By Andrew Ackerman
WASHINGTON -- The Federal Reserve said it was ending a yearlong reprieve that had eased capital requirements for big banks, disappointing Wall Street firms that had lobbied for an extension.
Friday's decision means banks will lose the temporary ability to exclude Treasurys and deposits held at the central bank from lenders' so-called supplementary leverage ratio. The ratio measures capital -- funds that banks raise from investors, earn through profits and use to absorb losses -- as a percentage of loans and other assets. Without the exclusion, Treasurys and deposits count as assets. That will likely force banks to hold more capital or reduce their holdings of those assets, both of which could ripple through markets.
Analysts have been keying on the issue, which is widely viewed on Wall Street as carrying potential implications for markets from bonds to stocks to commodities.
Some analysts had warned that the exemption's sunset could add to volatility in the $21 trillion market for U.S. government bonds at a time when Wall Street is concerned that heavy debt issuance to pay for federal stimulus spending and other Biden administration priorities would amplify t he 2021 increase in Treasury yields.
But the Fed said it would consider a broader revamp of the rules and banks aren't immediately expected to change their activity, tempering the market reaction Friday. The yield on the 10-year Treasury note was roughly unchanged at midday Friday, as were the major stock indexes.
"This is not a disastrous outcome, but it is not optimal in our view either," said Krishna Guha, vice chairman of Evercore ISI, an investment banking advisory firm.
The Fed said it would soon consider ways to recalibrate the leverage ratio and its treatment of ultrasafe assets. Without more permanent changes, banks may over time have a perverse incentive to load up on riskier assets, because the ratio is risk insensitive, meaning it treats ultrasafe assets the same as junk bonds, Fed officials told reporters.
"Because of recent growth in the supply of central bank reserves and the issuance of Treasury securities, the board may need to address the current design and calibration of the SLR over time to prevent strains from developing that could both constrain economic growth and undermine financial stability," the Fed said in a statement.
The Fed stressed that overall capital requirements for big banks wouldn't decline after any recalibration.
Large lenders aren't facing an imminent cliff on March 31, when the exemption ends, because their capital levels aren't so close to the threshold that the changes will put them overboard, large bank executives said.
Instead, the lenders will have time to see how the Fed's current market interventions play out and how customers react with their deposits over the summer months, when the economy is expected to recover quickly.
They will also be watching regulatory guidance on what the permanent changes would be, and how fast they could be in place, before making significant changes to their own operations, one executive said. The chance of a permanent fix was viewed as a positive because it means the worst of the problems will likely be avoided, the person said.
Banks have a range of levers they can pull as they get close to their capital levels, but it will depend on where the pressure is on their balance sheets.
Among the most likely moves, and one they have deployed in years after the 2008 financial crisis, is to threaten some big corporate depositors with fees for parking their cash. The deposits that have flooded the banks over the past year are unprofitable for banks and considered too short-term to lend out. To fix the problem, the banks could threaten negative interest rates on those deposits in an attempt to drive them away.
On their quarterly conference call with analysts in January, JPMorgan Chase & Co. executives warned they could be forced to push away clients, issue new debt or reduce shareholder payouts if the Fed didn't extend the relief.
"Remember, we were able to reduce deposits $200 billion in like months last time," Chief Executive Jamie Dimon said on the call. "But we don't want to do it. It's just very customer unfriendly to say 'please take your deposits elsewhere.'"
The central bank adopted the temporary exclusion a year ago in an effort to boost the flow of credit to cash-strapped consumers and businesses and to ease strains in the Treasury market that erupted when the coronavirus hit the U.S. economy. The market has since stabilized.
Treasury issuance has soared along with federal government deficits since the start of the pandemic, as businesses across the country shut down and laid off millions of workers, and the government ramped up spending to cushion the economy and combat the coronavirus.
The Congressional Budget Office last week projected the deficit for the current fiscal year will total $2.3 trillion, nearly a trillion dollars less than the record-setting gap last year, but more than officials projected in September.
Friday's decision became more complicated for the Fed after the issue became more of a partisan fight.
Senior Democrats such as Senate Banking Committee Chairman Sherrod Brown of Ohio and House Financial Services Committee Chairwoman Maxine Waters (D., Calif.) said before the Fed's decision that an extension of the relief would be mistake, weakening the postcrisis regulatory regime. Republicans generally pressed for an extension.
Big U.S. banks must maintain capital equal to at least 3% of all of their assets, including loans, investments and real estate. By holding banks to a minimum ratio, regulators effectively restrict them from making too many loans without increasing their capital levels to cover potential losses.
The banks are sitting on giant stockpiles of cash, U.S. government debt and other safe assets. By tweaking how the ratio is calculated last year, the Fed was effectively trying to engineer a swap. Remove Treasurys and central-bank deposits from the calculation, the thinking went, and banks should be able to replace them in the asset pool with loans to consumers and businesses.
U.S. lenders saw their loan books increase about 3.5% last year, the slowest pace in seven years, according to research from Barclays using Federal Deposit Insurance Corp. data.
Write to Andrew Ackerman at andrew.ackerman@wsj.com
(END) Dow Jones Newswires
03-19-21 1530ET
