The Federal Reserve has announced a proposal to ease a significant capital rule, a move that banks argue will enhance their operational flexibility. This proposal, however, has sparked dissent among some officials who express concerns about potential risks to the financial system. The capital rule in question, known as the enhanced supplementary leverage ratio (eSLR), plays a crucial role in regulating the amount and quality of capital that banks are required to hold on their balance sheets.
Introduced in the aftermath of the financial crisis, the eSLR was designed to bolster the stability of the nation’s largest banks by ensuring they maintain adequate capital reserves. In recent years, however, as bank reserves have increased and worries about Treasury market liquidity have emerged, there has been growing pressure from both Wall Street executives and Federal Reserve officials to relax these capital requirements.
The Federal Reserve is set to vote on the proposed capital rule changes at 2 p.m. ET on Wednesday. If approved, the measure would reduce the top-tier capital that large banks must maintain by 1.4%, equating to approximately $13 billion for holding companies. Furthermore, subsidiaries of these banks would experience an even more substantial reduction, with a decrease of around $210 billion. Notably, the new capital standards would align the requirements for globally systemic important banks and their subsidiaries.
Under the proposed changes, capital requirements would be adjusted to a range of 3.5% to 4.5%, down from the current 5%. Subsidiaries would face similar reductions, moving from a previous requirement of 6% to the new range. This significant adjustment aims to alleviate the constraints imposed by the existing leverage ratio, which has become more restrictive as banks have accumulated safer, low-risk assets over the past decade.
Current Vice Chair for Supervision Michelle Bowman and Governor Christopher Waller have publicly supported the proposed changes. Bowman emphasized that the adjustments would enhance resilience in U.S. Treasury markets, thereby minimizing the risk of market dysfunction and reducing the necessity for the Federal Reserve's intervention during future financial stress. She stressed the importance of proactively addressing the unintended consequences of bank regulation while maintaining a framework that promotes safety, soundness, and financial stability.
Conversely, governors Adriana Kugler and Michael Barr, the latter being the former vice chair of supervision, have voiced their opposition to the proposal. Barr argued that even if some additional intermediation in the Treasury market were to occur during normal conditions, the proposal would likely fall short of providing meaningful assistance during periods of market stress. He cautioned that firms might utilize the proposed changes primarily to distribute capital to shareholders rather than to enhance their role in Treasury intermediation.
The current leverage ratio has faced criticism for penalizing banks that hold Treasurys, as it treats these low-risk assets similarly to high-yield bonds for capital purposes. The documents released by the Federal Reserve indicate that the proposed regulations aim to align with Basel standards, which set international benchmarks for banking regulations. As the Federal Reserve prepares to vote on these significant changes, the financial community awaits the impact of this proposal on both the banking sector and the broader market.
