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The Federal Reserve has launched one of the biggest cuts in US bank capital requirements by proposing to allow higher leverage at the largest US bank since the 2008 financial crisis.
The US Central Bank said Wednesday it planned to reduce the strengthened supplemental leverage rates of the largest banks. This rule requires that you ensure high quality capital in advance for total leverage, including assets such as loans and unbalanced sheet exposures such as derivatives. It was founded in 2014 as part of a drastic reform in the wake of the financial crisis.
Large banks have long asked regulators to facilitate supplemental leverage ratios, punishing them for holding low-risk assets such as the US Treasury, and hindering their ability to drive transactions in the $2.9 billion government debt market.
“The changes will allow these agencies to promote the functioning of the Treasury Department and engage in other low-risk activities during periods of financial stress,” said Michelle Bowman, vice-chairman of the Federal Reserve oversight. “Importantly, this change will not lead to material reductions in the tier 1 capital requirements of the largest banks.”
The change will reduce capital requirements for eight major banks affected by $13 billion (1.4%), the Fed said.
The largest and most globally systematic US banks, including JPMorgan Chase and Goldman Sachs, must have what is called Tier One Capital (other items that absorb the initial loss worth at least 5% of their total assets).
The plan presented by the Fed on Wednesday is expected to reduce this from 3.5% to 4.5% of the major bank’s total assets, bringing it to the requirements of European, Chinese, Canada and Japanese banks.
The Financial Times reported in May that US regulators were planning to reduce supplemental leverage rates as the Trump administration is trying to reduce restrictions on the financial industry.
Critics with a lower supplemental leverage ratio have raised concerns that withstanding the rules will increase the likelihood of a repeating 2008 bank crash.
In a letter to regulators this week, Elizabeth Warren, a top Democrat on the Senate Banking Committee, said:
Some bank executives have suggested that the Fed can exclude low-risk assets such as the Treasury and central bank deposits from their leverage ratios, as happened temporarily during the coronavirus pandemic.
Most large US banks are more constrained by other rules, such as the Fed’s stress test and risk-adjusted capital requirements. Analysts at Morgan Stanley estimated that only state streets, which are truly “constrained” by the SLR, are truly “constrained.”
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However, leverage ratios often constrain the banks during market stress when deposits flow into the bank, and often constrain the ability to become intermediate in the Ministry of Finance market. In the dash for cash after the 2020 pandemic hit, some banks, such as JPMorgan, said they must pull their deposits away due to leverage ratio constraints.
The Fed is also planning a meeting next month to discuss broader reforms to US bank regulations. Bowman said future changes will bring “many potential improvements” to what she called “skewed capital requirements.”
