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Calls to exclude U.S. Treasuries from leverage ratio imply fear of their rising risk

Section: Daily Dispatches

By Antonio Carlos Fernandes
via Medium, San Francisco
Thursday, March 7, 2024

A recent letter from the International Swaps and Derivatives Association Inc. (ISDA) to the Board of Governors of the Federal Reserve System highlights a larger risk in the United States and international banking sector than what is commonly perceived by the market.

The letter, dated March 5, emphasizes the urgent need for reform in the supplementary leverage ratio (SLR) and enhanced supplementary leverage ratio (eSLR) framework. 

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Specifically, it calls for the exclusion of on-balance sheet U.S. Treasuries from the total leverage exposure used in calculating the SLR for global systemically important bank holding companies (GSIB surcharge). This reform is seen as crucial to preserve the resilience of the U.S. Treasury markets, the U.S. economy, and the international financial system at large.

Though this issue may not be in the forefront of public attention, the arguments put forth in the letter are indeed alarming. Banks are advocating for U.S. Treasuries to be excluded from their supplementary leverage ratio calculation for several key reasons.

First, U.S. Treasuries are traditionally regarded as the “risk-free asset” due to being backed by the full faith and credit of the U.S. government. Excluding them from leverage ratio calculations implies that banks perceive them as risky, which could undermine confidence in U.S. government debt.

Second, the supplementary leverage ratio serves as a critical backstop to risk-based capital requirements, ensuring that banks do not become overleveraged even with assets considered to be safe. The proposal to carve out Treasuries from this calculation weakens the protection against excessive leverage.

Furthermore, if Treasuries are excluded, banks might be inclined to accumulate significant amounts of Treasury debt without it impacting their SLR. This concentration of risk heightens the interconnectedness between the banking system and government debt, posing systemic risks.

The request for this exclusion also hints at banks' concerns regarding the size of their Treasury holdings compared to their capital base. This could signal broader anxieties about the U.S. fiscal situation and government debt levels.

Any perception that banks require special exemptions for holding U.S. government debt could shake global confidence in Treasuries as a safe-haven asset and could impact the status of the U.S. dollar. ...

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Antonio Carlos Fernandes is senior policy adviser at the European Investment Bank in Luxembourg.

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