The Federal Reserve unveiled a proposal on Wednesday aimed at relaxing a critical capital regulation that banks argue has restricted their operational capabilities. This initiative has sparked disagreement among officials, with at least two expressing concerns that such a change could compromise vital financial safeguards.
The proposed adjustment centers on the enhanced supplementary leverage ratio (eSLR), a rule designed to dictate the amount and quality of capital that banks must hold on their balance sheets. This regulation was established in the aftermath of the financial crisis to enhance the stability of the nation’s largest banking institutions.
Despite its original intent, there has been growing pressure from Wall Street executives and some Federal Reserve officials to reassess these requirements, particularly as bank reserves have increased and worries about Treasury market liquidity have surfaced. Currently, the regulations assess all forms of capital uniformly.
“The notable rise in the volume of relatively safe, low-risk assets on banks’ balance sheets over the past decade has rendered the leverage ratio more constricting,” stated Fed Chair Jerome Powell. “Given this backdrop, it is prudent to revisit our initial approach.”
The Fed has opened up a 60-day window for public comments regarding the proposal.
The draft measure aims to decrease the top-tier capital requirements for major banks by 1.4%, translating to approximately $13 billion for bank holding companies. There is a more significant anticipated drop for subsidiaries, estimated at $210 billion, although the capital will ultimately remain within the parent banks. The proposition applies uniform regulations to globally systemic important banks and their subsidiaries.
Under the proposed regulations, capital requirements would be reduced from the current 5% to a range of 3.5% to 4.5%, with subsidiaries also seeing a drop from 6% to the same new range.
The overall objective of the plan is to enable banks to manage a greater quantity of low-risk assets, such as Treasuries, which currently receive similar capital treatment as high-yield bonds. Regulators at the Fed are advocating for capital requirements to function as a safety buffer rather than a constraint on banking activities.
Nonetheless, Governors Adriana Kugler and Michael Barr, the former vice chair of supervision, openly opposed the proposal. Barr remarked, “Even if some additional Treasury market intermediation were to occur in normal times, this proposal is unlikely to alleviate pressures in times of stress. In essence, firms might exploit the proposal to distribute capital to shareholders and pursue high-return opportunities, rather than genuinely enhancing their Treasury intermediation.”
Criticism surrounds the leverage ratio, with detractors arguing that it penalizes banks for holding Treasuries. Official documentation released on Wednesday suggests that the new regulatory framework is aligned with internationally recognized Basel standards for banks.
