Federal Reserve Proposes 1.4% Capital Reduction for Banks

The Federal Reserve has proposed a significant reduction in capital requirements for the nation's largest banks, amounting to $13 billion. This proposal has sparked a contentious debate among the Fed's board members, with two governors expressing strong opposition to the plan. The proposed changes aim to adjust the enhanced supplementary leverage ratio, a post-financial crisis regulation that dictates the amount of high-quality capital banks must hold relative to their total assets. The ratio would be reduced from 5% to a range of 3.5% to 4.5% for major banks, while their subsidiaries would see a larger reduction of $210 billion in capital requirements, although the funds would remain with the parent companies.

Fed Chair Jerome Powell defended the changes, citing a significant increase in low-risk assets on bank balance sheets over the past decade. He argued that this increase has made the leverage ratio more restrictive. The regulation has been criticized for treating Treasury securities the same as higher-risk investments for capital purposes. The measure opens a 60-day public comment period, during which bank holding companies would see their required capital levels drop by 1.4%, while their subsidiaries face much larger reductions of $210 billion in requirements.

Vice Chair for Supervision Michelle Bowman and Governor Christopher Waller supported the proposal, arguing that it would enhance the functionality of the Treasury market. Bowman emphasized the importance of proactive regulatory adjustments to address unintended consequences of bank regulation while maintaining safety and soundness standards. Fed regulators frame the changes as allowing banks to hold more low-risk inventory like Treasury securities, as the current system treats government bonds the same as high-yield corporate debt for capital calculation purposes.

However, Governors Adriana Kugler and Michael Barr, the former vice chair of supervision, expressed strong opposition to the measure. Barr questioned whether the changes would achieve their stated Treasury market objectives. He predicted that banks would likely use the freed capital to distribute to shareholders and engage in the highest return activities available to them, rather than to meaningfully increase Treasury intermediation. The proposal aligns with Basel international banking standards, which establish global frameworks for bank capital requirements and risk management practices.

Wall Street executives and some Fed officials have long advocated for modifying the leverage ratio requirements, citing growing bank reserves and concerns about Treasury market liquidity as justifications for regulatory adjustments. The enhanced supplementary leverage ratio was introduced as part of post-2008 financial crisis reforms aimed at preventing another systemic banking collapse. The regulation requires banks to maintain sufficient capital buffers regardless of the perceived risk of their asset holdings. Fed officials now view the capital requirements as potentially constraining rather than simply providing a safety net, as the current framework treats all assets equally, regardless of their risk profiles or liquidity characteristics.

The Federal Reserve's divided approach to capital requirements reflects broader tensions between financial stability concerns and market functionality goals. The 60-day comment period will likely generate significant input from banking industry representatives and financial stability advocates before final implementation decisions.