Easing US Leverage Rules: Boosting Treasury Market Liquidity Now
Explore how easing US leverage rules, especially the Supplementary Leverage Ratio, can unlock bank capacity to support the $29 trillion Treasury market, enhancing liquidity and stabilizing borrowing costs.
Key Takeaways
- SLR requires banks to hold capital against all assets, including safe Treasuries.
- Banks argue SLR limits their ability to support Treasury market liquidity.
- Temporary SLR relief during COVID-19 improved Treasury holdings and market stability.
- Regulators consider permanent exemptions or recalibrations of SLR for Treasuries.
- Easing leverage rules could lower borrowing costs and reduce Treasury market volatility.
Imagine a rule designed to keep banks safe but ends up tying their hands when it comes to supporting the backbone of U.S. finance—the Treasury market. That’s the story of the Supplementary Leverage Ratio (SLR), a post-crisis capital rule requiring banks to hold capital against all assets, even the safest ones like U.S. Treasuries. The banking sector is now pushing for a rethink, arguing that easing these leverage rules could unleash banks’ capacity to absorb Treasury issuance, boost liquidity, and calm market volatility. This article dives into what the SLR is, why banks want reform, and how recent experiences during the pandemic offer a glimpse of what’s possible. We’ll also explore the regulatory debates and what easing leverage rules means for the $29 trillion Treasury market and the broader economy. Buckle up for a fresh look at a complex but crucial financial puzzle.
Understanding the Supplementary Leverage Ratio
The Supplementary Leverage Ratio, or SLR, is a regulatory capital rule born from the ashes of the 2007-2009 financial crisis. It demands that large banks hold a minimum of 5% capital against their total leverage exposure, which includes all assets and off-balance-sheet items, regardless of risk. That means even the safest assets—like U.S. Treasuries and central bank reserves—eat up precious balance sheet space. Imagine being forced to reserve a chunk of your wallet for cash you know is rock solid; it feels like overkill. Banks argue this blunt approach discourages them from holding more Treasuries or actively trading them, limiting their role in the Treasury market. This constraint is especially felt by the largest U.S. banks, which face an enhanced 2% surcharge on top of the base 3% SLR. The rule’s risk-agnostic nature, while a safety net, has become a straitjacket that some say stifles market liquidity and economic growth.
Banks’ Case for Easing Leverage Rules
Banks have been ringing alarm bells for years, insisting the SLR has morphed from a baseline safeguard into a binding constraint that hampers lending and Treasury market activity. Picture a bustling marketplace where sellers are forced to keep half their goods locked away—trading grinds to a halt. That’s how banks describe the current SLR’s impact on their ability to absorb new Treasury issuance, especially during market stress. The $29 trillion Treasury market, a cornerstone of global finance, relies heavily on banks to provide liquidity and stability. When banks pull back, borrowing costs for the U.S. government and, by extension, businesses and households, can rise. Kevin Fromer, CEO of the Financial Services Forum, calls the current leverage requirements outdated and misaligned with economic growth. Treasury Secretary Scott Bessent has also flagged reform as a “high priority,” signaling regulatory appetite for change. The banking industry’s optimism is palpable, hoping for proposals as soon as this summer to ease these capital burdens.
Lessons from the COVID-19 SLR Exemption
The pandemic offered a real-world experiment in SLR relief. In 2020, the Federal Reserve temporarily exempted U.S. Treasuries and central bank reserves from the SLR calculation. The effect was immediate and telling: banks’ leverage ratios improved, freeing up balance sheet space that translated into increased Treasury holdings and trading activity. Market liquidity improved, and volatility indices declined, signaling calmer waters in a stormy period. Banks most constrained by the SLR before the exemption responded with the greatest market participation, proving that the rule’s rigidity was indeed a choke point. This episode provides concrete evidence that easing leverage rules can enhance the Treasury market’s functioning without compromising safety—at least in the short term. It’s a powerful counterpoint to skeptics who warn that relaxing leverage requirements risks financial stability.
Regulatory Options on the Table
Regulators are weighing multiple paths to reform the SLR. One straightforward option is permanently exempting Treasuries and central bank deposits from the SLR calculation, mirroring the temporary pandemic relief. This would instantly free up capital for banks to hold more government debt. Alternatively, regulators might recalibrate the SLR formula, particularly for the largest banks, to reduce capital charges on low-risk assets without a blanket exemption. This nuanced approach aims to balance risk sensitivity with market support. The banking sector is also pushing for broader capital relief, including revisiting the GSIB surcharge and annual stress tests. Past attempts to ease these rules, such as the 2018 effort to tailor the enhanced SLR to banks’ risk profiles, stalled, but current momentum under the administration’s deregulatory agenda suggests change is on the horizon.
Balancing Market Benefits and Financial Safety
Supporters of easing leverage rules argue that reforms will empower banks to better support the Treasury market, lowering borrowing costs and reducing volatility during heavy issuance or financial stress. The potential benefits ripple through the economy, from government financing to business loans and household borrowing. Yet, skeptics caution that the SLR’s risk-agnostic design is a vital backstop against excessive risk-taking, ensuring no hidden dangers slip through. Relaxing these rules could weaken the financial system’s resilience if not carefully calibrated. The challenge for regulators is to strike a balance—unlocking liquidity and market functioning without compromising the safeguards that prevent crises. As proposals emerge, this balancing act will shape the future of U.S. banking regulation and Treasury market health.
Long Story Short
The debate over easing the Supplementary Leverage Ratio is more than a regulatory tweak—it’s a potential game-changer for the Treasury market’s heartbeat. Banks have shown that when relieved from rigid capital constraints, they can step up as vital market makers, smoothing liquidity and reducing volatility. Yet, this push for relief walks a tightrope between unlocking economic benefits and preserving the financial system’s resilience. Regulators face the challenge of balancing these priorities as they consider permanent exemptions or formula recalibrations. For taxpayers, businesses, and households, the stakes are high: a more liquid Treasury market can mean lower borrowing costs and a steadier economic foundation. As reforms loom on the horizon, staying informed and understanding these shifts will help you navigate the evolving financial landscape with confidence and clarity.