UPDATE: The Federal Reserve Board's vote tally on the proposal has been added.
The country's largest banks are due to get a capital break under proposed changes to a risk-blind regulatory mechanism, but they would still have to hold capital against low risk assets.
During an open meeting, the Federal Reserve Board, the central bank, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. released a joint proposal on Wednesday afternoon that would amend the enhanced supplementary leverage ratio, or eSLR, to ensure it is no longer the primary restriction for which banks must manage.
The Fed Board voted 5-2 to put the proposal out for public comment, with Fed Govs. Michael Barr and Adriana Kugler both dissenting.
For months,
Fed Vice Chair for Supervision Michelle Bowman said in a prepared statement that the proposed reforms would deliver relief to the banks that own the largest primary dealers to ensure the SLR is no longer their main binding restraint. In doing so, she said, those firms will be able to bring greater stability to an increasingly fragile U.S. debt market.
"The proposal will help to build resilience in U.S. Treasury markets, reducing the likelihood of market dysfunction and the need for the Federal Reserve to intervene in a future stress event," Bowman said. "We should be proactive in addressing the unintended consequences of bank regulation, including the bindingness of the eSLR, while ensuring the framework continues to promote safety, soundness, and financial stability."
Fed Gov. Christopher Waller joined Bowman in supporting the proposal ahead of Wednesday's meeting.
But the proposal is not without controversy. Barr — who served as vice chair for supervision until his
"Enhancing the resilience of the U.S. Treasury market is an important objective that I share with my colleagues, but this proposal unnecessarily and significantly reduces bank-level capital by $210 billion for global systemically important banking organizations and weakens the eSLR as a backstop," Barr said. "I am skeptical that it will achieve the stated objective of improving the resiliency of the Treasury market."
The proposal calls for replacing the current eSLR — which requires the eight biggest banks to hold additional capital equal to 2% of their on- and off-balance-sheet exposures — with a new capital charge, equal to one-half of each bank's global systemically important bank, or GSIB, surcharge.
Specifically, the new capital charge would be calculated using the method 1 scoring system, which considers a bank's size, interconnectedness, cross-jurisdictional activity, complexity and substitutability.
In a memo released alongside the proposal, Fed staff explained that this shift would address the issue of banks being bound by the current SLR due to their exposure to assets with no credit risk — namely U.S. debt instruments and funds held at the central bank — while still ensuring that the leverage ratio is indicative of a bank's overall size.
"Using a requirement based on the GSIB surcharge framework would tailor the eSLR to each GSIB's systemic footprint and produce a calibration that is consistent with the objective for supplementary leverage ratio requirements to act as a backstop to risk-based capital requirements," the memo reads.
The staff added that the changes would bring the U.S. SLR framework into better alignment with global standards set by the Basel Committee on Banking Supervision. The current framework exceeds the internationally agreed-upon minimum.
As a result of the proposal, the impacted banks would see an estimated 27% decline in aggregate common tier 1 equity requirements — equal to $210 billion — at the depository level, though the institutions would still have to retain the vast majority of that freed up capital because of risk-based requirements at the bank holding company level.
Overall, the proposal projects that only $13 billion, or 1.4% of overall GSIB capital, could be shed without running up against regulatory minimums. Bowman said this will prevent banks from simply using the additional balance sheet capacity created by the reform to repurchase stock or issue larger dividends to investors.
"These changes at the bank level do not enable them to increase capital distributions to shareholders, as their holding companies would generally remain constrained by risk-based capital requirements," she said. "In fact, the GSIB holding companies are required to contribute assets to their bank subsidiaries to cover capital shortfalls, if needed, pursuant to secured support agreements and are subject to general source of strength obligations."
But Barr argued that these projections understate the potential stability ramifications of the change. In particular, he took issue with the assumption that the depository-level declines in capital would be offset by reallocation of capital at the holding company level.
"The proposal downplays the concern about the decline in bank-level capital by pointing to the expectation that holding companies serve as a source of strength to their banks," Barr said. "In practice, however, there are lots of examples of firms failing without supporting their bank subsidiary, as happened with Silicon Valley Bank in 2023."
The change to the eSLR would also impact the calculation of other parts of the regulatory framework, namely the total loss absorbing capacity and long-term debt requirements applied to GSIBs. These, too, would be brought down to the level called for by the Basel committee.
In one potential disappointment to large banks and their representatives in Washington, the proposal does not seek to exempt Treasuries or reserves from the calculation of the eSLR, a shift that would have opened significant balance-sheet capacity and enabled virtually limitless Treasury intermediation capacity. At the height of the COVID-19 pandemic, the Fed made such an exemption to stabilize the U.S. debt market and many banks have since argued for making that policy permanent.
In his statement, Waller said the proposal does enough to incentivize Treasury market intermediation — or, at least, removes the current disincentive — while still allowing banks some choice over their business pursuits and balance sheet construction.
"I believe the proposed approach to simply reduce the degree to which the eSLR binds is preferable to explicitly excluding particular assets, like government liabilities," he said. "It is not our job to pick winners and losers. The proposed approach will leave those choices and the risk management to the banks, which is appropriate."
