Federal Reserve Proposes 1.4% Capital Buffer Cut for Large US Banks

The Federal Reserve has proposed a significant reduction in the capital buffer required for large US banks, a move that has sparked internal debate within the Fed board. This proposal, initiated by Fed Chair Jerome Powell, aims to relax the enhanced supplementary leverage ratio (eSLR), a regulation implemented post-2008 financial crisis to prevent another banking collapse. Powell argues that the current eSLR has become overly restrictive, particularly as banks now hold more low-risk assets.

The proposed changes would lower the capital requirement for bank holding companies by 1.4%, freeing up approximately $13 billion. For bank subsidiaries, the reduction is more substantial at $210 billion, although this capital would remain on the books at the parent level. Under the current framework, holding companies must maintain capital at 5%, but the new proposal suggests a range between 3.5% and 4.5%. Subsidiaries, currently at a 6% threshold, would also move to this range.

This shift comes after years of pressure from Wall Street executives and Fed officials who argue that the eSLR treats all assets equally, regardless of risk. US Treasurys, generally considered safe, are given the same weight as high-yield bonds under the current setup. With bank reserves increasing and liquidity in the Treasury market becoming a concern, Powell and others advocate for a more flexible regulatory framework.

However, not all Fed governors support the proposal. Adriana Kugler and Michael Barr have expressed strong opposition. Michael, who previously served as vice chair for supervision, believes the change would not enhance banks' ability to support the economy during a financial crisis. He argues that banks are likely to use the freed-up capital to increase shareholder returns or engage in high-risk activities, rather than to stabilize the Treasury market.

On the other hand, Michelle Bowman, the current vice chair for supervision, and Fed Governor Christopher Waller support the change. Michelle claims the proposal could help stabilize Treasury markets by allowing banks to hold more safe assets without penalties. Christopher echoes Powell’s concerns, stating that the leverage ratio now acts more like a constraint than a protection, especially for banks holding large volumes of low-risk assets.

Opponents like Adriana and Michael worry that banks will not use the freed-up capital productively, potentially leading to increased shareholder returns or risky investments. This concern aligns with the original intent of the post-crisis rules, which aimed to prevent such behavior. The proposal also aims to align the US framework with Basel standards, the global baseline for banking regulations, to standardize how banks operate across borders.