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Breakingviews – Wall St may get greater of two bank capital evils

A man wears a protective mask as he walks on Wall Street during the coronavirus outbreak in New York City, New York, U.S., March 13, 2020. REUTERS/Lucas Jackson

WASHINGTON (Reuters Breakingviews) – Wall Street capital rules are on the move – again. Big banks are glum about the end of a temporary relaxation of constraints on their leverage, which until last week had let them guzzle Treasuries with abandon. They may still get a reprieve since looser leverage limits help the central bank too. But the watchdog may tighten other capital requirements instead.

As the pandemic raged last year, the Fed decided to let banks exclude Treasuries and deposits with the central bank from the calculation of their total assets, when computing what’s known as the supplementary leverage ratio. That meant they could buy up government debt, and sell securities to the Fed, without breaching one of the measures the regulator uses to check lenders are sound.

The change, which the Fed let expire on March 31, gave them more room to lend. For example, JPMorgan had a leverage ratio of 6.9% in the 2020 fourth quarter, whereas without the exemption it would have had a ratio of 5.8%, according to Jefferies. The minimum the biggest U.S. banks can have at the level of their holding company is 5%.

It’s not just banks who benefited, though. The central bank is buying around $80 billion of Treasury debt a month until the economy recovers, and it needs Wall Street firms to help out. Central bank reserves – which grow when lenders get payments for the securities they sell to the Fed – are already expected to soon exceed $4 trillion, more than double the level in February 2020. If those count towards the leverage ratio, there will be less scope to do other things like make loans.

As a compromise, the Fed is considering recalibrating the rule. But progressive politicians like liberal Senator Elizabeth Warren don’t want to see banks get free gifts. The central bank also needs the support of other watchdogs like the Office of the Comptroller of the Currency, which may be less inclined to give banks leeway.

One possible trade-off could be a relaxation of leverage rules that don’t account for the riskiness of assets, but with an increase in capital ratios that do, the other main measure that regulators watch. Those ratios are already less affected by holdings of Treasuries or central bank reserves, and the Fed could easily raise the minimum requirement, if only for the biggest lenders. That might leave banks with the feeling they’ve traded one capital nuisance for another.

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