The Federal Reserve Board’s decision on Wednesday sent shockwaves through the financial sector, as it voted to advance a proposal that would lower capital requirements for the nation’s largest banks—a move supporters say will strengthen the U.S. Treasury market, but which critics warn could weaken the banking system’s defenses.
At the center of the debate is the enhanced supplementary leverage ratio (eSLR), a rule first implemented in the wake of the 2008 financial crisis as part of the Basel III reforms. The eSLR was designed to ensure that large banks, including giants like JPMorgan Chase, Bank of America, and Goldman Sachs, maintained a robust capital buffer against all their assets, even those considered low-risk, such as U.S. Treasury securities. According to Bloomberg, the current rules require holding companies to keep a capital ratio of 5%, and their banking subsidiaries 6%.
For years, big banks have argued that these requirements tie up capital that could otherwise be used to facilitate trading in the $29 trillion Treasury market, especially during periods of market stress. The industry has lobbied for relief, claiming the eSLR has become a binding constraint that limits their ability to act as intermediaries and support market liquidity. The SLR was originally intended as a backstop, but bankers contend it now impedes their ability to respond flexibly during times of volatility.
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The Trump administration had previously pushed for changes that would encourage banks to invest more heavily in longer-term Treasury Notes by exempting those holdings from reserve requirements. The hope was that greater demand for these notes would push down yields, lower borrowing costs for the government, and stimulate economic activity through reduced interest rates on loans.
On Wednesday, the Fed Board voted 5-2 to propose changes to the eSLR, reducing the capital requirement for holding companies to a range of 3.5% to 4.5%, down from 5%. Subsidiaries would see their requirement lowered to the same range from 6%, according to the Business Times3. The proposal, jointly issued with the Office of the Comptroller of the Currency, will be open for public comment for 60 days.
Fed Chair Jerome Powell, in remarks before Congress, said, “It would be better if we had a leverage ratio that was a backstop rather than a binding thing, and that’s what this proposal is going to do,” emphasizing that the changes are intended to restore the eSLR to its original role as a safeguard, not a primary constraint on lending. Michelle Bowman, the Fed’s vice-chair for supervision, echoed this view, stating, “The proposal will help to build resilience in US Treasury markets, reducing the likelihood of market dysfunction and the need for the Federal Reserve to intervene in a future stress event.”.
Not everyone on the Board agreed. Michael Barr, Bowman’s predecessor, warned that the proposed changes would weaken the eSLR and reduce bank-level capital by $210 billion for the largest global banks, raising the risk of bank failures and higher losses for the Deposit Insurance Fund. Board member Adriana Kugler also dissented, saying she was not convinced the benefits to Treasury market intermediation justified the significant reduction in tier 1 capital requirements, especially given the potential for increased financial stability risks.
The proposal does not go as far as some in the industry might wish; it will not exclude Treasury securities and deposits at Fed banks from the SLR calculation, as was temporarily allowed during the COVID-19 pandemic. However, the Fed is seeking public input on alternatives, including the possibility of excluding Treasuries held for trading or all U.S. Treasuries and reserves from the calculation.
As the 60-day comment period begins, the financial industry and regulators alike will be watching closely to see whether the proposed easing of capital rules will strike the right balance between supporting Treasury market resilience and maintaining the safety and soundness of the banking system.
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