For years, the largest banks in the United States have lobited against a rule created after the 2008 financial crisis designed to reinforce their stability and ensure that they could withstand major losses in times of turbulence.
This week, financial regulators led by the Federal Reserve agreed to flex this rule, starting what is expected to be a broad movement to loosen regulatory reins in Wall Street.
The rule in question, called the “supplementary leverage index”, requires creditors to maintain an easily accessible money reserve in relation to their total leverage. This includes assets such as treasury loans and titles, as well as exhibitions that do not appear on the bank’s balance, but generate revenue, as derivatives.
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This is not the first time the Fed has given a great time off to the banks in this regard. When financial markets collapsed at the beginning of the Covid-19 pandemic, the Fed offered a temporary relief for banks to have more freedom to lend companies and continue active in the important US government’s title market, at a time when the economy suffered a big shock.
But by relaxing the rule permanently-a decision approved by 5 votes to 2 on Wednesday-opponents warn that this can make the financial system more fragile, precisely when President Donald Trump policies feed extreme volatility.
“When you reduce capital requirements, it increases the leverage in the system, which, by definition, creates less resilience,” said Sheila Bairro, who chaired the Federal Deposit Insurance Corp. from 2006 to 2011. “You should have a really good reason to do that, and I don’t see that reason.”
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The proposal presented by financial regulators this week would reduce the required capital reserve for the eight largest banks, considered the most systemically important due to their size and connections to the global financial system.
These institutions, whose instability could cause damage to the world economy, have been required since 2014 to maintain an improved supplementary leverage rate of at least 5% of their total assets.
Change would reduce this rate to a range of 3.5% to 4.5%, which represents a reduction of US $ 13 billion, or 1.4% at the holding level.
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Jerome Powell, president of the Fed, voted in favor of the proposal, saying that it was “prudent” the Central Bank to reevaluate the previous rule and ensure that banks do not have a disincentive to participate in “low risk activities.”
The measure was immediately celebrated by bank lobbyists, who have been campaigning for years for regulators to relax the rule.
Greg Baer, CEO of the Bank Policy Institute, said the Fed proposal was a “first step to a more rational capital frame.” Kevin Fromer, president of the Financial Services Forum, said such changes would allow the largest US banks to be “more able to support market functions that impact companies and consumers across the country.”
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Two Fed directors opposed changes. Adriana Kugler, director, joined Michael Barr, who was previously vice president of supervision before leaving office in January, voting against the proposal.
Barr warned that the proposal would increase the risk of bank bankruptcy by “reducing unnecessary and significantly” the size of the security network. For subsidiaries of the largest banks, capital requirements would fall 27%, leading to a $ 210 billion reduction in capital.
A binding restriction?
At the center of the question is how much the supplementary leverage rate restricts the operational capacity of banks. The rule treats traditionally safe actives, such as Treasury titles, just as high -risk titles. If banks are about to have enough capital based on their assets, they cannot make shareholders payments or grant bonuses to executives. To avoid exceeding this limit, there is a risk of banks to stop receiving deposits, grant loans or buy Treasury Titles – all considered active.
During the pandemic, banks were able to exclude their leverage calculations their participation in treasure securities and the money kept in the Fed – also known as reserves. This was done to prevent the index from becoming a “binding restriction” and discouraging banks to stop government bonds.
Those who support the changes proposed by the Fed argue that banks will be able to stop more Treasury titles, relieving pressure on one of the world’s most important markets. This increase in demand by releasing bank balance sheets can raise the price of the Treasury securities, reducing income and, consequently, the government’s funding cost.
Treasury Secretary Scott Bessent, whose main goal is lower interest rates, said that flexing the leverage could lead to a drop in “dozens of base points” in the income of 10-year government securities. The income of these titles influences mortgage rates, credit cards and other loans.
However, according to Morgan Stanley analysts, most major banks are currently not limited by the leverage rate. Fulfilling other capital rules, most are already in accordance with the index. Therefore, analysts do not expect banks to “increase significantly” their participation in Treasury titles.
Bank of America strategies have reached the same conclusion. And data from the period when the index was flexible in 2020 do not show a clear response that banks increased their participation in treasure securities, partly due to other factors at stake at the time.
Senator Elizabeth Warren, Massachusetts Democrat, warned in an interview that banks will probably take steps to increase profits.
“The data show that whenever the regulations are relaxed, banks use this money for dividends and action repurchase,” she said.
“The biggest threat to the Treasury title market at this time is Donald Trump,” he said. “If he and Secretary Bessent really want to improve the functioning and efficiency of the title market, they should first abandon irresponsible economic policies that feed concerns in the market.”
“The last one that the Fed should make is to weaken a rule that would serve as a shock in case of economic shock,” Warren added.
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