The capital requirement rules put in place after the 2008 financial crisis to ensure that big banks have enough capital to survive a financial crisis were relaxed last year to strengthen the financial system at the start of the pandemic. coronavirus.
The U.S. Federal Reserve has said it will reinstate capital requirements for large banks that have been relaxed as part of the Fed’s efforts to shore up the financial system in the early days of the coronavirus pandemic.
The Fed has said it will not extend relief from what’s called the additional leverage ratio beyond March 31. The easing of regulation was intended to give banks some flexibility in the assets they could hold to meet regulatory requirements during the pandemic turmoil, as banks suddenly had to write billions of dollars down. ready.
The banking sector had been pushing for an extension of the relief, but on Thursday the Fed said that since the easing of requirements last year, “the treasury market has stabilized.”
Shares of major Wall Street banks fell early in trading, with JPMorgan Chase and Wells Fargo down about 3%. The Dow Jones Industrial Average fell 263 points, or 0.8%. The 10-year Treasury yield rose to 1.74% from 1.70%.
The additional debt ratio forces the big banks to hold capital equal to around 3% of their assets. The required ratio is higher – 5% – for banks considered to be the most important for the overall financial system. The rule was adopted as part of regulatory reforms after the global financial crisis and recession of 2007-2008. The idea was to make sure that banks retain enough capital to survive market meltdowns.
Yet the rule has also been accused of amplifying the turmoil that erupted in financial markets a year ago when the pandemic first hit hard. Banks, foreign central banks and hedge funds, among others, had desperately sought to get rid of Treasuries and other bonds to raise liquidity. Treasury yields rose in response. To calm the credit markets, the Fed stepped in to buy hundreds of billions of dollars in treasury bills itself.
The financial industry argues that the rule discourages banks from holding Treasurys because it increases their assets and lowers their additional leverage ratio (SLR). This compromises their ability to act as intermediaries in the treasury market and facilitate trade, the banks say.
Another problem is that the Fed’s treasury purchases have flooded the banking system with liquidity reserves. These reserves reduce a bank’s SLR by increasing its assets. Total bank reserves now stand at nearly $ 3.5 trillion, up from around $ 1.5 trillion before the pandemic.
Treasury bills are considered low risk and cash reserves are considered risk free. But SLR, unlike other bank capital requirements, does not take risk into account.
A year ago, the Fed temporarily exempted Treasury securities and cash reserves from the SLR calculation. This exemption will expire on March 31. Bank lobbyists say that without an extension of the exemption, the big banks will be less likely to hold Treasury securities.
If this were to happen, interest rates could rise, making loans more expensive. The 10-year Treasury yield is used as a benchmark for mortgage rates and other borrowing costs. The banks also say that removing the exemption will discourage them from making loans, which would reduce their capital.
But some top Democrats in Congress are opposed to keeping the exemption, increasing the pressure the Fed is facing. Earlier this month, Senator Elizabeth Warren, Democrat of Massachusetts, and Senator Sherrod Brown, Democrat of Ohio, urged Fed Chairman Jerome Powell and other major banking regulators to reject pressure from the banks for an extension.
“The banks’ demands for an extension of this relief appear to be an attempt to use the pandemic as an excuse to weaken one of the most important post-crisis regulatory reforms,” the senators wrote.
If banks are worried about running out of capital, Warren and Brown said, they could strengthen their balance sheets by suspending dividend payments.
“We are also convinced that the thousands of community banks that are not subject to SLR requirements would be happy to take deposits that the big banks could reject,” they said.