The Federal Reserve on Friday announced it will not extend an exemption ending March 31 that allowed banks to exclude Treasurys and deposits with the central bank from calculation of a key bank capital measure known as the supplementary leverage ratio.
The exemption was put in place last year during the market turmoil that followed the shutdown of the economy because of the pandemic.
However, the Fed said it would invite comment on possible longer-run changes to the SLR.
Suspense on Wall Street about the Fed’s decision on the exemption has been building in recent weeks. Essentially some analysts said that big banks would have a reduced appetite for Treasurys if they had to add them to the calculation of their capital requirements.
Chris Weston, head of research at Pepperstone, had said that financial institutions would “dump a chunk of their U.S. Treasury exposure.”
Fed officials said they were comfortable letting the temporary relief expire given that banks have strong capital positions and said they didn’t think the decision would be disruptive.
There has been a broad sell-off in Treasurys in recent weeks on worries about the potential inflationary impact of the latest $1.9 billion stimulus package passed by Congress. In addition, government borrowing is set to rise to pay for the measure and a possible infrastructure package that could pass Congress later this year.
The 10-year U.S. Treasury note yield
has risen to 14 month highs this week.
Backers of financial reform efforts didn’t want the Fed to extend the temporary relief. They view the SLR as perhaps the most accurate gauge of bank capital because it doesn’t allow firms to adjust for risk.
“It’s the right outcome,” said Jeremy Kress, a former Fed staffer and professor at University of Michigan’s Ross business school, but Kress said he was worried about any modifications the Fed might make to the SLR.
While the Fed said any SLR changes wouldn’t erode the overall strength of bank capital requirements, they’ve said that before and have proceeded to weaken rules, Kress noted.
“So we’ll need to see what they propose here,” he said.
Top Democrats in the Senate had pushed for the Fed to end the exemption.
Sen. Sherrod Brown, the chairman of the Senate Banking Committee, called the SLR “one of the most important regulatory requirements for large banks put in place after the 2007-2008 financial crisis.”
The general consensus had been that financial regulators would extend the SLR exemption until Jelena McWilliams, the chairman of the Federal Deposit Insurance Corp. said that she didn’t think banks needed it, said Ian Katz, a director at Capital Alpha Partners.
The Fed’s emergency measure last April, put in place along with the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency, came in the wake of a buyers strike for Treasurys in the wake of the coronavirus pandemic. Facing an unprecedented shutdown of the U.S. economy, all types of non-bank financial firms wanted to sell Treasurys to raise cash.
In addition to Treasurys, banks will have to hold additional capital for their deposits at the Fed.
Bank stocks fell on the Fed decision.
When the Fed conducts quantitative easing as it is now — buying $80 billion of Treasurys and $40 billion of mortgage-related assets each month — this creates cash reserves held at the Fed on bank balance sheets.
Bank trade groups said the Fed is filling up a bathtub and bank’s can’t put the money to use quickly, meaning they have to hold more capital for the growing reserves on their balance sheets.