In what might generously be described as a curious interpretation of “financial stability,” the United States’ top banking regulators are reportedly considering a reduction of up to 1.5 percentage points in the capital buffer requirement applied to the largest banks—just as markets grow increasingly volatile.
The Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency are said to be discussing a revision of the enhanced Supplementary Leverage Ratio (eSLR)—a post-crisis safeguard meant to ensure megabanks hold enough capital relative to their total exposures. The proposed adjustment would lower the requirement for bank holding companies from the current 5% to a range of 3.5% to 4.5% and for their banking subsidiaries from 6% to the same range.
This marks a potential return to the deregulatory mood of 2018 when the Trump administration spearheaded “tailored” approaches for global systemically important banks (G-SIBs). Notably, the reform would not exclude Treasury securities outright from the eSLR calculation, as some had anticipated, but would solicit public feedback on whether such exemptions should be considered.
The rationale behind this regulatory retreat? To improve liquidity in the $29 trillion US Treasury market—never mind that regulators are simultaneously issuing warnings about market fragility caused by excessive leverage and poor risk buffers.
Fed Chair Jerome Powell has hinted that current capital rules may be constraining Treasury market intermediation. In February, he delicately expressed “concern” about long-standing liquidity issues in that very market—though whether the proposed loosening will resolve that problem or introduce new ones remains highly questionable.
Critics—both inside and outside the Fed—are understandably sceptical. While the banking lobby insists the eSLR over-penalises Treasury holdings and stifles participation during times of stress, others point out that when the rules were temporarily eased during the COVID crisis, most banks chose not to increase Treasury purchases. The reason? Exploiting the flexibility would have restricted dividend payouts and share buybacks—a sacrifice few were willing to make.
Former Fed attorney Jeremy Kress was blunt: “There’s little evidence that freeing up balance sheet space leads to more Treasury market intermediation. More likely, banks will return the favour to shareholders.”
Indeed, loosening leverage ratios during a period of mounting fiscal imbalance and geopolitical tension could be seen as inviting moral hazard on a grand scale. Treasury Secretary Scott Bessent has acknowledged that such a shift could even reduce Treasury yields by several dozen basis points—a boon for government financing perhaps, but one achieved at the expense of systemic resilience.
Former Treasury official Graham Steele didn’t mince words either: “This sort of deregulation won’t fix the underlying issues in the Treasury market. It will just make the financial system more fragile.”
In short, Washington appears determined to patch market dysfunction with regulatory leniency—hoping that banks will voluntarily use the breathing room for the public good rather than the more likely outcome: ramped-up capital distributions and a renewed game of balance-sheet arbitrage.
It’s a gamble—and one whose risks may only become clear when the next shock comes knocking.