The Federal Reserve on Friday refused to extend the reign of the pandemic period, which eased the amount of capital banks had to maintain relative to treasuries and other holdings, in a move that could upset Wall Street and the bond market.
In a brief announcement, the Fed said it would allow the change in the leverage ratio to expire on March 31st. The original move, announced on April 1, 2020, enabled banks to exclude treasuries and deposits with Fed banks from the leverage rate calculation.
The decision to ease capital requirements is seen as key to calming the turbulent treasury markets in the early days Covid-19 pandemic. The need for cash has caused a massive sell-off in the bond market that the Fed has helped cover through its liquidity programs.
The central bank said it would ask for public comment on how to adjust the SLR in the future, but decided to release the exemption now, as planned.
“The board will take appropriate action to ensure that any changes in the SLR do not erode the overall strength of banks’ capital requirements, ”the Fed said in a statement.
Fed officials said they would seek information on how best to adjust the relationship at a time when reserves are operating at historically high levels.
Wall Street has lobbied intensely for an extension of the exemption as banks are flooded with deposits that require them to hold compensatory capital against customers ’money.
Bank shares were mostly lower after the announcement but government bond yields have changed little.
“It’s surprising. To some extent you can see that from the market reaction. I think some people thought the Fed would kill her to give her more than 12 days.” said Michael Schumacher, head of rate strategy at Wells Fargo.
Schumacher noted that banks are larger holders of five-year treasury bills, whose yields have risen since the announcement.
By deciding not to extend the SLR break, the Fed is taking a risk further growth in interest rates because banks could decide to sell some of their shares in the Treasury, so they don’t have to maintain required reserves. Fed officials say the treasury market has stabilized and Friday’s decision should not change that.
However, Fed officials say banks are still well-capitalized even without exception and do not believe banks will need to sell their coffers to meet required reserves. The largest banks have about $ 1 trillion in capital, and with the abolition of SLR incentives, they will adjust to those levels only slightly, Fed officials said.
The supplementary leverage ratio is a product of banking reforms following the financial crisis that sought to ensure that banks did not take on too much risk. Fed officials worry that easing the ratio could encourage banks to fill up with risky assets like junk bonds, which have the same weight as required reserves as safer economies.
“Patti Domm contributed to this report.”.