The Federal Reserve on Friday declined to extend a pandemic-era rule that eased the amount of capital banks had to hold against treasury and other holdings, in a move that could upset Wall Street and the bond market.
In a brief announcement, the Fed said it would allow a change to the additional leverage ratio on March 31. The first step, announced on April 1, 2020, allowed banks to exclude Treasury bills and deposits with Fed banks from the leverage ratio calculation. .
The decision to ease capital requirements was widely regarded as key to calming the tumultuous treasury markets in the early days of the Covid-19 pandemic. A need for cash had triggered a massive bond market sell-off, which the Fed helped cover through its liquidity programs.
The central bank said the public will ask for comments on how to adjust the SLR in the future, but had decided to drop the exemption now, as planned.
“The Board will take appropriate action to ensure that any changes to the SLR do not affect the overall strength of banks’ capital requirements,” the Fed said in a statement.
Fed officials said they will seek input on how best to adjust the ratio at a time when reserves are running at historically high levels.
Wall Street has lobbied extensively for an extension of the exemption as banks have been inundated with deposits requiring them to offset capital with client money.
Bank stocks were significantly lower after the announcement, but government bond yields had changed little.
“It’s surprising. You can see it to some extent in the response of the markets. said Michael Schumacher, head of rates strategy at Wells Fargo.
Schumacher noted that banks are larger holders of 5-year Treasury bonds, the yields of which increased slightly after the announcement.
By deciding not to extend the SLR hiatus, the Fed risks further hikes in interest rates, as banks could decide to sell some of their Treasury bills so they don’t have to maintain reserve requirements. Fed officials say the Treasury market has stabilized and Friday’s decision shouldn’t change that.
However, Fed officials say banks are still well capitalized, even without the exception, and they don’t believe banks need to sell their treasury to meet reserve requirements. The largest banks have about $ 1 trillion in capital, and withdrawing the SLR lighting will only marginally adjust those levels, Fed officials said.
The additional leverage ratio is a product of post-financial crisis banking reforms that prevented banks from taking too much risk. Fed officials are concerned that a relaxation of the ratio could encourage banks to use risky assets like junk bonds, which carry as much weight as reserve requirements as safer holdings.
—Patti Domm contributed to this report