What You Need to Know
- Banks were allowed to load up on Treasurys and deposits without having the capital to protect against losses.
- That allowance ends on March 31 but the bond market has also reacted to the change, with higher Treasury yields.
- The change could pave the way for the Fed to relax restrictions on dividend payouts.
The Federal Reserve will let a significant capital break for big banks expire at month’s end, denying frenzied requests from Wall Street.
In response to the pandemic, the Fed allowed lenders to load up on Treasuries and deposits without setting aside capital to protect against losses. It will lapse March 31 as planned, the Fed said in a Friday statement.
Though the regulator has concluded the threat that COVID-19 poses to the economy isn’t nearly as severe as it was a year ago, the Fed also said it’s going to soon propose new changes to the so-called supplementary leverage ratio, or SLR. The goal is to address the spike in bank reserves that has been triggered by the government’s stimulus programs.
Because of recent growth in the supply of central bank reserves and the issuance of Treasury securities, the board may need to address the current design and calibration of the SLR over time to prevent strains from developing that could both constrain economic growth and undermine financial stability,” the Fed said.
The expiration of the temporary capital break may disappoint banks and bond traders, as many industry analysts had wanted the Fed to extend the deadline for at least a few months, especially since the $21 trillion Treasury market has seen recent volatility.
Treasury dealers have already been exiting the market at a rapid clip — more than $80 billion was pulled in the last two weeks in advance of the central bank’s decision. But Fed officials believe the market is sufficiently stable and banks’ capital is high enough to return to the pre-pandemic requirement while the agency considers long-term changes.
The biggest U.S. banks have nearly $1 trillion in capital, meaning they are already above the $800 billion that they need to comply with the full SLR, according to Fed estimates. Lenders themselves will have to decide how much they want to exceed the agency’s minimum requirement.
With the Fed declaring banks to be well capitalized, there’s a chance it will no longer be able to justify its pandemic-spurred constraints on dividends. While the regulator already relaxed an earlier ban on stock buybacks, it’s still restricting shareholder payouts. Fed Chairman Jerome Powell said this week that a decision is coming soon on dividends.
“This takes out of play the biggest political impediment to the Fed removing all COVID-19-related restrictions on big bank capital distributions,” Jaret Seiberg, an analyst for Cowen & Co., wrote in a Friday note. The Fed could drop its remaining constraints this year, he predicted.
Central bank officials provided no details on the permanent modifications they’ll propose to the SLR, but they did say they don’t want the industry’s overall capital levels to change. The Fed added that it will work with the other banking agencies: the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. Those regulators also announced Friday that they will let the temporary relief end March 31.
The agencies’ decision means big banks such as JPMorgan Chase & Co., Citigroup Inc. and Bank of America Corp. must soon return to their customary SLR — a measure of their capital against all their assets.