Capital requirements were relaxed during COVID as markets stabilize
The Federal Reserve will not extend temporary relief on a bank regulation known as the supplementary leverage ratio (SLR), it said on Friday, despite large efforts by banks to persuade the central bank to do so.
The SLR is a regulation that requires the largest U.S. banks to hold a minimum level of capital. Like many post-crisis measures, the SLR is broadly designed to ensure that banks are able to absorb any losses stemming from financial or economic shocks.
When the Fed originally announced the change in April 2020, it insisted that the measures were to protect liquidity conditions in the Treasury market. It also clarified that the measures would be temporary and expire on March 31, 2021.
“Since that time, the Treasury market has stabilized,” the Fed said in its statement Friday.
“The Board will take appropriate actions to assure that any changes to the SLR do not erode the overall strength of bank capital requirements,” the central bank said, adding that it would field recommendations on permanent changes to the SLR at a later date.
As the Fed aggressively ramped up its money printing to support the economy through the COVID-19 crisis, the Fed and two other banking regulators opted to loosen the calculation of the SLR. The concern: that the flood of liquidity would balloon U.S. government debt holdings in the banking industry.
Because of the way the SLR is calculated, a sharp increase in U.S. Treasuries could push banks to fall below their regulatory minimums.
The banking industry lobbied the Fed to extend the exemption through 2021, arguing that the Fed’s continued money printing continues to put pressure on the industry’s ability to absorb U.S. government debt.
But Credit Suisse analyst Zoltan Pozsar wrote March 16 that the expiry of the SLR exemptions would likely have no effect on the functioning of the Treasury market. Pozsar noted that none of the eight largest banks would fall below their 5% regulatory minimums if the exemption expired.
“The market assumes that the SLR exemption is what has ‘glued’ the rates market together since 2020, and that the end of exemption means that large U.S. banks will have to sell Treasuries. That view is wrong,” Pozsar said.
Fed officials noted that the largest banks currently have a roughly 25% buffer above minimum thresholds for the SLR, which they feel is comfortable. The decision to let the exemption expire was broadly supported among the Fed’s six-member board.
The Fed will field comment on “permanent” changes at an unspecified time.
“Because of recent growth in the supply of central bank reserves and the issuance of Treasury securities, the Board may need to address the current design and calibration of the SLR over time to prevent strains from developing that could both constrain economic growth and undermine financial stability,” the Fed said.