MNI: Fed Governors Oppose Proposal To Ease Bank Leverage Rule

Federal Reserve governors Michael Barr and Adriana Kugler said Wednesday they oppose a proposal to ease leverage rules for big banks, arguing it would significantly reduce capital requirements with dubious benefits for Treasury market intermediation.

The central bank's board meets late Wednesday to consider a plan to reduce the degree to which the enhanced supplemental leverage ratio is binding, a change that regulators say will enable the biggest banks to promote Treasury market functioning during periods of market stress. 

The eSLR requires the biggest banks to hold capital against relatively safe assets as a backstop to risk-based capital requirements. As reserves and Treasury holdings in the banking system have skyrocketed over the past decade, the SLR has had the unintended consequence of disincentivizing dealers from engaging in Treasury market making. 

The proposal would see a significant reduction in capital requirements at the bank level and increase the risk that a global systemically important bank would fail or not be able to undergo an orderly resolution, Barr and Kugler said. It would reduce tier 1 capital requirements by 27% at GSIBs' depository institution subsidiaries, resulting in a USD210 billion decline in bank capital, as well as reduce total loss absorbing capacity by 5% or USD73 billion, and long-term debt requirements by 16% or USD132 billion. 

For U.S. GSIBs, the proposal replaces the 2% eSLR buffer with half of the GSIB’s method 1 surcharge to restore the leverage requirement. This approach would significantly reduce the likelihood of the eSLR becoming binding under stress conditions for the largest banks and would more closely align it with the Basel leverage ratio standard, the Fed said. 

For GSIB bank subsidiaries, the proposal also replaces the 3% eSLR buffer with half of the GSIB’s method 1 surcharge, enabling the largest banks to allocate capital more efficiently within their organizations, including to their affiliated broker-dealers, the Fed said. 

TREASURY MARKET

Easing the eSLR is also unlikely to significantly enhance Treasury market intermediation, especially in times of stress, Barr and Kugler argued. 

Treasury market intermediation primarily happens at the broker-dealer level, but the overwhelming bulk of the capital depletion under the proposal happens in the bank, Barr said. 

"While firms could, in theory, use the additional headroom provided under the proposal to increase their participation in Treasury market intermediation, it is not clear that result would occur. Firms could just as easily shift to other activities with low risk-based capital requirements and significantly higher returns than Treasury market intermediation," he said. 

The bank holding companies could also divert the freed-up capital to returning equity to shareholders, he said. 

"If banks use up their excess capital in normal times, there will not be excess capital in stressful times." (See MNI INTERVIEW: US Bond Selloff A 'Stern Warning' To Fed -Stein)

DENOMINATOR CHANGE

Wednesday's proposal also seeks comment on modifications to the calculation of the SLR’s denominator, such as excluding U.S. Treasuries held for trading at broker-dealers or excluding all U.S. Treasuries and reserves, similar to emergency SLR relief during the pandemic.  

"Such a change would be ill-advised. Such a decision easily leads to a slippery slope — an erosion in global capital levels as other jurisdictions apply a similar logic to their own sovereign debt," Barr said. 

Governor Chris Waller joined Barr in registering his opposition to such a permanent change. "It is not our job to pick winners and losers. The proposed approach will leave those choices and the risk management to the banks, which is appropriate," Waller said.