The Federal Reserve (Fed) announced on Wednesday (June 25) its plan to relax a key regulation, allowing large banks to hold fewer capital reserves when holding low-risk assets such as US Treasuries, in order to boost trading and liquidity in the Treasury market.
On Wednesday, Fed officials passed the proposal by a vote of 5 to 2, significantly lowering the “enhanced supplementary leverage ratio” (eSLR) and opening a 60-day public comment period.
The eSLR was introduced by the Fed in the aftermath of the 2008 financial crisis as a banking regulatory indicator to measure the leverage and capital adequacy of large banks in order to strengthen their resilience amid market volatility.
Implemented in 2014, the eSLR requires large banks to maintain a certain ratio of high-quality capital (such as common equity or retained earnings) regardless of the risk level of their assets, serving as a baseline to control the overall leverage of banks.
However, over the past decade, banks have increasingly held more low-risk assets, making this ratio more constraining.
Fed Chair Jerome Powell stated, “This leverage ratio has become increasingly binding, giving us reason to reassess the original design.”
According to the proposal, the primary capital ratio of the 8 US institutions designated as Global Systemically Important Banks (GSIBs) will be lowered from the current 5% to between 3.5% and 4.5%, freeing up an estimated $13 billion in capital. At the same time, the capital ratio of their subsidiary entities will be reduced from 6% to between 3.5% and 4.5%, releasing approximately $210 billion.
However, the Fed emphasized that even with the decrease in subsidiary capital, the parent company remains subject to other regulatory constraints, ensuring that overall risk control mechanisms are still in place.
This reform will align the capital requirements of large US banks more closely with standards in European, Chinese, Canadian, and Japanese markets.
Nevertheless, the proposal has sparked internal divisions within the Fed. Supporters include Chair Powell, Vice Chair Michelle Bowman, and Governor Christopher Waller, who believe that this adjustment will enhance the resilience of the US Treasury market and reduce the need for Fed intervention in case of market issues.
Bowman stated that this reform will allow banks to allocate capital more efficiently.
However, two governors openly opposed the proposal, Adriana Kugler and former Vice Chair of Supervision Michael Barr.
Barr pointed out that this reform could increase the risk of large banks’ collapse and questioned whether it would indeed improve the stability of the Treasury market. He expressed concerns that banks might use the released capital for other high-risk or high-return businesses rather than strengthening the trading capabilities in the Treasury market.