The Federal Reserve on Friday refused to extend a pandemic-era rule that relaxed the amount of capital that banks had to hold against Treasury bills and other equity, in a measure 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 31. The initial move, announced on April 1, 2020, allowed banks to exclude Treasury bills and deposits at Fed banks from the calculation of the leverage ratio.
The decision to relax capital requirements was widely seen as the key to calming the Treasury markets that had been in turmoil in the early days of the Covid-19 pandemic. The need for money had caused a massive sale in the bond market that the Fed helped cover through its liquidity programs.
The central bank said it would request public comment on how to adjust the SLR in the future, but decided to let the exemption expire now, as planned.
“The Council will take appropriate measures to ensure that any changes to the SLR do not undermine the overall soundness of the bank’s capital requirements,” the Fed said in a statement.
Fed officials said they would seek information on how best to adjust the ratio at a time when reserves are operating at historically high levels.
Wall Street had been lobbying heavily for an extension of the exemption, as banks were inundated with deposits that compel them to hold off against the client’s money.
Banks’ shares plummeted after the announcement, but yields on government bonds have changed little.
“It’s surprising. You can see it to some extent by the reaction of the markets. I think some people imagined that if the Fed were to eliminate it, they would give more than 12 days.” said Michael Schumacher, head of fee strategy at Wells Fargo.
Schumacher noted that banks are the largest holders of 5-year Treasury notes, whose yields rose slightly after the announcement.
By deciding not to extend the breach of the SLR, the Fed risks a further increase in interest rates, as banks may decide to sell some of their holdings in treasury so that they do not have to maintain reserve requirements. Fed officials say the Treasury market has stabilized and Friday’s decision is unlikely to change that.
However, Fed officials say banks are still well-capitalized, even without the exception, and do not believe that banks will need to sell their Treasury bills to meet reserve requirements. The largest banks have about $ 1 trillion in capital, and rescinding the reduction in the SLR will adjust these levels only marginally, Fed officials said.
The supplementary leverage ratio is a product of post-financial crisis banking reforms that sought to ensure that banks did not take too much risk. Fed officials fear that easing the relationship could encourage banks to overburden themselves with risky assets, such as junk bonds, that have the same weight in reserve requirements as safer stakes.
—Patti Domm contributed to this report.