On Friday, the Federal Reserve refused to extend a pandemic-era rule that relaxed the amount of capital banks they had to hold against Treasurys and other holdings, to an extent that could upset Wall Street and the bond market.
In a brief announcement, the Fed said it would allow a change in the supplementary leverage ratio to expire on March 31st. The initial move, announced on April 1, 2020, allowed banks to exclude treasury and bank deposits from the Fed from the leverage ratio calculation. .
The decision to relax capital requirements has been widely seen as key to calming what had been the tumultuous Treasury markets in the early days of the Covid-19 pandemic. The need for cash had led to a massive sale in the bond market that the Fed helped cover through its liquidity programs.
The central bank said it would solicit public comment on how to adjust the SLR in the future, but had decided to leave the expiration now, as planned.
“The Board will take appropriate action to ensure that any changes to the SLR do not erode the overall soundness of bank capital requirements,” the Fed said in a statement.
Fed officials said they will look for information on how best to adjust the ratio at a time when reserves are operating at historically high levels.
Wall Street had been pushing hard for an extension of the exemption, as banks have been inundated with deposits forcing them to keep capital offset by customers ’money.
Bank shares were largely lower after the announcement, but government bond yields varied little.
“It’s amazing. It can be seen to some extent by the reaction of the markets. I think some people thought that if the Fed killed him, they would give him more than 12 days.” said Michael Schumacher, head of tax strategy at Wells Fargo.
Schumacher noted that banks are the largest holders of five-year Treasury bills, whose performance increased after the announcement.
By deciding not to extend the breakdown of SLRs, the Fed risks a further rise in interest rates, as banks may decide to sell some of its holdings in the Treasury, so they do not have to maintain reserve requirements. Fed officials say the Treasury market has stabilized and Friday’s decision should not change that.
However, Fed officials say banks still have a good capitalization, even without exception, and do not believe banks should sell their treasures to meet reserve needs. Larger banks have about $ 1 trillion in capital and terminating the relief of SLRs will adjust these levels only marginally, Fed officials said.
The complementary leverage ratio is the product of post-financial banking reforms that sought to ensure that banks did not take too many risks. Fed officials are concerned that the easing of the ratio could encourage banks to carry risky assets such as junk bonds, which carry the same weight with respect to reserve requirements as safer holdings.
—Patti Domm contributed to this report.