Enhanced supplementary leverage ratio applied to eight G-SIBs needs to be recalibrated, says the Bank Policy Institute.

The Bank Policy Institute (BPI) is calling for the enhanced supplementary leverage ratio (eSLR) applied to the eight global systemically important banks (G-SIBs), adopted in 2014 by the US Federal Reserve Board, to be recalibrated so it acts more as a backstop for risk-based capital requirements and less of a binding capital constraint.

The eight US G-SIBs are Citigroup, JPMorgan Chase, Bank of America, Bank of New York Mellon, Goldman Sachs, Morgan Stanley, Wells Fargo, and State Street.

The bank advocacy group said in a note on March 3, that a binding eSLR had created unintended consequences, such as reducing demand for safe assets and disincentivises banks from providing liquidity to US Treasury markets.

Reserve balances have ballooned since the onset of the Covid-19 event and are expected to surpass $5tn by the end of 2021

The Bank Policy Institute

In 2014, the Fed argued that some of the consequences would be offset by a decline in reserve balances — driven by a shrinkage in the Fed’s own balance sheet — and would help make the leverage ratio more of a backstop to risk-based requirements.

“Instead, reserve balances have ballooned since the onset of the Covid-19 event and are expected to surpass $5tn by the end of 2021 (compared with $2.6tn in 2014), and remain elevated for the foreseeable future,” the authors wrote, warning that failure to do so could result in further disruptions to the US Treasuries market. 

Low-risk activities

In April 2020, the Fed decided to temporarily exclude reserve balances and US Treasuries from the denominator of the eSLR to make it easier for banks to support the economy during the Covid-19 pandemic.

The BPI said this encouraged banks to engage more in low-risk balance sheet activities, such as making markets in Treasuries and providing related repo financing. “Indeed, banks’ holdings of Treasuries- and agency mortgage-backed securities increased nearly $670bn, or about 41% over the course of 2020. During the same period, reserve balances held by those banks increased from $530bn to $1.14tn,” the note’s authors wrote.

As a result they are calling upon the Fed to extend the exclusion for reserve balances and US Treasuries from the SLR denominator. “This extension would mitigate the effect of the Federal Reserve’s balance sheet growth on intermediation by bank holding companies,” they wrote, adding that the extension should last until the banking agencies agree on a long-term solution to make leverage capital requirements a backstop to risk-based requirements once again.

This article first appeared in The Banker’s sister publication Global Risk Regulator.


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