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MNI EXCLUSIVE:Fed To Extend Capital Relief, Eyes Permanent Fix

MNI (Washington)
WASHINGTON (MNI)

U.S. regulators are keen to avoid tightening banks' capital standards and to safeguard a still-fragile Treasury market.

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U.S. regulators including the Federal Reserve are likely to extend a temporary rule easing banks' supplementary leverage ratios for several months more amid concerns that a return to higher capital standards would crimp the flow of credit to a still-convalescent economy, an industry source and former regulatory officials told MNI.

Officials will also debate permanent concessions to banks at a time of unprecedented expansion of reserves from QE, despite objections from Democratic lawmakers that easier SLR rules weaken the post-crisis financial stability framework, sources said.

Last week's bond sell-off serves as a fresh reminder of the fragility of the Treasury market despite massive interventions since last spring, and the Fed would not want to allow SLR relief to lapse this month only to be forced to resurrect it soon after, sources said.

"It is extremely likely that the SLR exemption will be extended, but for how long the reprieve will go might depend on what we see in Treasuries, liquidity funding, repos, and how the United States fares more broadly in the economy in the next two calendar quarters after the March 31 deadline," John Popeo, a consultant who spent a decade in various roles at the Federal Deposit Insurance Corporation and the Boston Fed, told MNI. "I would expect a two-quarter delay at least."

LOANS DIP

Under the temporary reprieve last year, lenders were allowed to exclude cash and Treasuries from their assets to meet the capital-to-assets ratio, set at 3% or 5% for the largest systematically important institutions. This came as reserves more than doubled to USD3.4 trillion since the start of the pandemic, leaving lenders with stockpiles of cash, Treasuries and other assets that put downward pressure on SLR.

The change was also meant to free up capital for lending to businesses and consumers, but banks have reduced the portion of their balance sheets dedicated to loans to a multi-decade low in recent months -- another reason some lawmakers oppose the extension of relief.

"It was supposed to be temporary and it was controversial when they did it. It was aimed at expanding banks' capacity to lend and that hasn't happened," Sheila Bair, former chair of the Federal Deposit Insurance Corporation, told MNI.

Banks have argued that loan demand has been extraordinarily weak during the pandemic and lenders are hesitant to go down the credit spectrum.

"There's a fair argument that banks need to expand their capacity as dealers to absorb Treasury debt," Bair added, but the Fed could limit SLR relief to elevated Treasury balances rather than extend the exemptions wholesale.

PERMANENT SOLUTION

But that proposal and other ideas for modifications may not meet Basel requirements in a way that they can made permanent after the Covid crisis passes, former regulators said.

The Fed and the Office of the Comptroller of the Currency in 2018 approved a proposal to loosen the SLR for the biggest banks by replacing their 2% add-on with a lower surcharge tied to a measure of riskiness. But Fed Governor Lael Brainard voted against the move and the FDIC did not join the proposal, which was never finalized. It would likely face blowback again in the current political climate.

Fed Board General Counsel Mark Van Der Weide told a bankers conference Tuesday that the central bank is "in the process now of figuring out what to do next" on SLR and also "thinking through" the best design for a "permanent SLR."

"We are going to be doing a lot of work on the leverage ratio" this year, he said, "and making sure we have the leverage ratio in the right place."