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The Federal Reserve has kicked off one of the largest reductions of US bank capital requirements since the 2008 financial crisis by proposing to allow higher leverage at the biggest American banks.
The US central bank said on Wednesday it planned to slash the enhanced supplementary leverage ratio for the biggest banks. The rule requires them 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 aggregate capital requirements at the holding company level for the eight big banks affected by $13bn, or 1.4 per cent, the Fed said.
The Fed proposal would lead to a bigger reduction in capital requirements for the deposit-taking subsidiaries of the biggest US banks. These subsidiaries’ capital requirements would fall by 27 per cent, resulting in a $210bn reduction in bank capital, according to the central bank. But it added that this would be offset by other constraints at a holding company level.
The biggest and most globally systemic US banks, including JPMorgan Chase and Goldman Sachs, 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 would reduce this to between 3.5 per cent and 4.25 per cent, the Office of the Comptroller of the Currency, a US bank regulator, said on Wednesday. That would bring it in line with the requirements of the largest European, Chinese, Canadian and Japanese banks.
Greg Baer, head of the Bank Policy Institute, a lobby group, said the Fed’s proposal was “a first step toward a more rational capital framework” that would “promote the banking system’s ability to provide critical liquidity to the US Treasury market”. But he said “further action” was needed to maximise banks’ financing capacity.
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.
Fed governors Michael Barr and Adriana Kugler both objected to the Fed’s proposal, pointing specifically to the risks caused by reducing capital requirements for bank subsidiaries. Chair Jay Powell and governor Chris Waller supported the proposal, alongside Bowman.
Barr said the proposal would “significantly increase” the risk of a big bank failing but he was “sceptical that it will achieve the stated objective of strengthening the resiliency of the Treasury market”.
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. The Fed did not include this in its proposal, but it invited feedback on whether it could be done as an “additional modification”.
Most big US banks are more constrained by other rules, such as the Fed’s stress tests and risk-adjusted capital requirements, which limit how much they benefit from SLR reform.
However, the leverage ratio often becomes more of a constraint on banks at times of market stress when deposits flow into the banks, restricting 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”.
Additional reporting by Akila Quinio in New York
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