Inside the Supplementary Leverage Ratio SLR – Bond Market Impact

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Our New York Times best seller is now published in 12 languages and focuses on the failure of Lehman Brothers. In the post financial crisis era, capital adequacy has been an important driver of the strength of U.S. banks relative to the rest of the world. The Supplementary Leverage Ratio SLR is the ultimate measure of capital adequacy. If the Fed doesn’t extent the SLR, it will have a large impact on the bond market, stress is high. Essentially, the SLR measures in percentage terms a bank’s ability to take losses on its assets. The formula is SLR = (tier 1 capital)/(total leverage exposure). This change reduces the denominator in the SLR calculation and as a result temporarily increases banks’ SLR.

If the Fed ends the SLR cushion, we see US banks as a net seller of Treasuries. As they are short in duration, it could well be enough to do some crowding out, and push the 10-year back up to 1.6%, and likely break above. This will put more pressure on long duration equities, aka the Nasdaq 100 NDX.

With TGA (Treasury General Account) cash coming in by this Summer to the tune of $1.1T as per the current TBAC schedule.. Bank SLR defined as Tier 1 Capital/(On + Off Balance Sheet Assets will decline. This is because deposits will come in and cash will go up at banks. Cash asset is in the denominator of SLR calc. As a result, U.S. banks won’t have room to accommodate the cash deposits.. their SLRs could trip minimum requirements.

Fed could fix all this by  excluding cash & treasuries from the SLR calc making the denominator lower and SLR higher for Banks so they don’t trip their minimum requirement which is 6% at the OpCo where most  of the deposits get flushed in with TGA.

No SLR relief means banks must turn away deposits and then there is nowhere for money market capital to reinvest (ex RRP which is still capped) that MMF Bill maturities floods more cash. So entire money market constellation trades close to zero or lower and Banks can’t buy US Treasuries no room on Balance sheet due to SLR so they start puking them out, TROUBLE!

Nominal GDP vs. Bond Yields
The Street is up at 6-7% 2021 GDP growth expectations.  BUT, including the inflation outlook – nominal GDP growth could be nearly 10% in 2021, but comparisons get tough in 2022 with growth estimates falling below 3%.

The March 31, 2021 Deadline

This month policymakers MUST consider extending the interim final rule that allows bank holding companies to exclude U.S. Treasuries and deposits held at Federal Reserve Banks from the calculation of their Supplementary Leverage Ratio (SLR) through March 31st, per ACG Analytics in Washington.

On April 1st, 2020, the Federal Reserve announced that it would exempt U.S. banks’ Treasury bond holdings and holdings at Federal Reserve Banks from Supplementary Leverage Ratio (SLR) calculations for one year. This was done “to ease strains in the Treasury market resulting from the coronavirus.” SLR rules broadly affect financial institutions with more than $250 billion in assets and require them to hold a minimum ratio of 3% Tier 1 capital against their total leverage exposure.

This form of regulatory relief enjoyed by big banks is set to expire on March 31st, 2021. If the Federal Reserve chooses not to extend the modified SLR rules, these banks will be forced to raise the level of capital held against their Treasury bonds and deposits at the Federal Reserve. This could result in a temporary decrease in market liquidity and lower demand for U.S. government debt as financial institutions reduce their exposure.

The Federal Open Market Committee (FOMC) will conclude its 2-day meeting on March 17th and an announcement on the SLR rule’s status could be made then. However, the issue has become politicized due to a recent letter by Senate Banking Committee Chairman Sherrod Brown (D-OH) and Committee member Sen. Elizabeth Warren (D-MA) requesting that the rule change be permitted to expire. Despite this, ACG Analytics believes that the SLR rule change will be… Join us…

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