D.C. power shift complicates Fed decision on capital rule

WASHINGTON — Pressure continues to mount on the Federal Reserve from both sides as the central bank mulls an extension of temporary capital relief for the big banks.

The Fed last April announced a one-year easing of the supplementary leverage ratio, a tough measure of capital strength, for bank holding companies with more than $250 billion of assets. It was followed the next month by similar moves from other agencies for banks under their watch.

With the Fed’s measure slated to expire on March 31, big banks say they still need the relief to support the economic recovery and ease strains in the Treasury market. But the power shift in Washington following the November election — putting Democrats in control of the White House and Congress — has emboldened voices on the left to push back, saying banks have already had enough of a break.

“It’s an early test of whether the shifting political winds and the new congressional leadership and evolving list of new regulators is going to change the decision making on this,” said Sheila Bair, a former Republican-appointed chair of the Federal Deposit Insurance Corp. “I hope it does.”

The supplementary leverage ratio, or SLR, is an extra cushion imposed on the biggest banks, measuring their capital against their entire balance sheets. The temporary steps announced last spring allowed banks to exclude Treasuries and reserves held at the Fed from the SLR calculation, enabling them to expand their balance sheets and help the support the economic during the coronavirus pandemic.

Fed Chair Jerome Powell told lawmakers Feb. 23 that the central bank had not reached a decision on an extension yet. Some believe President Biden’s victory in November and Democrats’ gaining control of the Senate could factor into whether to extend the capital reprieve.

Bloomberg News

The industry says the relief should remain in place as banks and the government continue to respond to economic need resulting from COVID-19.

“Members believe that the extension of the [Fed’s interim final rule] is critical to the continued ability of banking organizations to continue accepting deposits and acting as intermediaries in the U.S. Treasury market,” according to a Feb. 23 letter to the central bank by three financial services trade groups.

But key Democrats and other big-bank critics have come out strongly against the Fed and the agencies prolonging the relief. They argue that a further capital reprieve is unnecessary as long as banks continue to pay dividends to their shareholders.

“The banks’ requests for an extension of this relief appear to be an attempt to use the pandemic as an excuse to weaken one of the most important post-crisis regulatory reforms,” said Senate Banking Committee Chair Sherrod Brown, D-Ohio, and Sen. Elizabeth Warren, D-Mass., in a Feb. 26 letter to the heads of the agencies.

Banks subject to the SLR must maintain a minimum 3% ratio against their total leverage exposure. The ratio is 5% for the largest bank holding companies.

Fed Chair Jerome Powell told lawmakers Feb. 23 that the central bank had not reached a decision on an extension yet.

Yet after President Biden’s victory in November and Democrats’ gaining control of the Senate, the new political dynamics in Washington will almost certainly factor into the decision on whether to extend the capital reprieve, said Gilbert Schwartz, a former Fed attorney and partner at Schwartz & Ballen.

“I think there’s no question that the politics are playing into this. It has to be from the standpoint of the change in the political scene,” he said. “I think they’ve got to be mindful that Congress is looking over their shoulder.”

The Fed had estimated last year that the temporary change in the calculation of the SLR would reduce the total required amount of capital at bank holding companies by $17 billion, eliciting backlash from Democrats who expressed concern about banks shedding capital in the middle of a crisis.

Although policymakers like Brown and Warren don’t have the power to undo the regulators’ decisions on bank capital requirements, they could still be influential, said Gregg Gelzinis, senior policy analyst at the Center for American Progress.

“Industry efforts on financial deregulation have the highest chance of success when they operate in the esoteric shadows of financial regulatory arcana,” he said. “But the more that policymakers in key roles … can shine a light on these issues … it’s less likely that that deregulation will flourish and will succeed.”

However, the banking regulators are no stranger to political pressure, and will likely make a decision on the extension based on the realities of the economy, said Arthur Angulo, managing director at Promontory Financial Group and former senior official at the Federal Reserve Bank of New York.

“I think the Federal Reserve will do what it thinks will benefit the economy and won’t necessarily be swayed by the letter that Sens. Warren and Brown wrote,” he said.

Angulo added that prolonging the exclusions from the capital ratio would mirror the Fed’s recent stance that its temporary liquidity facilities established at the outset of the pandemic should remain in effect to support the economic recovery. That stance was largely applauded by Democrats, and put the Fed at odds with the Trump administration, which wanted the facilities wound down.

“If the Fed were to extend the SLR [relief] temporarily, it would be entirely consistent with the approach they advocated for before Congress at the end of last year,” Angulo said.

Banks have argued that, without the SLR relief, it would be difficult for them to absorb the influx of deposits in the system and act as intermediaries in the U.S. Treasury market, since the Fed is expected to continue purchasing securities at the same pace for many more months.

“It seems to me that the Fed and the other agencies — particularly the Fed — think it’s an important tool to have out there,” said Schwartz. “So why would you want to upset the apple cart at this point?”

But others counter that the SLR relief might not have been all that successful in the first place. While all of the large bank holding companies were automatically granted the relief, Goldman Sachs and HSBC were the only institutions to opt in at the bank level. And to the extent that the change enabled banks to lend to more households and businesses, data has shown that lending is actually down at the biggest banks.

“This idea that somehow this is for Main Street America — come on,” said Bair. “I don’t buy that for a minute. The only indirect benefit to Main Street America is if it’s helping the Fed support the Treasury market, which, of course, is supporting fiscal stimulus for Main Street.”

While Democrats also see the capital relief as “a gift to the big banks,” some Republicans might be wary of extending the exemption as well, said Thomas Hogan, former chief economist for the Senate Banking Committee and senior research fellow at the American Institute for Economic Research.

“Some of the Republicans as well are also interested in raising capital requirements for banks and see that as one of the most important regulatory rules that we have,” he said.

It would also be challenging for officials to argue that banks are healthy enough to pay dividends to shareholders (the Fed eased restrictions on capital distributions in December) but too constrained to support the economic recovery, said Gelzinis.

“If there was a real problem about banks absorbing this increase in deposits and reserves over the next several months, then that balance sheet growth could be funded by retaining capital and not making those distributions and not paying out share buybacks,” he said.

Most agree that banks will almost certainly face increasing pressure as the amount of reserves in the system keeps piling up, but experts disagree whether the solution is exempting Treasuries and reserves from the SLR calculation.

“As the Fed is continuing to do this … expansionary monetary policy by increasing reserves, then banks are going to feel pressure from that, and the regulatory constraints are going to be harder for them to avoid, or potentially put pressure on them in unexpected ways,” said Hogan.

For Schwartz, that’s why regulators could be hesitant to let the exemption expire.

“Given the change in administration and the fact that … the end [of the pandemic] may be in sight, now is not the time to throw something [out], which is potentially disruptive,” he said.

Ultimately, those who hope the new administration and Democratic control of Congress have ushered in a more restrictive mindset about regulatory relief could end up disappointed, Bair said.

She noted that the regulatory agencies are still mostly led by Trump appointees. Top leaders at the Fed and FDIC were installed by the past administration, and the Office of the Comptroller of the Currency is led by an interim chief, Blake Paulson.

“My guess is the Biden regulators will be less sympathetic to the banks’ arguments, but they’re not really in place yet, and it’s sort of the same cast of characters at the Fed,” Bair said.

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