Just as memories of the financial crisis are fading and tough new banking regulations are beginning to bite, some current and former regulators wonder whether one of the rules is too much of a burden for markets and taxpayers. At issue is the requirement that the largest US banks set aside $6 of capital for every $100 of assets on their books – double what they had to hold before. Because this so-called Supplementary Leverage Ratio (SLR) rule applies to all bank assets including Treasuries, it has made owning that ultra-safe government debt and related trades more expensive.
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Wall Street has complained about costs of many measures designed to make the financial system safer, but regulators have been firm. However, when banks argue that the SLR, which came into force early last year, unnecessarily burdens short-term financing, current and former officials say they may have a point.
“It has turned out to be quantitatively more of a problem than some people had anticipated,” said Jeremy Stein, who was a Fed governor when the supplementary leverage ratio was adopted. Stein left the central bank for Harvard University in 2014.
Any softening of the regulation could signal that, nearly a decade after Wall Street’s meltdown sparked a global recession, a safety-first approach may be giving way to a more nuanced one where costs play a greater role in regulators’ considerations.
Privately, some regulators are now asking themselves whether the cost of complying with the rule may diminish its benefits, according to people familiar with internal discussions. The Federal Reserve and other central banks are analyzing the rule and its impacts.
The Fed and other US bank supervisors acknowledge that some short-term lending has disappeared since the rule’s introduction. They differ, though, over how much SLR should be blamed and whether any adjustments are needed.
New York Fed President William Dudley, whose branch of the Fed is studying the effects of SLR, has pointed out that the rule has curbed banks’ repo funding, but like other regulators he has held back with recommending changes.
SLR may come up as a topic on Monday when Dudley meets regulators from the Securities and Exchange Commission, the US Treasury and other agencies along with senior bank and market officials to discuss the health of the US Treasury market.
Small Change, Big Impact
The rule’s impact is most visible in the US repo market, where financial institutions and central banks park and borrow short-term funds by agreeing to sell and buy back US Treasuries. (Graphic: http://tmsnrt.rs/2eg3boF)
Since banks are required to set aside the same percentage of capital whether they lend to a car buyer or the US government, holding Treasuries became more expensive and prompted banks to scale back their repo operations.
That has depressed volumes, which for large and mid-sized banks have fallen to about $1.2 trillion in January 2016, from about $1.7 trillion in January 2013, according to a New York Fed presentation.
Big players, such as Goldman Sachs & Co, Citigroup Inc, Bank of America Corp and JPMorgan Chase & Co are among those most affected.
Stanford University professor Darrell Duffie estimates in his research that bid-ask spreads in repo markets have risen four-fold over the last two years, reflecting rising trading costs for hedge funds and others relative to money market funds.
The rule can also come at a cost to taxpayers.
In nearly two years big banks have had to set aside more capital for holding government debt, Treasury yields have inched up. JPMorgan estimates that higher interest payments will add up to $260 billion over the next decade.
A group representing the world’s major central banks and chaired by Dudley is already examining how bank rules can hinder the trade of government debt in key markets.
The Committee on the Global Financial System (CGFS), a subgroup of the Bank for International Settlements in Basel, Switzerland, is expected to issue its findings early next year, according to people familiar with its work.
In August, the Bank of England eased its own reserve rules, excluding cash and short term loans held at the bank and other assets from its leverage calculation.
In the United States, advocates for leading Wall Street propose exempting government bonds from the leverage rule, arguing they are far safer than other assets. Some regulators say, however, that making such an exemption would be unwise and may not be necessary. They argue that other changes in money market rules and the Fed’s own repo activities may have caused changes in market trading.
“If you start carving out assets you are making value and political judgments,” Tom Hoenig, vice chairman of the Federal Deposit Insurance Corporation and an outspoken advocate for strong capital standards, told Reuters in an interview.
“A leverage ratio can only work if there are no exclusions.”
But Duffie told Reuters there was “a lot of second-guessing” among regulators. “Most will say ‘we wish we hadn’t gone this far but we are here and it’s very difficult to modify the rule.”
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