Bank Policy Institute CEO Greg Baer has issued a statement regarding the Federal Reserve Board's recent decision to advance a proposal on the supplementary leverage ratio (SLR). The proposal is seen as an initial step towards creating a more rational capital framework that allows banks to better fulfill their role in market intermediation and economic support.
Baer stated, "Today’s proposal marks a first step toward a more rational capital framework that enables banks to perform their core purpose of intermediating markets and supporting economic growth. We are hopeful that this proposal begins the process of returning the SLR to its intended purpose: a backstop, not a binding constraint."
The proposal suggests recalibrating the enhanced supplementary leverage ratio (eSLR), which applies specifically to U.S. global systemically important banks (GSIBs). Unlike risk-based capital requirements, which assess capital charges based on asset risk levels, leverage ratios like the SLR treat all assets equally. This means safe assets such as U.S. Treasury bonds incur the same capital charge as higher-risk loans.
According to Baer, "Adjusting the eSLR would have a de minimis effect on large banks’ capital—just a 0.74% reduction based on the latest available data." He further noted that claims suggesting significant reductions in bank capital due to this adjustment are misleading.
The current constraints imposed by leverage ratios have been challenging for banks' balance sheets, especially concerning U.S. Treasury market intermediation. The growth of the Treasury market has outpaced bank balance sheet capacity partly due to these constraints. Since 2007, outstanding Treasuries have grown nearly fourfold compared to primary dealer balance sheets.
Baer emphasized that while recalibration is positive, comprehensive reform is necessary for maximizing banks' financing capacity. "A sensible recalibration of the requirement, as proposed today, will promote the banking system’s ability to provide critical liquidity to the U.S. Treasury market," he said.
The Federal Reserve's temporary removal of reserves and Treasuries from SLR calculations during COVID-19 provided additional space on bank balance sheets. This action supported both the Treasury market and broader economy during stressful periods.
Additionally, other leverage requirements like Tier 1 leverage ratios also require reconsideration. Baer pointed out that these requirements can limit banks' ability to accept new deposits when they become binding.
The Bank Policy Institute represents universal and regional banks along with major foreign banks operating in the United States. It conducts research and analysis on regulatory policies and advocates for aligning capital frameworks with actual risk levels while eliminating redundancies in capital requirements.