Rolling Back Relief

With the Covid-19 pandemic, it became necessary to give banks some leeway in their capital provisioning norms - just to make sure the credit was well flowing through the markets. In the US, this took the form of the Fed slashing the Supplementary Leverage Ratio (SLR), inter alia. This metric requires US banks to maintain tier 1 capital equal to about 3% of their total assets (including complex derivative exposures). The requirement is 5% for the ‘too big to fail’ systemically important banks. Now the relief offered on this term is being rolled back, and banks are so-not okay with it.

Opportunity Costs We’re Not Talking About

The Fed decided to ease the mandated requirement in the wake of the pandemic - credit growth was the priority. So banks were allowed to ‘not hold’ any capital against their assets in the form of Treasury bonds and reserves. Note that these are government securities - deemed to be ‘riskless instruments’. However, things are different now - the pandemic is receding, the economy is ticking up and it’s time to ensure the capital buffers are adequate. Another 2008-07 type financial crisis is the last thing we want right now. Hence, starting March 31, the Fed wants banks to start setting aside that capital again. The banks’ take on this - if government securities are riskless anyway, why waste capital providing a buffer for it, instead of lending it and enhancing credit flow?

Quite a High Price to Pay

?And that’s not the only solid argument for permanently doing away with this requirement. Asking banks to provision against Treasury bonds is ‘too much to ask for’ at this point. The government has issued a huge amount of debt to meet its fiscal needs and banks hold a large quantum of this debt. Nudging banks to offload the Treasury bonds (by imposing the requirement again) will lead to a spike in yields. In case of the capital requirement against reserves - as the bank's reserves with the central bank have increased by $2 trillion, this would mean setting aside capital to the tune of $100 billion. Well, whatever be the reasons not to go with tightening the norms, central bank regulation won’t flinch. However, the Fed has promised some relief by easing how the leverage ratio is calculated.