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As expected, Wall St banks are pushing regulators to make a temporary deregulatory capital change *permanent*.
Doing so would materially undermine big banks' ability to absorb losses, increasing their likelihood of failure during the recovery & beyond.
1/
As expected, Wall St banks are pushing regulators to make a temporary deregulatory capital change *permanent*.
Doing so would materially undermine big banks' ability to absorb losses, increasing their likelihood of failure during the recovery & beyond.
1/
In April, regulators allowed banks to exclude Treasuries & reserves from the denominator of the supplementary leverage ratio (SLR)--a risk-neutral capital requirement that applies to the largest banks in the country & complements risk-weighted capital requirements. 2/
Why did regulators take that action?
Banks were facing significant deposit inflows at the start of the pandemic as investors de-risked & corporations drew down on lines of credit. A chunk of those deposits were then used to fund safe assets, for several reasons. 3/
Banks were facing significant deposit inflows at the start of the pandemic as investors de-risked & corporations drew down on lines of credit. A chunk of those deposits were then used to fund safe assets, for several reasons. 3/
This dynamic didn't impact banks' risk-weighted capital ratios--Treasuries & reserves receive a 0% risk weight. But it did start to eat away at banks leverage ratios, which (by design & for good reason) do not distinguish between the real or perceived riskiness of assets. 4/
The concern was that big banks would pull back as intermediaries--at the worst time-- if they ultimately bumped into their minimum SLR requirements due to this dynamic. 5/
Did regulators do the right thing at the time?
There were better options to handle this issue. By materially lowering leverage requirements, regulators left banks overly vulnerable during a period of extreme economic uncertainty. 6/
There were better options to handle this issue. By materially lowering leverage requirements, regulators left banks overly vulnerable during a period of extreme economic uncertainty. 6/
This was not a surprising dynamic. In fact, it had been contemplated during the development of the post-crisis capital framework.
- regulators could have excluded new Treasuries & reserves only, above a bank's pre-pandemic levels. This would have reduced the capital impact. 7/
- regulators could have excluded new Treasuries & reserves only, above a bank's pre-pandemic levels. This would have reduced the capital impact. 7/
- regulators could have increased the leverage ratio itself to offset any decline in capital stemming from the denominator carveout--neutralizing the capital impact.
These options would have addressed the deposit influx/safe asset dynamic, while maintaining capital. 8/
These options would have addressed the deposit influx/safe asset dynamic, while maintaining capital. 8/
I should also note that during this period, regulators continued to allow big banks to pay dividends. If you are worried about the capital ratio declining, instead of using a reg carveout to shrink the denominator...you could have also prevented the numerator from shrinking! 9/
Ok, so fast forward to today. We thankfully haven't dealt with any big bank failures (yet) for several reasons--including the support provided to businesses & households.
The SLR carveout is set to expire at the end of March. Big banks are lobbying to make it permanent. 10/
The SLR carveout is set to expire at the end of March. Big banks are lobbying to make it permanent. 10/
It's important to understand that banks have been arguing for this change ever since it was implemented. They hate leverage requirements, because they work. They are hard to game using financial engineering & (relatedly) they appropriately capture off-balance sheet exposures. 11/
Today, banks are arguing that they'll have to turn away customer deposits if the SLR goes back into full effect.
1) At this point, no longer in the acute phase of the influx, so what? If JPM wants to turn away deposits & they flow to PNC, that's not a public policy concern. 12/
1) At this point, no longer in the acute phase of the influx, so what? If JPM wants to turn away deposits & they flow to PNC, that's not a public policy concern. 12/
2) If JPM (leading this lobbying push) cared deeply about serving these depositors, it could fund the balance sheet expansion with some capital--capital that it plans to send to shareholders through dividends & restarted buybacks.
Just... don't do that & problem solved! 13/
Just... don't do that & problem solved! 13/
3) The current SLR (super-regionals) & eSLR (Wall St) reqs are already too low.
Permanently reducing them by shrinking what's counted in the denominator would overly expose the economy to the catastrophic risks associated with big bank failures during the recovery & beyond. 14/
Permanently reducing them by shrinking what's counted in the denominator would overly expose the economy to the catastrophic risks associated with big bank failures during the recovery & beyond. 14/
Regulators must reject this big bank lobbying effort. Then, as the economy recovers, they should evaluate better ways to address the deposit influx issue next time & increase capital to ensure big banks are even more resilient, no matter what the next shock looks like. 15/15
