The Federal Reserve on Friday refused to extend a rule from the pandemic era that relaxed the amount of capital banks they had to maintain against Treasurys and other stocks, in a move 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, enabled banks to exclude Treasury and deposits with Fed banks from the calculation of the leverage ratio. .
The decision to relax capital requirements is widely regarded as the key to calming the turbulent treasury markets in the early days of the Covid-19 pandemic. A need for cash caused a huge sell-off in the bond market that helped the Fed cover through its liquidity programs.
The central bank said it would seek public comment on how to adjust the SLR in the future, but decided to postpone the release, as planned, now.
“The Board will take appropriate steps to ensure that any changes to the SLR do not erode the overall strength of the bank’s capital requirements,” the Fed said in a statement.
Fed officials have said they will seek input on how to best adjust the ratio at a time when reserves are running at historically high levels.
Wall Street has strongly advocated for the extension of the exemption, as banks have been flooded with deposits that require them to keep capital offsets against customers’ money.
Bank shares were largely lower after the announcement, but government bond yields have changed little.
“It’s amazing. You can see it to some extent from the reaction of the market. I think some people thought that if the Fed killed it, it would give it more than twelve days.” says Michael Schumacher, head of tariff strategy at Wells Fargo.
Schumacher noted that banks are larger holders of 5-year treasury bonds, the yield of which is higher after the announcement.
By deciding not to extend the SLR cut, the Fed is running a further rate hike, as banks may decide to sell some of their treasury holdings so they do not have to maintain the reserve requirements. Fed officials say the Treasury market has stabilized and Friday’s decision may not change that.
However, Fed officials say banks are still well-capitalized without exception, and they do not believe banks will have to sell their treasury to meet reserve requirements. The Fed said the largest banks have about $ 1 billion in capital and that the SLR relief will be withdrawn.
The supplementary leverage ratio is a product of banking reforms after financial crisis aimed at ensuring that banks do not risk too much. Fed officials are concerned that easing the ratio could encourage banks to upload risky assets such as junk bonds, which carry the same weight against the reserve requirements as safer ownership.
—Patti Domm contributed to this report.