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The Federal Reserve has kicked off one of the biggest reductions of US bank capital requirements since the 2008 financial crisis by proposing to allow higher leverage at the biggest American banks.
The central bank said on Wednesday it planned to slash the enhanced supplementary leverage ratio for the biggest banks. The rule requires big banks 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 was established in 2014 as part of sweeping reforms in the wake of the financial crisis.
Big banks have long been calling on regulators to ease the supplementary leverage ratio, complaining it punishes them for holding low-risk assets such as US Treasuries and hinders their ability to facilitate trading in the $29tn government debt market.
“This change will enable these institutions to promote Treasury market functioning and engage in other low-risk activities during periods of financial stress,” said Michelle Bowman, the Fed’s vice-chair for supervision. “Importantly, this change would not lead to a material reduction of the tier one capital requirements of the largest banks.”
The change would reduce capital requirements for the eight big banks affected by $13bn, or 1.4 per cent, the Fed said.
The biggest and most globally systemic US banks, including JPMorgan Chase and Goldman Sachs, currently need to have so-called tier one capital — common equity, retained earnings and other items that are first to absorb losses — worth at least 5 per cent of their total assets.
The plans presented by the Fed on Wednesday are expected by analysts to reduce this to between 3.5 per cent and 4.5 per cent of the big banks’ total assets, bringing it in line with the requirements of the largest European, Chinese, Canadian and Japanese banks.
The Financial Times reported in May that US regulators were planning to reduce the supplementary leverage ratio, as the Trump administration seeks to lessen restrictions on the financial industry.
Critics of a lower supplementary leverage ratio have raised fears that watering down the rule will increase the chances of a repeat of the 2008 banking crash.
Elizabeth Warren, the top Democrat on the Senate banking committee, said in a letter to regulators this week: “If the banking agencies gut this requirement, the big banks will load up on more debt, pay out more money to shareholders and executives, and put the entire economy at risk of another financial crash.”
Some bank executives had suggested the Fed could exclude low-risk assets such as Treasuries and central bank deposits from the leverage ratio calculation — as happened temporarily for a year during the coronavirus pandemic.
Most big US banks are more constrained by other rules, such as the Fed’s stress tests and risk-adjusted capital requirements, which may limit how much they benefit from SLR reform. Morgan Stanley analysts estimated that only State Street was genuinely “constrained” by the SLR.
However, the leverage ratio often becomes more of a constraint on banks at times of market stress when deposits flow into the banks, constraining their ability to intermediate in Treasury markets. In the dash for cash after the pandemic hit in 2020, some banks, such as JPMorgan, said they had to turn away deposits because of the leverage ratio constraints.
The Fed is also planning a conference to discuss broader reform of US bank regulation next month. Bowman said future changes would bring “many potential improvements” to what she called “distorted capital requirements”.
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