The new proposal recalibrates capital rules to support smoother market functioning and the economy, Fed Chair Jerome Powell says.
The Federal Reserve has adopted a draft proposal to ease a key capital requirement for the nation’s largest banks, aiming to reduce regulatory pressure that discourages them from holding low-risk assets such as U.S. Treasurys and to make it easier for these institutions to act as intermediaries in the Treasury market during times of stress, when liquidity is most needed.
At a public board meeting in Washington on June 25, Fed governors voted 5-2 to advance a long-awaited plan to modify the enhanced supplementary leverage ratio (eSLR)—a post–2008 financial crisis safeguard that requires global systemically important banks (GSIBs) to hold capital against all assets, regardless of risk. The proposal will now be published in the Federal Register and will be open for public comment for 60 days.
Fed chair Jerome Powell, speaking before the vote, endorsed the proposal and pointed to the banking sector’s overall strength. But he warned that the current leverage rule may be over-calibrated, potentially discouraging banks from holding safe assets and contributing to market strain.
“In the case of the leverage ratio, over-calibration may lead to diminished liquidity in the Treasury markets and other unintended consequences,” Powell said. “A leverage requirement functions best when it is generally a backstop to risk-based capital requirements,” Powell continued, adding that when leverage requirements are binding, they can discourage banks from participating in lower-risk lower-return activities that support the U.S. financial system and economy, such as Treasury market intermediation.
The proposed rule would replace the current flat leverage buffer of 2 percent at the parent bank level and 6 percent at the subsidiary level with a variable buffer based on each bank’s systemic risk score.
That change would reduce total capital requirements for America’s biggest banks by about 1.4 percent, according to Fed staff estimates. While capital requirements for bank subsidiaries would fall by a much larger 27 percent, most of that capital would remain locked within the banking group due to holding company rules and would not be available for shareholder payouts.
By Tom Ozimek
