U.S. Regulators Plan 1.5% Capital Buffer Cut for Large Banks

U.S. regulators have announced plans to reduce capital buffer requirements for large banks, a move that could significantly impact the Treasury market and overall financial liquidity. The proposal, which targets systemically important banks such as JPMorgan Chase, aims to relax constraints that have been hindering banks' trading activities in the vast U.S. Treasury market. This adjustment is expected to enhance liquidity and narrow spreads, potentially benefiting market participants.

The regulatory adjustment involves changes to the enhanced Supplementary Leverage Ratio (eSLR) requirements. For bank holding companies, the capital requirements could decrease from 5% to a range between 3.5% and 4.5%. Similar reductions are expected for subsidiary requirements. These changes follow concerns from the banking industry regarding existing regulatory constraints, which have limited banks' ability to engage in market-making activities. Industry participants believe that the reduction in capital buffers will make it easier for banks to participate in these activities, thereby improving liquidity in the U.S. Treasury market.

While the proposal has not yet been formally announced by officials from the Federal Reserve, FDIC, and OCC, trade organizations have called for clarity and timelines to help banks adjust to these evolving rules. The reduction in capital buffers is part of a broader effort by regulators to balance financial stability with economic growth. By easing capital requirements, regulators hope to encourage banks to increase lending, which can stimulate economic activity and support job creation. However, the move also raises concerns about the potential risks associated with lower capital buffers, as banks may become more vulnerable to financial shocks.

The proposed changes come at a time when the banking sector is facing various challenges, including rising interest rates and credit concerns. By reducing the capital buffers, regulators hope to alleviate some of the pressure on banks, allowing them to operate more efficiently and support economic recovery. However, the move has also raised concerns about the potential risks associated with lower capital requirements, as banks may become more vulnerable to financial shocks.

The Bank Policy Institute (BPI) has expressed serious concerns about the proposed revisions to the bank rating methodology by Moody’s Ratings. The changes, published by Moody’s, would impose higher and untailored capital and liquidity requirements across the banking sector. BPI argues that these changes would arbitrarily raise capital and liquidity standards without justification, despite widespread recognition that U.S. banks are already well-capitalized and highly liquid. Brett Waxman, BPI Senior Vice President and Senior Associate General Counsel, stated that Moody’s plan would amount to a capital increase by stealth, effectively imposing higher requirements with insufficient empirical evidence or economic justification. This proposal punishes well-managed banks by shifting the goalposts despite no real changes to their riskiness. The result would be reduced credit availability, slower economic growth, and higher borrowing costs.

BPI emphasizes the need for a bank rating methodology that is objective, transparent, and consistently applied. Among the key issues raised with the proposal are higher capital requirements, higher liquidity requirements, and poor interest rate risk management standards. BPI warns that the combined effect of these changes would increase volatility in ratings, impose artificial constraints on banks’ operations, and result in reduced lending capacity.

The Federal Reserve has also been considering ways to reduce the volatility of capital requirements stemming from the annual stress test results. On April 17, the Fed requested comment on a proposal to reduce the volatility of the capital requirements stemming from the annual stress test results. This move is aimed at providing banks with more stability in their capital planning, allowing them to better manage their resources and support economic growth.

The planned reduction in capital buffers for large banks is a significant development in the regulatory landscape. While the move is aimed at providing banks with more flexibility and supporting economic growth, it also raises concerns about the potential risks associated with lower capital requirements. The banking sector will need to carefully navigate these changes and adapt to the evolving regulatory environment to ensure financial stability and support economic recovery.