The Federal Reserve on Friday declined to extend a pandemic rule that eased the number of capital banks to be held vis-à-vis Treasurys and other holdings, which could upset Wall Street and the bond market.
In a brief announcement, the Fed said it would allow the leverage ratio to change until March 31st. The first step, announced April 1, 2020, allowed banks to exclude government bonds and deposits with Fed banks from the leverage ratio calculation.
The decision to relax capital requirements was widely seen as key to calming turbulent financial markets in the early days of the Covid-19 pandemic. The need for cash had led to a massive sell-off in the bond market, which the Fed covered with its liquidity programs.
The central bank announced that it would ask for a public statement on the future adjustment of the additional leverage ratio, but had decided to allow the exemption to expire now as planned.
“The Board of Directors will take appropriate steps to ensure that changes to the SLR do not affect the overall strength of the bank’s capital requirements,” the Fed said in a statement.
Bank stocks were significantly lower after the announcement, dragging the broader market down, but government bond yields were mixed.
Fed officials said they would be looking for information on how best to adjust the ratio when reserves are at historically high levels.
Wall Street had campaigned heavily for an extension of the exemption as banks were flooded with deposits where they had to hold the counter capital against customer funds.
“It’s surprising. You can tell, to some extent, from the reaction of the markets. I think some people thought if the Fed killed it they’d give it more than 12 days.” said Michael Schumacher, director of interest rate strategy at Wells Fargo.
Schumacher noted that banks are larger holders of 5-year Treasury bills, the yields of which turned out to be higher after the announcement.
In deciding not to extend the SLR hiatus, the Fed risks another hike in interest rates as banks may decide to sell some of their treasury holdings so they don’t have to meet reserve requirements. Fed officials say the financial market has stabilized and Friday’s decision shouldn’t change that.
However, Fed officials say banks, without exception, are still well capitalized and they don’t believe banks will have to sell their government bonds in order to meet reserve requirements. The largest banks have around $ 1 trillion in capital, and the lifting of the SLR relief will only marginally adjust these levels, Fed officials said.
The additional leverage ratio is a product of post-Great Recession banking reforms to ensure banks do not take too much risk. Fed officials fear that easing the ratio could lead banks to reload risky assets like junk bonds, which weigh the same weight against reserve requirements as safer stocks.
– Patti Domm contributed to this report.