Removing Treasuries from Bank Balance Sheet Calculations Could Unleash Financial Risk

US government debt known as Treasuries is seen as a foundation of the global financial system with almost $900 billion of bonds exchanged daily in a market approaching $30 trillion in value The Trump administration is now proposing a radical overhaul allowing America’s largest banks to exempt Treasuries from balance sheet risk calculations a move designed to encourage more government bond buying by removing existing penalties for holding them

This change targets a key post financial crisis rule the supplementary leverage ratio or SLR which currently requires big banks to hold additional capital as a buffer against all assets regardless of their risk profile Under the SLR Treasuries are treated as having similar risk as far less stable junk bonds a position that has drawn strong criticism from bankers and commentators alike

Leading industry voices including JP Morgan chief executive Jamie Dimon argue that current rules deter banks from acting as financial market intermediaries especially during volatile periods Regulators such as US Treasury Secretary Scott Bessent contend that adjusting the rules would lower US borrowing costs benefit the economy and support a Treasury market now facing weaker demand from foreign investors Federal Reserve Chair Jerome Powell has remarked it is prudent to reconsider the approach as the volume of low risk assets has grown considerably in recent years

Regulatory proposals under discussion include either tying capital requirements to each bank’s systemic importance rather than the blunt SLR or even fully excluding government bonds and central bank deposits from the ratio entirely Early estimates suggest that such changes could free up an extra $5.5 trillion on bank balance sheets and lead to a 27 percent drop in capital requirements for major banking groups

Critics caution that a return to looser precrisis rules poses real threat Sheila Bair former head of the Federal Deposit Insurance Corporation recalls how higher capital requirements provided crucial resilience in 2008 and warns that removing these safeguards may lead to more risk taking failed banks and potentially major losses for taxpayers Recent experience with Silicon Valley Bank illustrates the potential problem as SVB’s heavy Treasury holdings suffered steep value declines when interest rates rose sharply in 2023 triggering its collapse and sale to HSBC

Analysts at Morgan Stanley note that the previous pandemicera exemption is not a valid comparison with today as it coincided with an extraordinary surge in customer deposits Capital buffers exist for a reason and should not be weakened lightly Harvard professor Ken Rogoff points out the global banking system held up well under stress because of these requirements and warns that sudden bond market selloffs often leave the public shouldering the cost

With high stakes for financial stability and public finances alike regulators must weigh the risks of market dysfunction and the lessons of history before overhauling these cornerstone rules