An article in the March 21st New York Times “New York Fed Chief Expresses Concern on New Leverage Rule” by Peter Eavis is worth looking at. The general topic was NY Fed governor Dudley’s views on Supplementary Leverage Ratio (SLR) rules.
The article says that Governor Dudley is quietly pushing back on SLR.
“…An influential New York bank regulator has privately raised concerns in recent weeks about a proposed rule that seeks to make the nation’s largest banks safer, frustrating other regulators who see it as a centerpiece of a financial system overhaul and want it to take effect swiftly…”
and
“…Mr. Dudley raised the possibility that the rule could inhibit the Fed’s ability to conduct monetary policy…”
How would that happen? For that you have to jump to the end of article.
“…bankers have often asserted that it could weigh on two types of assets that play a big role in transmitting monetary policy changes into the wider economy…”
“…One is ‘repo’ loans, which are short-term market loans that are collateralized with bonds provided by the borrower. The other is cash that banks have on deposit at the Fed. In theory, banks may hold less cash and engage in fewer repo loans if the leverage ratio goes up. In turn, that might make it harder for the Fed to conduct monetary policy smoothly and effectively…”
So it sounds like the standard version of the theory that higher capital requirements (that SLR bring) force banks to cull activities that don’t make it over a return hurdle rate. Repo, and especially HQLA repo, is likely to be one of those businesses. This assumes that even after netting down balance sheets, the returns don’t make the cut. We have seen evidence of that already and wrote about it in our post “Deutsche to cut their US balance sheet by 25%, much of it on the back of repo”.
But here is the rub: if repo businesses shrink their capacity, the fear is that the Fed could face trouble utilizing repo as a tool to conduct monetary policy. Already balance sheet dedicated to repo has gone down — but is this going to get to the point when the bank’s capacity to transact with the Fed will be limited?
The Fed is already addressing the issue: the reverse repo facility is a case in point. By transacting with counterparties well beyond the traditional primary dealers, the Fed is less dependent on the trading capacity of the PDs. Will the Fed do more to insure they can use markets to conduct monetary policy, in effect disintermediating the banks (and creating deeper connections with shadow banks)? Hard to tell right now but it will be a space worth watching.
The second issue raised was that somehow SLR would mean banks would hold less cash. This seems like a fuzzy reference to excess reserves. Would the banks, which are the natural end depositories for cash put into the system via QE, simply turn the money away? If banks needed to reduce that amount of cash they hold, they will simply lower the rates they pay. Given that the current rates are pretty much zero, that means heading toward negative territory. Connecting the dots between SLR, QE, excess reserves, and negative interest rates is, admittedly, a bit of a stretch. But the Fed has been very cautious about rates going negative and if SLR gives it that one last push, Dudley’s reluctance might be understandable.