Divided Fed proposes rule to ease capital requirements for big Wall Street banks

The Federal Reserve has proposed easing its enhanced supplementary leverage ratio (eSLR), a key capital rule, which would reduce top-tier capital requirements for large banks by approximately 1.4%, totaling $13 billion for holding companies and $210 billion for subsidiaries. Supported by Fed Chair Powell and other officials, this adjustment aims to enhance Treasury market liquidity and alleviate the perceived penalty on banks for holding low-risk assets like Treasuries. However, Governors Kugler and Barr dissented, contending the proposal is unlikely to bolster stability during stress events and may instead incentivize banks to prioritize shareholder distributions or higher-return activities over increased Treasury intermediation.

Analysis

The Federal Reserve has proposed a material easing of the enhanced supplementary leverage ratio (eSLR), a key post-crisis capital rule for globally systemic important banks. The proposal would reduce top-tier capital requirements for holding companies by 1.4%, equivalent to approximately $13 billion, and lower the requirement for subsidiaries by $210 billion, with the new capital range set at 3.5%-4.5% from the current 5%-6%. Proponents, including Fed Chair Jerome Powell and Vice Chair Michelle Bowman, argue this adjustment is necessary to alleviate the binding constraint the eSLR places on banks holding low-risk assets, thereby enhancing U.S. Treasury market liquidity and resilience. They contend the current rule perversely penalizes banks for holding safe government debt. However, the proposal faces notable dissent from within the Fed, with Governors Adriana Kugler and Michael Barr arguing against it. Their primary concern is that the freed-up capital will not be deployed to increase Treasury market intermediation as intended, but will instead be directed towards shareholder distributions or higher-return activities, thus failing to improve market stability during times of stress and potentially weakening the financial system's safety net.

Key Decisions for Investors

• Investors should view this proposal as a net positive for large U.S. banks, as it directly frees up capital that can be deployed for shareholder returns or other investments, and should identify banks for which the eSLR is currently the most binding constraint.
• Monitor bank capital allocation announcements following the potential rule change; a significant pivot towards share buybacks and dividends over increased Treasury holdings would validate the concerns raised by dissenting Fed governors and may indicate short-term shareholder gain at the expense of long-term systemic stability.
• Track key indicators of Treasury market liquidity and bank intermediation to assess whether the policy achieves its stated goal, as failure to improve market function could lead regulators to reconsider this easing in the future.