FED To “Tailor” Leverage Ratios

In another sign of weakening banking supervision, the FED proposes new rules to  “tailor leverage ratio requirements“.  Tailoring appears to mean reduce!

The Federal Reserve Board and the Office of the Comptroller of the Currency (OCC) on Wednesday proposed a rule that would further tailor leverage ratio requirements to the business activities and risk profiles of the largest domestic firms.

Currently, firms that are required to comply with the “enhanced supplementary leverage ratio” are subject to a fixed leverage standard, regardless of their systemic footprint. The proposal would instead tie the standard to the risk-based capital surcharge of the firm, which is based on the firm’s individual characteristics. The resulting leverage standard would be more closely tailored to each firm.

The proposed changes seek to retain a meaningful calibration of the enhanced supplementary leverage ratio standards while not discouraging firms from participating in low-risk activities. The changes also correspond to recent changes proposed by the Basel Committee on Banking Supervision. Taking into account supervisory stress testing and existing capital requirements, agency staff estimate that the proposed changes would reduce the required amount of tier 1 capital for the holding companies of these firms by approximately $400 million, or approximately 0.04 percent in aggregate tier 1 capital.

Enhanced supplementary leverage ratio standards apply to all U.S. holding companies identified as global systemically important banking organizations (GSIBs), as well as the insured depository institution subsidiaries of those firms.

Currently, GSIBs must maintain a supplementary leverage ratio of more than 5 percent, which is the sum of the minimum 3 percent requirement plus a buffer of 2 percent, to avoid limitations on capital distributions and certain discretionary bonus payments. The insured depository institution subsidiaries of the GSIBs must maintain a supplementary leverage ratio of 6 percent to be considered “well capitalized” under the agencies’ prompt corrective action framework.

At the holding company level, the proposed rule would modify the fixed 2 percent buffer to be set to one half of each firm’s risk-based capital surcharge. For example, if a GSIB’s risk-based capital surcharge is 2 percent, it would now be required to maintain a supplementary leverage ratio of more than 4 percent, which is the sum of the unchanged minimum 3 percent requirement plus a modified buffer of 1 percent. The proposal would similarly tailor the current 6 percent requirement for the insured depository institution subsidiaries of GSIBs that are regulated by the Board and OCC.

Author: Martin North

Martin North is the Principal of Digital Finance Analytics

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