Fed to Decide on Extending Emergency Capital Relief for Big Banks

WASHINGTON—The Federal Reserve faces a decision in the coming days over whether to extend relief that temporarily loosened restrictions for the way big banks account for ultrasafe assets such as Treasury securities.The Fed last April said that for one year it would exclude Treasurys and deposits held at the central bank from lenders’ so-called supplementary leverage ratio, in an effort to boost the flow of credit to cash-strapped consumers and businesses. The ratio measures capital—funds that banks raise from investors, earn through profits and use to absorb losses—as a percentage of loans and other assets. Without the exclusion, Treasurys and deposits count as assets. Banks want an extension to the relief, set to expire at the end of March. Without it, some may come close to violating the capital requirements over the coming months. To keep that from happening, they may be forced to buy fewer Treasuries or shy away from customer deposits. This would mean playing a smaller role as intermediaries in the Treasury market, or holding fewer deposits—which they use to buy Treasurys or park as Fed reserves—just as Congress passed a $1.9 trillion relief bill that could push an additional $400 billion in stimulus payments into depository accounts, analysts say.

If banks pulled back significantly from Treasury purchases, that would add to the upward pressure on bond yields that has rattled markets in recent weeks.

The central bank’s interest-rate-setting committee holds a policy meeting next week, but this decision will be made by a different body, the Fed board of governors, which could act before, at or after the meeting.

Analysts say the issue comes down to whether banks should be given relief to accommodate the Biden administration’s expansive fiscal policy or whether banks should bear the costs of that policy. They also warn that any reduction in banks’ market-making role in the Treasury market would be undesirable, given already volatile markets.

When the coronavirus tore through industry, commerce and society in March 2020, the U.S. economy came to a screeching halt. Top executives relive the tough decisions they made as they scrambled to weather the storm. Photo Illustration: Adele Morgan/The Wall Street Journal

“This would nudge up a bit the modest but nonzero risk that the bond market will struggle to digest all the issuance ahead, forcing the Biden administration to reconsider its ambitious fiscal plans,” wrote

Krishna Guha,

vice chairman of Evercore ISI, in a March 5 research note.

Complicating the decision for the Fed: What might have been a largely technical debate over the functioning of the Treasury market has become a partisan fight over big banks’ capital levels.

Big U.S. banks must maintain capital equal to at least 3% of all of their assets, including loans, investments and real estate. By holding banks to a minimum ratio, regulators effectively restrict them from making too many loans without increasing their capital levels.

In two days of congressional testimony last month, Fed Chairman

Jerome Powell

fielded questions about whether the central bank planned to extend the relief from eight lawmakers, unusually high interest in an obscure capital requirement. Mr. Powell repeatedly declined to say what the Fed would do.

“We’re right in the middle of thinking about what to do about that,” Mr. Powell told Sen. Steve Daines (R., Mont.), who asked if “it would be a good idea to waive the supplementary leverage ratio for say a year until some of these special circumstances” have subsided.

Two Senate Democrats—Banking Committee Chairman Sherrod Brown of Ohio and Elizabeth Warren of Massachusetts—have pressed Mr. Powell not to extend the relief, warning in a Feb. 26 letter that doing so would be a “grave error,” weakening the postcrisis regulatory regime.

“Opposition in Congress against the relaxation of bank regulation is strong,” wrote

Roberto Perli

and Benson Durham of Cornerstone Macro, an investment research firm. “Such political pressure, at a minimum, slows things down.”

If there are concerns about banks’ ability to accept customer deposits and absorb reserves because of the leverage restrictions, regulators should suspend bank dividends and buybacks, Mr. Brown and Ms. Warren wrote.

“Banks could fund their balance sheet growth in part with the capital they are currently sending to shareholders and executives,” the pair wrote, adding they are “confident that the thousands of community banks that are not subject to the SLR requirements would be happy to accept deposits that large banks may reject.”

Banks say restrictions on future payouts would be a mistake.

“Banks need to attract equity in this capital markets system just like any other company,” said Kevin Fromer, chief executive officer of the Financial Services Forum, a big-bank industry group. “Providing returns to shareholders is part of the prudent balanced allocation of capital by these institutions.”

Banks are sitting on giant stockpiles of cash, U.S. government debt and other safe assets, fueled by the Fed’s aggressive purchases of government-backed debt. The money for these purchases are often held as bank deposits, which grew 25% at the largest U.S. banks to $7.8 trillion last year, according to the Forum.

Write to Andrew Ackerman at andrew.ackerman@wsj.com

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