The US has taken a major step to ease some of the requirements that were placed on banks in the wake of the 2008-09 financial crisis, issuing a proposal that would let the largest lenders free up some of the capital they hold for times of market turmoil.
The Fed said on Wednesday it planned to slash the enhanced supplementary leverage ratio for the biggest banks. The rule requires them to have a preset amount of high-quality capital against their total leverage, which includes assets such as loans and off-balance sheet exposures such as derivatives.
It marks the most significant rule improvement yet for Wall Street in the Trump era, one that loosens requirements for America’s largest financial institutions to support markets and encourages the purchases of US Treasuries during times of uncertainties.
Details of the Proposal
The move is part of a broader set of rollbacks the Trump administration is expected to make, including changes to how banks are rated, how they are examined by regulators for financial stability, and the annual stress tests the largest lenders must take.
The Fed wants to ease restrictions that force banks to keep a fixed amount of capital of all their current assets, no matter how risky or safe these assets are. The changes could reduce capital requirements by estimates of $13 billion at the holding company level and $210 billion at the subsidiary level, as stated by Fed officials. This could allow banks to access and move capital freely across their subsidiaries. ⁽¹⁾
The Fed’s proposal also asks banks to comment on possibly excluding Treasuries from the leverage ratio denominator for all banks. Banks and the public have 60 days to comment on the proposal. A final rule is expected later this year. ⁽²⁾
Reason Behind the Change
The supplementary leverage ratio (SLR) was made to help ensure that banks hold capital against assets, especially US Treasuries. But banks argue it limits their trading in Treasury markets during times of uncertainty. ⁽³⁾
Fed Chairman Jerome Powell stated that the proposal could make the SLR more supportive instead of restrictive. He also noted the significant increase in safe-haven assets on bank balance sheets in order to protect their portfolios. ⁽⁴⁾
Industry and Regulatory Perspectives
Big banks such as JP Morgan, Citigroup, Goldman Sachs and others have pushed for lower leverage ratios, suggesting that it could allow them to support financial markets by buying more Treasuries. ⁽⁵⁾
Fed Vice Chair for Supervision Michele Bowman supports the change, stating that it could build resilience in US Treasury markets and reduce market issues. She views this as the first step in overhauling “distorted” capital rules tightened after the 2008 crisis. ⁽⁶⁾
However, there are people who oppose the proposal. Fed Governor Michael Barr, who recently resigned from his position as the Fed’s top regulator, warned it could increase the risk of another major bank failure. Other people who oppose it also stated it could allow too much flexibility, which could bring more market manipulation. ⁽⁷⁾
How Could the Proposal Impact Financial Markets?
By easing restrictions on capital, banks can purchase more US Treasuries, especially during times of economic uncertainties, leading to enhancement in liquidity and stabilization in yields.
Bank stocks could also see a boost as reduced capital requirements could lead to higher corporate profits and increased returns. Easing capital requirements might also lead to rate cuts, leading to more lending, investment and economic activity. Hence, risk-on sentiment improves. ⁽⁸⁾
Officials have indicated that they are also preparing to propose a set of risk-based capital requirements that the US agreed to undertake as part of an international Basel III agreement following the 2008 financial crisis.
