The Federal Reserve is temporarily relaxing a rule that imposes additional capital requirements on deposits and Treasury securities held by the biggest U.S. banks.
The supplementary leverage ratio, or SLR, requires banks to hold an extra buffer of high-quality capital against a bank’s total assets (including derivatives exposure and off-balance sheet transactions). Under the Fed’s new rule, banks’ Treasury securities and deposits with Federal Reserve Banks won’t count toward those assets.
“Liquidity conditions in Treasury markets have deteriorated rapidly, and financial institutions are receiving significant inflows of customer deposits along with increased reserve levels,” the Fed said in its announcement. “The regulatory restrictions that accompany this balance sheet growth may constrain the firms’ ability to continue to serve as financial intermediaries and to provide credit to households and businesses. The change to the supplementary leverage ratio will mitigate the effects of those restrictions and better enable firms to support the economy.”
The decision signals a complete turnaround in money-market conditions from early March, when dislocations in interest rates indicated that banks’ cash reserves were in short supply. The Fed responded to that shortage on March 15 by announcing unlimited purchases of Treasury securities and agency mortgage-backed securities.
Those Fed purchases inundated banks’ balance sheets with reserves. On top of that, large banks have also received “significant inflows of customer deposits,” the Fed says, as investors and companies stock up on cash to prepare for the halt in economic activity meant to contain the spread of the new coronavirus within the U.S.
In other words, banks now appear to have an excess of reserves, at least going by their activity in money markets, according to George Pearkes of Bespoke Research Group. While at the start of this month they were pledging Treasuries to borrow cash short term, after the Fed’s stimulus efforts, they have started to pledge cash to borrow Treasuries short term.
“Liquidity availability has gone from inadequate (not enough reserves) to excessive (repo rates in danger of going negative) in less than two weeks,” Pearkes wrote in a note.
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