US Banks Hold Their Breath Ahead Of Fed Leeway Expiration

The stakes are high as we head to 31st March. By then, the positive leeway the Fed gave to US banks on how to treat Treasuries and reserves comes to an end, unless the Fed decides to extend it. We think they will, but not with conviction. If they don't, there are $600bn of Treasuries that banks may feel obligated to off-load. Not a small number by any stretch.

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Around a year ago, when Covid-19 was really hammering the US system and economy, the Federal Reserve decided to allow banks to buy Treasuries and hold deposits without regulatory restriction.

The Fed was in a systemic-panic-containment mode a year ago, as it rolled out a series of measures aimed at keeping the system afloat, while at the same time providing various life-lines to the wider economy

At that time, the Treasury market needed support, as deteriorating liquidity and elevated bid/offer spread became an issue. The market was stressed and the system had been under some pressure.

The ease of restriction on US banks lasts until the end of the month - 31 March. In all probability, the Fed will extend it by at least six months. To understand why, and what the nuances are, we dig a little deeper. But this deep dive also helps to understand why the Fed might decide against extending, which would have far more consequences.

Why was allowing banks to buy more Treasuries and hold more reserves even important?

As a starting point, banks take deposits. At its simplest level, those deposits are used to either provide loans to consumers and businesses, or they can be invested in ultra-safe securities, like Treasuries. Both of these avenues generate a return for the bank – a traditional savings and loan model. And some of those excess deposits end up as reserves held at the central bank.

But this cannot be done without limit, and there are various regulatory requirements that banks need to abide by to ensure their activities are underpinned by a suitable amount of capital. However, the one at issue here is the supplementary leverage ratio – it requires a minimum capital of 3% relative to total leverage exposure, and that leverage exposure includes holdings of Treasuries and reserves at the Fed.

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