The Federal Reserve Board and the Office of the Comptroller of the Currency, the branch of the U.S. Treasury Department that oversees national banks, proposed a rule on April 11 that would revise the leverage ratio requirements for the eight largest and most systemically important U.S. banking organizations.
The two agencies explained that under the current rules, the "enhanced supplementary leverage ratio" applied to these eight banking organizations is based on a fixed leverage standard. The proposal instead would tie the standard to each firm's risk-based capital surcharge, which is based on the firm's individual characteristics. They estimated that the proposed changes would reduce the required amount of tier 1 capital at the holding company level by approximately $400 million.
Federal Reserve Governor Randal Quarles, speaking about the proposal at a Congressional hearing on April 17, said the proposal would help ensure that leverage capital requirements serve as a "backstop" to risk-based capital requirements rather than as a binding constraint on bank activities. "When the leverage ratio acts as a primary constraint, it can actually encourage excessive risk-taking behavior because it does not distinguish between the capital cost of safer and that of riskier assets," Quarles said. "The proposal would calibrate the eSLR so that it is less likely to act as a primary constraint while still continuing to serve as a meaningful backstop. The proposal also would enhance efficiency by making each firm's leverage surcharge a function of its individual systemic footprint."
Although the proposal does not make any changes to the treatment of derivatives or client collateral, the two agencies said the recalibration of the leverage standard is intended to avoid "negative outcomes" such as reduced participation in providing clearing services and other low-risk lines of business.
The proposal was not approved unanimously, however. Federal Reserve Governors Jerome Powell and Randal Quarles voted for the proposal, but Governor Lael Brainard dissented. In addition, the Federal Deposit Insurance Corporation did not approve the proposal, which means that the proposed change to the leverage standard would not apply to banks regulated by that agency.
On May 21, FIA submitted a response to the proposal welcoming it as a good first step but urging further reforms in the treatment of cleared derivatives. Areas FIA highlighted include recognizing the exposure-reducing effect of initial margin, adopting a modified SA-CCR methodology, and eliminating double counting in the surcharge methodology.