Treasury's Liang floats recurring leverage ratio relief

Bloomberg News

WASHINGTON — Nellie Liang, undersecretary for domestic finance at the Treasury Department, said that bank regulators should consider modifying limits on the overall amount of leverage a bank can assume, to help banks better support market liquidity during periods of stress without reducing overall capital requirements.

Speaking at the Psaros Center's Financial Markets Quality Conference at Georgetown University Tuesday, Liang said potential options could include excluding central bank reserves from the SLR calculation and adjusting the ratio in response to economic or market conditions.

"During the march 2020 event the Fed did relax the whole supplementary leverage ratio for one year to allow the markets to resume smooth functioning," she said. "I think if it were on a pre-planned, expected basis, it could even be more … useful and have a broader impact."

The SLR is a non-risk-weighted capital requirement designed to ensure banks hold adequate capital against all of their assets and measures a bank's core capital — or Tier 1 capital — relative to its total leverage exposure.

The SLR ensures that banks maintain a minimum level of capital as a buffer against losses, regardless of the riskiness of their assets. Banks that fall under the Federal Reserve's prudential standards are generally required to keep a minimum SLR of 3% and the eight U.S. global systemically important banks must maintain a ratio of at least 5%.

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Liang recalled how in the early days of the pandemic, banks began holding more Treasuries as investors sold off securities and shifted to cash. This influx of deposits and Treasury holdings increased the capital banks needed to maintain under the SLR. 

However, in April of that year the Fed issued a temporary final rule that would temporarily exclude U.S. Treasuries and deposits at Federal Reserve Banks from the calculation of the SLR. The rule expired as originally scheduled in March 2021, but regulators' exclusion of banks' Treasury holdings and reserves from the calculation relieved many banks from the additional capital requirement.

A paper from Fed affiliated researchers noted that while the relief was viewed positively by the industry, such feedback "admittedly provides a partial and imperfect lens to assess the efficacy of such a policy."

Liang noted, however, that any action on revising the SLR would take a backseat to the ongoing revision of risk-weighted capital requirements for large banks, which regulators are currently addressing under the Basel III endgame proposal. This proposal has already sparked significant debate, with large banks arguing that higher capital requirements will limit their ability to lend, despite some adjustments regulators have made in response to industry concerns. The revisions are likely to cut additional capital requirements for the largest banks in half while still tightening certain oversight of risk-weighted assets.

"Basel III has been a big part of the discussions for the last year," Liang said. "SLR is not part of that. It would not get addressed until after Basel three was discussed."