Fed Leverage Rule Reforms: A Tipping Point for Bank Profitability and Treasury Liquidity?

The Federal Reserve's upcoming June 25 meeting has placed the spotlight on potential reforms to bank leverage rules, a move that could reshape the financial landscape for U.S. Global Systemically Important Banks (GSIBs). At stake are capital constraints that have limited banks' ability to intermediate in the Treasury market—a cornerstone of financial stability—and their capacity to generate returns through lending and trading activities. For investors, the stakes are clear: these reforms could unlock significant value for banks with large Treasury exposures while introducing new risks tied to regulatory uncertainty and systemic stability.

The Current Leverage Crunch: Why It Matters

Since 2019, the Supplementary Leverage Ratio (SLR) and its enhanced counterpart (eSLR) have been the primary capital constraints for U.S. GSIBs, particularly during periods of market stress. During the 2020 pandemic, the Fed's temporary exemption of Treasury securities and reserves from leverage calculations demonstrated its power: it allowed banks to expand balance sheets by 4% without breaching capital limits, enabling them to stabilize markets.

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The problem persists today. For every $1 billion in Treasury holdings, banks' SLR falls by nearly 5 basis points—a drag that grows as Treasury holdings accumulate. Exempting Treasuries permanently could boost SLRs by over 5% for banks with large holdings, reducing the likelihood of capital constraints during crises. This is critical as the Congressional Budget Office projects U.S. public debt to surge 85% by 2035, requiring banks to absorb an expanding Treasury market.

The Fed's Proposal: A Double-Edged Sword

The proposed reforms aim to exempt Treasuries and reserves from leverage calculations, aligning the SLR with its original purpose: a non-risk-based backstop, not a primary constraint. For banks, this could free up capital for two key activities:
1. Lending: With reduced leverage pressures, banks could expand risk-weighted assets (RWAs), boosting net interest margins (NIMs). .
2. Market-Making: Treasury holdings, which currently weigh on leverage ratios, could grow without penalizing capital buffers, enhancing liquidity in a market where dealer balance sheets are already near all-time highs.

However, risks lurk. A sudden easing of leverage rules could incentivize banks to over-extend into riskier assets, raising systemic concerns. Additionally, the Fed's shift toward a “more robust” inflation-targeting framework—discarded flexible average inflation targeting—adds uncertainty about future policy consistency.

Investment Implications: Positioning Ahead of June 25

The Fed's June meeting is a pivotal moment for investors. Here's how to position:

Overweight Banks with High Treasury Exposure

• JPMorgan Chase (JPM): As the sole U.S. bank in Bucket 4 (2.5% capital buffer), its SLR relief could be most pronounced. Its $222.74 billion in Treasury holdings (per FR Y-9C data) positions it to benefit disproportionately.
• Citigroup (C) and Bank of America (BAC): Both in Bucket 3 (2.0% buffer), their Treasury-heavy trading books and large dealer platforms make them prime beneficiaries of liquidity reforms.
• Goldman Sachs (GS): While its balance sheet is smaller, its market-making prowess in Treasuries and derivatives could see outsized gains from reduced capital drag.

Underweight Institutions with CRE Exposure

Regional banks with high commercial real estate (CRE) concentrations—already under pressure from rising office vacancy rates—may struggle to offset the risks of leverage reforms. Their CRE-heavy portfolios lack the capital-light resilience of Treasuries.

Monitor Fed Language and Market Signals

Investors should watch for Fed guidance on the eSLR buffer adjustments and whether reforms will be paired with stricter risk controls. A could reveal shifts in market expectations.

Conclusion: A Balancing Act

The Fed's leverage reforms could be a game-changer for banks' profitability and Treasury market resilience. Yet, success hinges on balancing capital relief with safeguards against systemic risk. For now, the June 25 meeting is a clear catalyst. Investors should prioritize large-cap banks with robust Treasury exposures while remaining vigilant to regulatory execution and market volatility. The path forward is clear—but the terrain remains uneven.

Final thought: In a world of rising public debt and constrained balance sheets, the Fed's reforms may not just be a win for banks—they could be the lifeline the Treasury market needs.