While Two ‘Fs’ In Cliff, There Isn’t In The SLR Heading Toward One

A few have asked, so I’ve written up what is actually a shorter piece on this SLR business is all about. First, SLR stands for Supplementary Leverage Ratio (and it’s not SLF, as I managed to leave two of the same typos in this article, even allowing the mistake to make it into the headline). Parts of the SLR were set aside last year as a COVID crisis tool, but are scheduled to come back at the end of March 2021.

That’s the “cliff”.

What’s the SLR and where did this thing come from?

Short version: capital ratios had failed miserably to alert bank regulators or anyone else in the pre-crisis era to a dangerous and sustained systemic increase in leverage. What used to be called commercial banks (or investment banks) figured out how to manipulate them, relying heavily on instruments like credit default swaps (the majority of AIG’s CDS book, for example, had been used for just this purpose), to achieve something called regulatory capital relief.

Basically, how to make risky assets seem safe according to the rules for the purposes of being forced to hold less capital against the whole bunch. Hidden leverage.

To fix, or attempt to fix the problem, regulators got together in the smoldering aftermath of what they called a “subprime mortgage crisis” deciding to supplement capital ratios with another calculation that doesn’t weight assets for different risk “buckets.” By treating everything the same, it was hoped the new number would better and more accurately depict the full leverage used by every institution.

No matter if assets are safe or downright dangerous, this SLR measures the whole balance sheet in more homogenized fashion (including derivative books and off-balance sheet positions; though, it needs to be pointed out, this is neither straightforward nor uncontroversial, but that’s beyond the scope of this post). In other words, where a UST security is assigned a very low risk-weighting when calculating Tier 1 Capital ratios, it is weighted the same as any other asset for the purposes of the SLR.

In the aftermath of GFC2 (the COVID crisis, according to central bankers), in May 2020 the US bank regulator triplets approved the following change in the SLR calculation:

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Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

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