U.S. Fed to let bank-leverage exemption expire this month, will review
rule
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[March 20, 2021] By
David Henry and Michelle Price
WASHINGTON (Reuters) - Big U.S. banks will
have to resume holding an extra layer of loss-absorbing capital against
U.S. Treasuries and central bank deposits from next month after the
Federal Reserve said on Friday it would not extend a temporary pandemic
regulatory break due to expire this month.
The Fed said it would, however, launch a formal review of the capital
rule, known as the "supplementary leverage ratio," due to concerns it is
no longer functioning as intended as a result of the central bank's
emergency COVID-19 monetary policy measures.
While the Fed's decision to review the rule is a win for Wall Street
banks, which have long argued the leverage ratio is fundamentally
flawed, its refusal to extend the exemption, as many analysts had
expected, came as a disappointment.
Shares of the largest U.S. banks fell after the news, with JPMorgan
Chase & Co losing as much as 4% before closing down 1.6% on the day.
Bank of America Corp's and Citigroup Inc lost 1% and 1.1%, respectively.
"Wall Street bank stocks will get punished because now they will have to
put more money aside," Edward Moya, senior market analyst at foreign
exchange brokerage Oanda, said in an email.
He added, however, that the planned review of the leverage ratio "should
alleviate concerns that this is a final decision."
To ease Treasury market stress and encourage banks to lend to Americans
struggling amid lockdowns, the Fed last April excluded Treasuries and
central bank deposits from the leverage ratio until March 31.
Uncertainty over whether it would stick to that expiration date has
compounded anxiety in fixed income markets. Banks have warned that
allowing the rule to expire could push them to pull back from buying
government debt and from lending, potentially sparking another bout of
market turmoil.
The issue has become a political hot potato, with powerful Democrats
pressuring Fed Chair Jerome Powell to deny Wall Street what they say is
an unwarranted break that could increase systemic risks. They point out
that big banks have plenty of cash to buy back shares and issue
dividends.
"This is a victory for lending in communities hit hard by the pandemic,
and for the stability of our financial system," said Democratic Senator
Sherrod Brown, who had previously warned the Fed that extending the
exemption would be a "grave error."
Benchmark 10-year Treasury yields jumped around five basis points on the
announcement to 1.750%, nearing Thursday's the one-year high of 1.754%.
But Fed officials said they were confident that allowing the exemption
to expire would not impair Treasury market liquidity or cause disruption
because the market had stabilized and big banks are flush with capital.
BALLOONING BALANCE SHEET
The leverage ratio was adopted after the 2007-2009 financial crisis as a
safeguard to prevent big banks from manipulating other capital rules. It
requires them to hold additional capital against assets regardless of
their risk.
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The Federal Reserve building is pictured in Washington, DC, U.S.,
August 22, 2018. REUTERS/Chris Wattie/
But the ratio is rapidly becoming the primary limit on banks' balance sheets
which have swelled as a result of the Fed pumping cash into the economy amid the
pandemic.
In the last year, the Fed has nearly doubled its balance sheet to more than $7.7
trillion through around $3.4 trillion in bond purchases. That extraordinary
intervention, along with near-zero interest rates, aims to keep money flowing
through the banking system.
As a result, bank deposits at the Fed, known as reserves, have sky-rocketed to
$3.9 trillion since the pandemic began, according to Fed data from Thursday, and
are expected to increase by another $2 trillion before the Fed pares back
stimulus efforts.
“That pressure is pretty significant," said Gennadiy Goldberg, interest rate
strategist at TD Securities, adding it may cause banks to step away from "market
supporting roles."
Some banks might have to issue preferred shares to add enough capital in the
near term to handle the increasing deposits, which would dilute common stock by
1% to 2%, Glenn Schorr of Evercore ISI wrote in a note.
Banks say reserves and U.S. Treasuries are effectively risk-free and it makes
little sense to penalize them. (Graphic: Bank reserves held at the Fed have
skyrocketed,
The Fed indicated on Friday that it had heeded those complaints. Due to the
continued growth in reserves and Treasury issuance, it said it may recalibrate
the ratio "to prevent strains...that could both constrain economic growth and
undermine financial stability."
However, it added that any changes to the rule would not erode the overall
strength of bank capital requirements.
While the Fed's decision appears to be a neat compromise to appease both Wall
Street and progressive Democrats, the rule review, which will be subject to
public consultation, is likely to be a fraught and lengthy process, said
analysts.
Progressives, who say Powell is inclined to be too friendly to Wall Street on
regulatory issues, are generally skeptical of any attempt to crack open
post-crisis rules and may fight changes. That could leave the market in an
uncomfortable limbo, said analysts.
"Unless there is a fix relatively quickly, I think there’s going to be a lot of
caution in the market and a lot of concerns about volatility," said Goldberg.
(Reporting by David Henry and Michelle Price; additional reporting by Noor
Zainab Hussain, Karen Brettell, Pete Schroeder and Dan Burns; Editing by Andrea
Ricci, Marguerita Choy and Cynthia Osterman)
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