The Federal Reserve on Friday refused to extend a pandemic-era rule, which relaxed the amount of capital banks it had to hold against Treasurys and other holdings, in a move that could upset Wall Street and the bond market.
In a brief announcement, the Fed said it would allow an additional leverage change to expire on March 31. The initial move, announced on April 1, 2020, allowed banks to exclude treasuries and deposits with Fed banks from the calculation of the leverage ratio. .
The decision to relax capital requirements was widely seen as the key to calming what had been the tumultuous Treasury markets in the early days of the Covid-19 pandemic. The need for cash has led to a massive sell-off on the bond market, which the Fed has helped cover through its liquidity programs.
The central bank said it would ask for public comment on how to adjust the SLR in the future, but decided to let the exemption expire now, as planned.
“The board will take appropriate steps to ensure that any changes to the SLR do not erode the overall strength of bank capital requirements,” the Fed said in a statement.
Fed officials said they would look for information on how best to adjust the ratio at a time when reserves are at historically high levels.
Wall Street has been pushing hard for an extension of the exemption, as banks have been flooded with deposits that require them to hold offsetting capital against customers’ money.
Bank shares were largely lower following the announcement, but government bond yields were little changed.
“It’s surprising. You can see to some extent from the reaction of the markets. I think some people thought that if the Fed killed it, it would give it more than 12 days.” said Michael Schumacher, head of tariff strategy at Wells Fargo.
Schumacher noted that banks are larger holders of 5-year treasury bills, the yield of which has increased since the announcement.
When it decides not to extend the SLR break, the Fed risks further raising interest rates, as banks may decide to sell some of their holdings in the Treasury so that they do not have to maintain reserve requirements. Fed officials say the Treasury market has stabilized and Friday’s decision should not change that.
However, Fed officials say banks are still well-capitalized even without exception, and they do not believe banks will have to sell their treasuries to meet reserve requirements. The largest banks have a capital of about $ 1 trillion, and the cancellation of the SLR exemption will adjust these levels only marginally, Fed officials said.
The additional leverage ratio is a product of post-financial banking reforms that have sought to ensure that banks do not take too many risks. Fed officials worry that easing the ratio could encourage banks to charge risky assets, such as unwanted bonds, which have the same share of reserve requirements as safer holdings.
—Patti Domm contributed to this report.