Financial Services "Quick Hits" Series
On April 1, 2020, the Federal Reserve published an interim final rule to temporarily exclude U.S. Treasury securities and deposits held by banking organizations at Federal Reserve Banks from the calculation of total leverage exposure for purposes of the supplementary leverage ratio. The exclusion will be effective immediately upon the interim final rule’s publication in the Federal Register and will expire on March 31, 2021. Calculations for reports of supplementary leverage ratios as of June 30, 2020 should be made as if the exclusion had been in place for the entire second quarter of 2020.
Under the U.S. capital rules, certain large banking organizations (i.e., global systemically important bank holding companies (“GSIBs”), and bank holding companies, savings and loan holding companies, or U.S. intermediate holding companies subject to Category II or Category III capital standards) must maintain a supplementary leverage ratio of at least 3%. GSIBs are subject to even greater requirements.
The supplementary leverage ratio is calculated as a banking organization’s tier 1 capital divided by its total leverage exposure. Total leverage exposure includes all on-balance sheet assets and certain off-balance sheet exposures. Leverage ratios, including the supplementary leverage ratio, do not account for variations in the risk associated with holding a certain type or class of asset. Instead, leverage ratio requirements serve as mechanisms to correct for any underestimation of risk that may be embedded in a banking organization’s calculation of risk-weighted assets used in other capital measures.
In recent weeks, in response to the COVID-19 pandemic, the Federal Reserve has observed large acquisitions of U.S. Treasury securities and a significant increase in the amount of reserves held by banking organizations in their accounts at Federal Reserve Banks. These trends may be a result of balance sheet expansion from credit line draws, customer deposits of proceeds of asset sales, and Federal Reserve open-market operations, which have or will include asset purchases on a massive scale.
In the absence of the interim final rule, banking organizations with significant U.S. Treasury securities and deposits at Federal Reserve Banks (which otherwise are included in the total leverage exposure calculation) may be required to hold additional capital against those assets, despite their being essentially risk-free, to meet the supplementary leverage ratio requirement. The temporary exclusion of these assets from total leverage exposure will enable banking organizations to continue to maintain high levels of reserves at the Federal Reserve Banks and function as financial intermediaries, without the need to raise additional capital, during this critical time in financial markets.