U.S. Fed to let leverage exemption expire on March 31, will review rule

FILE PHOTO: The Federal Reserve building is pictured in Washington, DC, U.S., August 22, 2018. REUTERS/Chris Wattie/

WASHINGTON (Reuters) – The U.S. Federal Reserve will let a temporary bank leverage rule exemption expire on March 31, but it will review the rule due to concerns it is no longer functioning as intended as a result of the central bank’s emergency pandemic monetary policy measures.

To ease stress in the Treasury market sparked by the COVID-19 pandemic and to encourage bank lending as American households and businesses were hurt by lockdowns, the Fed last April temporarily excluded U.S. Treasuries and central bank deposits from the “supplementary leverage ratio.”

Friday’s decision means banks will have to resume holding an extra layer of loss-absorbing capital against those assets.

Uncertainty over the March 31 expiration has added to recent anxiety in fixed income markets. Analysts have said allowing the rule to expire could push banks to cut back on government debt and reduce the funding for other investors to buy bonds.

But on Friday, Fed officials said they were confident that allowing the exemption to expire would not impair Treasury market liquidity or cause market disruption because the Treasury market had stabilized and big banks have high levels of capital.

The leverage ratio was adopted after the 2007-2009 financial crisis as a backstop to other capital rules. But it is rapidly becoming the primary limit on banks as their balance sheets have swelled with funds from COVID-19 emergency stimulus programs.

Due to that growth in the supply of central bank reserves and the issuance of Treasury securities, the Fed said it may need to change the calibration of the ratio “to prevent strains from developing that could both constrain economic growth and undermine financial stability.”

However, it pledged that any changes to the rule would not erode the overall strength of bank capital requirements.

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