Fed unveils proposal to ease bank leverage requirements

The Federal Reserve unveiled a proposal to ease bank leverage requirements by overhauling the enhanced supplementary leverage ratio, tying capital requirements for large global banks to their systemic footprint rather than a flat percentage. This initiative aims to boost U.S. Treasury market participation and enhance market resilience, potentially reducing capital for depository institution subsidiaries by an average of 27% ($213 billion) and global bank holding companies by 1.4% ($13 billion), though capital is intended for internal reallocation rather than shareholder payouts. While supported by Fed leadership as a prudent adjustment to post-crisis rules, two governors plan to oppose the measure, citing concerns over the significant capital reduction and skepticism regarding its efficacy in improving Treasury market activities.

Analysis

The Federal Reserve has proposed a significant overhaul of the enhanced supplementary leverage ratio (eSLR), aiming to improve liquidity in the U.S. Treasury market by making the rule more risk-sensitive. The proposal would shift capital requirements for large global banks from a flat percentage against all assets to a model tied to each firm's systemic importance, specifically half of their GSIB surcharge. This change is projected to release substantial capital at the subsidiary level, with depository institutions seeing an average capital requirement reduction of 27%, or $213 billion. However, the impact on bank holding companies is minimal, with a 1.4% or $13 billion reduction, as Fed officials state the freed capital is intended for internal reallocation to support market-making activities rather than for immediate shareholder payouts. This regulatory easing, part of a broader deregulatory push, is not without internal opposition; Fed Governors Adriana Kugler and Michael Barr have signaled their intent to vote against the measure, expressing skepticism about its efficacy in improving Treasury market function and concern over the magnitude of the capital reduction.

Key Decisions for Investors

• Investors in large U.S. banks should view this proposal as a net positive for operational flexibility, as it could allow firms to reallocate capital more efficiently from low-risk assets to higher-return activities, even if direct capital returns to shareholders are constrained.
• Monitor developments in the U.S. Treasury market for signs of increased dealer capacity and tighter bid-ask spreads, as the successful implementation of this rule could reduce transaction costs and systemic risk during periods of market stress.
• Factor in the noted regulatory uncertainty, as the dissent from two Fed Governors, including the former Vice Chair for Supervision, signals potential for the rule to be modified or challenged under a future administration.