Fed’s Quarles casts doubt on permanent capital relief for big banks

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WASHINGTON — A senior Federal Reserve official appeared to throw cold water on hopes that the central bank will implement permanent relief sought by institutions in the calculation of a key capital measure.

Regulators implemented an interim rule change in May to allow systemically important banks to exclude Treasury securities and deposits at Federal regional banks from the supplementary leverage ratio, a more demanding capital benchmark designed to limit risky activities. The temporary relief was meant to help institutions lend to customers feeling the economic effects of the COVID-19 pandemic.

Some have suggested that safe holdings like Treasurys and Fed reserves should never have been included in the leverage ratio at the outset.

“Why would one need a capital buffer against reserves, which are worth one for one?” said Darrell Duffie, a professor of finance at Stanford University, on a panel for a virtual event sponsored by the CFA Institute.

But Fed Vice Chairman of Supervision Randal Quarles, speaking on the panel, said making the change permanent is not currently on the central bank's radar.

"I understand the desire to give thought to it but I would think it'd be premature to say that we ought to make that permanent currently,” said Fed Vice Chairman Randal Quarles.
"I understand the desire to give thought to it but I would think it'd be premature to say that we ought to make that permanent currently,” said Fed Vice Chairman Randal Quarles.

“It is clear… that [the SLR] was a significant disincentive for banks to respond to the pressures on the Treasury market in March, and when we made that exemption, they were able to respond much more fully,” he said. “So I understand the desire to give thought to it but I would think it'd be premature to say that we ought to make that permanent currently.”

While he cast doubt on permanent leverage ratio relief, Quarles described himself as a "proponent" of the Fed's establishing an overnight repurchase facility to support monetary policy.

The SLR requires banks with more than $250 billion of assets to maintain an extra cushion of high-quality capital against an institution's total assets. Institutions subject to the requirement must maintain a minimum 3% ratio against their total leverage exposure, with even tougher requirements for the most complex firms.

The temporary SLR relief — which will be in effect until March 2021 — was intended not only to enable banks to expand balance sheets but also to relieve some stresses in the functioning of the Treasury market. However, the Fed also estimated that the change would reduce the required amount of capital at bank holding companies by $76 billion. That drew backlash from some who felt that banks should refrain from shedding capital in the throes of a crisis.

Duffie said during he believed the Fed should exempt reserves and Treasurys from the calculation of the supplementary leverage ratio, a non-risked-based capital requirement in which all assets are weighted equally. To compensate for the resulting reduction in banks' loss protection, he said the Fed could increase risk-based capital requirements.

But Quarles suggested doing so would defeat the purpose of the SLR.

“Once you start excepting out of the denominator everything that you think is safe — so first you begin with reserves, and then Treasurys, and then why not repo and then why not agencies and then why not other countries’ sovereigns?” he said. “And then you just go down the list of whatever people want to create a greater incentive for banks to hold, and you've just got another risk-based ratio.”

Quarles also discussed the possibility of a standing repo facility as a way of improving the Fed’s interest rate control. The Fed has already injected billions into the repo market following a glitch in the market last year that caused short-term interest rates to surge above the central bank’s target as well as the onset of the coronavirus pandemic.

“It is worth noting that a standing repo facility for interest rate … purposes is, I think, a relatively straightforward for the Fed to do, but wouldn’t do much for this [liquidity] issue at all," said Quarles, adding that addressing the liquidity supply is "conceptually more difficult ... for us to think about.”

A permanent standing repo facility would be “totally justified” and could provide more stability to that market, added Vítor Constâncio, former vice president of the European Central Bank.

“The permanent facility would create, not only a ceiling to those excesses, but also would facilitate or guarantee better to holders of Treasurys that they can indeed easily repo them with the central bank,” he said.

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Capital requirements Coronavirus Randal Quarles Federal Reserve Regulatory relief Interest rates CFA Institute