure 3 shows how balance sheet capacity at the largest banks has evolved since the adoption of the eSLR. The capacity of U.S. GSIBs to acquire additional Treasuries has shown a persistent decline since 2016, consistent with the increase in the proportion of U.S. Treasuries in banks’ balance sheets shown in Figure 2.
A perfect test case to determine the impact of the SLR came in April 2020, when the Federal Reserve temporarily removed reserves and U.S. Treasuries from the denominator of the SLR calculation for banks.[5] This action was taken because the lack of dealer intermediation capacity had forced the Fed to make massive purchases of U.S. Treasury securities to address market dysfunction. The dysfunction occurred when a dash for cash during the onset of the COVID-19 pandemic overwhelmed dealer intermediation capacity.
By excluding cash and Treasuries from the SLR denominator, the Fed effectively lowered the amount of capital banks were required to maintain against these assets, freeing up their balance sheets to support the Treasury market and the economy during the crisis. According to Koont and Walz (2021), the relaxation of the SLR during COVID increased bank credit supply and improved Treasury market liquidity.[6]
After the expiration of the temporary SLR relief in March 2021, the Fed stated that it would soon invite comments on several potential modifications to the SLR.[7] However, nearly four years later, after political criticism of any step to provide capital relief to banks, no public consultation has been launched.
Reforming Leverage Ratios
The Federal Reserve and the Office of the Comptroller of the Currency published a proposal in 2018 to tailor the eSLR for U.S. Global Systemically Important Banks.[8] The proposal aimed to incentivize firms to engage in low-risk activities by adjusting the 2 percent eSLR buffer to one-half of the Method 2 GSIB surcharge. At that time, all GSIBs had Method 2 surcharges below 4 percent, meaning this modification would have increased their balance sheet capacity. Crucially, the proposal included changes to the eSLR buffer at the lead insured depository institution, which would allow banks to optimize capital allocation across different subsidiaries, including broker-dealers. In other words, the relaxation of capital requirements at the bank level allows for more capital to be deployed to broker-dealer subsidiaries and increases the balance sheet capacity of the broker-dealer.
Given the growth in GSIB surcharges due to economic growth and inflation, U.S. regulatory agencies could consider reissuing the eSLR proposal with a modification: replacing the 2 percent eSLR buffer with one-half of the Method 1 rather than the Method 2 surcharge. This approach aligns with Basel standards and matches how the eSLR buffer is defined. The U.S. version of the GSIB surcharge (Method 2) is about twice as high as the surcharge under Method 1 for several banks, as demonstrated in Table 2.
Table 2: GSIB Surcharges and Potential Deductions from SLR Denominator
Alternative approaches to adjust the eSLR include adopting changes similar to those implemented during the COVID-19 pandemic, specifically deducting both central bank deposits (Federal Reserve and foreign central banks) and U.S. Treasury securities from the calculation.[9]
Another option would be to combine the eSLR buffer modification with these denominator deductions. This combined approach would more effectively tailor the eSLR, as it would apply to all banks subject to the supplementary leverage ratio, not just the largest banks. Such a change could broaden and diversify the supply of Treasury and Treasury repo market intermediation.
Figure 4 illustrates the impact of each proposed adjustment to the eSLR on the balance sheet capacity of the largest banks. The chart also includes data on U.S. Treasury issuance. This comparison highlights how the eSLR needs to adapt to ensure banks can continue to support the liquidity of the Treasury market effectively.
Furthermore, the U.S. agencies need to make similar adjustments to the Tier 1 leverage ratio. Since there is no buffer in this ratio, relief requires excluding central bank placements and U.S. Treasury securities from its denominator. However, this approach faces a constraint under the “Collins Amendment,” which prohibits minimum leverage capital requirements from falling below the generally applicable leverage capital requirements that were in effect for insured depository institutions as of July 21, 2010.[10] Congressional action would therefore be needed to allow regulatory agencies to exclude central bank placements and U.S. Treasuries from the Tier 1 leverage ratio denominator while maintaining compliance with the Collins Amendment’s floor requirements.
Lastly, the denominator changes to leverage ratios would not be compliant with the Basel standards when assessed on a rule-by-rule basis, highlighting the need for a more comprehensive evaluation method. On a holistic basis, the application of a 4 percent Tier 1 leverage ratio imposes stricter constraints on U.S. Treasuries and reserve balances than those required by Basel. This raises questions about the appropriateness of such stringent capital requirements, especially for low-risk assets. Furthermore, the current regulatory framework appears to result in leverage ratios becoming the binding requirements for U.S. banks, which was not the original intent of the Basel framework. To address this, policymakers should strive for a balance between international compliance and more risk-sensitive capital requirements tailored to the U.S.
Conclusion
Large banks’ balance sheets have undergone significant changes in response to post-Global Financial Crisis regulations. Current leverage ratio calibrations have made leverage requirements binding constraints for many of the largest banks. These constraints are likely to become more binding during economic downturns, particularly when banks experience substantial deposit inflows and increase their holdings of risk-free assets.
U.S. regulatory agencies should reassess these leverage ratio calibrations. Several options exist to enhance large banks’ capacity to hold additional U.S. Treasury securities during periods of increased issuance. Implementation requires coordinated action through joint rulemaking by all three regulatory agencies, as changes must apply both at the bank holding company level and at the lead insured depository institution level.
To provide broad relief, the agencies must be willing to allow the definition and calibration of the SLR to deviate from certain Basel requirements, provided U.S. capital requirements remain holistically as stringent as the Basel requirements. Finally, congressional action may be necessary to implement needed reforms to Tier 1 leverage requirements.
[1] Principal trading firms are smaller, nonbank firms that trade on electronic platforms using automated trading strategies. They are important providers of short-term liquidity in Treasury markets.
[2] See for example “Stulz, Rene, Alvaro Taboada, Mathijs van Dijk, “Why are Bank Holdings of Liquid Assets so High?” NBER Working paper 30340, May 2023 and Hanson, Samuel, Victoria Ivashina, Laura Nicolae, Jeremy Stein, Adi Sunderam, and Daniel Tarullo, “The Evolution of Banking in the 21st Century: Evidence and Regulatory Implications,” Brookings Papers on Economic Activity, Spring 2024.
[3] See for example “Sundaresan, Suresh and Kairong Xiao, “Liquidity regulation and banks: Theory and evidence,” Journal of Financial Economics, Vol. 151, January 2024.
[4] Prior to the adoption of the stress capital buffer in 2020, we assume the implied SCB equals the maximum decline in each bank’s common equity tier 1 capital ratio under the Fed’s stress tests. While this proxy is somewhat imperfect because it includes dividends paid in each quarter of the planning horizon, rather than the four quarters of dividends included in the actual SCB calculation, it remains sufficient for the purposes of this analysis.
[5] In April 2020, the Federal Reserve Board allowed banks to deduct deposits held at Federal Reserve Banks (“reserve balances”) and Treasury securities from the denominator of the SLR on a temporary basis. Press Release, “Federal Reserve Board announces temporary change to its supplementary leverage ratio rule to ease strains in the Treasury market resulting from the coronavirus and increase banking organizations’ ability to provide credit to households and businesses,” April 1, 2020. https://www.federalreserve.gov/newsevents/pressreleases/bcreg20200401a.htm.
[6] See Koont, Naz and Stefan Walz, “Bank Credit Provision and Leverage Constraints: Evidence from the Supplementary Leverage Ratio,” Columbia Business School Research Paper, July 2021. Available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3798714. For the positive effect of the SLR relief announcement by market participants, see The Fed – Impact of Leverage Ratio Relief Announcement and Expiry on Bank Stock Prices. Lastly, Afonso, Gara, Marco Cipriani and Gabriele La Spada, “Banks’ Balance-Sheet Costs, Monetary Policy, and the ON RRP,” Federal Reserve Bank of New York Staff Reports, no. 1041 December 2022; revised August 2024, show that the expiration of the SLR relief incentivized banks to shed deposits and reduce participation in financial markets.
[7] A year later, with the Treasury market stabilized, the Federal Reserve allowed those changes to expire but announced in a press release that “[t]o ensure that the SLR—which was established in 2014 as an additional capital requirement—remains effective in an environment of higher reserves,” they “will soon be inviting comment on several potential SLR modifications.” Press Release, “Federal Reserve Board announces that the temporary change to its supplementary leverage ratio for bank holding companies will expire as scheduled on March 31,” March 19, 2021. https://www.federalreserve.gov/newsevents/pressreleases/bcreg20210319a.htm.
[8] In any future reproposal, it would be essential for the Federal Deposit Insurance Corporation (FDIC) to participate in the rulemaking process, as some bank-level requirements would affect FDIC regulations. For example, these changes could impact a bank’s ability to roll over existing brokered deposits or accept new ones without requiring a waiver.
[9] We have included both U.S. Treasury securities reported in the banking book (Schedule HC-B) and in the trading book (Schedule HC-D).
[10] The Collins Amendment stipulates that generally applicable minimum leverage requirements under Prompt Corrective Action (PCA) cannot be lower than their 2010 levels. As of 2010, the minimum requirement for a bank to be considered adequately capitalized under PCA was 4% Tier 1 leverage ratio. However, the pre-2010 PCA regime allowed for a lower minimum of 3% for banks meeting specific criteria, including a CAMELS 1 composite rating. Consequently, one interpretation of the Collins Amendment could potentially allow regulatory agencies to reduce the Tier 1 leverage minimum to 3%, aligning with the lower threshold permitted under certain conditions in the pre-2010 framework.
