U.S. Department of Finance's Potential Bank Regulatory Rule Modifications
The U.S. Department of Finance is considering modifying bank regulatory rules, potentially allowing banks to passively increase their holdings of U.S. debt. This move is seen as a way to alleviate pressure on the U.S. national debt and potentially lower interest rates.
Impact on U.S. National Debt Interest Rate
Dropping certain regulations could directly lower the U.S. national debt interest rate by an estimated 0.3% to 0.7%. This is seen as significant, especially given resistance to interest rate cuts from other sources. The action is interpreted as an urging of the U.S. Treasury Department to effectively lower interest rates multiple times. The core reason for this consideration is the unsustainable level of U.S. debt.
Understanding the Supplementary Leverage Ratio (SLR)
The key to understanding the potential impact lies in the Supplementary Leverage Ratio (SLR). Introduced after the 2008 financial crisis, the SLR serves as an indicator of a bank's anti-risk capability.
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Formula: SLR = (Tier 1 Capital / Total Leverage Exposure) * 100%
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Tier 1 Capital: Represents the bank's free capital plus its retained earnings (profit).
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Total Leverage Exposure: Encompasses all the bank's assets, excluding those deemed 100% risk-free. This includes loans, debt holdings (including U.S. debt), and other assets, regardless of their perceived risk level.
The SLR effectively forces banks to hold sufficient capital reserves against all assets, recognizing that even seemingly safe assets can potentially lose value. For example, a bank using 100 yuan of capital to purchase 2,000 yuan of bonds would have an SLR of 5%.
Consequences of the SLR Rule
While the SLR effectively prevents risk by demanding real gold and silver capital to the bottom, the rule has side effects.
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Advantage: Prevents banks from drilling holes, ensures risk prevention
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Side Effects:
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Holding more U.S. bonds increases a bank's total leverage.
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Banks need to supplement more tier-one capital to meet regulatory requirements.
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Decreases the incentive of banks to buy US debt.
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The U.S. Treasury's Dilemma
The U.S. Treasury Department is pushing for rule changes because of a decreased demand for U.S. debt. Increasing U.S. debt, fueled by spending and tax reduction plans, coupled with high interest payments, has created a difficult situation. With U.S. debt auctions becoming more frequent, the burden falls on banks to purchase these bonds, but doing so impacts their SLR.
Proposed Solutions: Modifying the SLR
The U.S. Treasury has two potential solutions to encourage banks to buy more U.S. debt:
- Excluding U.S. Bonds and Fed Prepayments from SLR Risk Threshold: This would mean that these assets are no longer fully counted toward a bank's leverage, allowing them to buy more without increasing regulatory pressure. A similar measure was implemented during the 2020 pandemic to stabilize markets and ensure banks could absorb the influx of government bonds. The problem is that once this policy becomes normal, then the financial security of SL2 will be emptied
- Lowering the Additional Capital Buffer for Global Systemically Important Banks (GSIBs): GSIBs are required to hold an additional 2% capital buffer on top of existing requirements. Reducing this buffer would free up capital for these large banks.
Calculations suggest that these measures could release significant liquidity and lower U.S. national debt interest rates.
Potential Risks and Concerns
While these measures could alleviate immediate pressure, they also carry risks. Emptying a bank's capital buffer, even with U.S. national debt, may create systemic financial risks in the long term, burying an invisible bomb for the U.S. bank system. Adjusting the SLR requires consensus from multiple institutions, and given current political dynamics, achieving such consensus may be challenging.
The U.S. Treasury Department's actions are seen as an attempt to cover up the U.S. debt crisis and delay the decline in U.S. credit. Whether it will protect the US dollar and stabilize the U.S. debt market remains to be seen.
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