I’m no expert, but shouldn’t any large changes to the supplemental leverage ratio be viewed as a negative catalyst for the stock market?
Risky Finance took note of this back in November, writing that regulatory capital had been decreased by as much as $3 trillion for the 6 largest banks due to the feds forbearance measures in response to the virus outbreak..
“The biggest forbearance measure was a move by the Fed in May to exclude treasury bonds and central bank deposits from the leverage exposure measure. That wiped $2 trillion off the SLR denominator, including $619 billion at JP Morgan alone.””Just one of the regulatory changes implemented by the fed in the response to the economic shutdowns would have reduced the denominator (total assets) for calculating the SLR by $3 trillion for the 6 largest banks (regulatory balance sheets)…””…without three critical forbearance measures, some banks such as Citigroup or Goldman Sachs would have been just 30 basis points away from the minimum, which would prompted the Fed to restrict their trading and lending activity.”
To calculate the SLR , just divide the Tier 1 Capital by a bank’s assets.
Tier 1 Capital = reserves, common equity, plus retained earnings and certain instruments with discretionary dividends and no maturity.
In the past, when the banking industry was much more competitive, it was common for banks to market themselves on their surplus (reserve) in order to attract new customers.
Changes to the leverage ratio can lead to very large increases–or decreases–to a banks’ ability to lend. To put that into perspective, according to Thomas Hoenig, a former Vice Chair of the Federal Deposit Insurance Corporation, if share buybacks of $83 billion, representing 72% of total payouts for the top 10 BHCs in 2017, were instead retained, under current capital rules, this could have increased small business loans by $750 trillion, or mortgage loans by almost $ 1.5 trillion…
But how does this affect the stock market, you might be wondering?
Well, if J.P. Morgan is going to be adding roughly $619 billion back to the assets used for calculating this leverage ratio, it should theoretically reduce the amount of credit that will be available for investors to speculate. This, of course, would not be a good thing..
Nick Panigirtzoglou, a top analyst at JPM , seemed to support this idea back in November when he argued that lockdowns could actually become a bullish signal because they would increase the likelihood of more quantitative easing from the fed.
“Although it has had a negative impact in the short term, the reemergence of lockdowns and resultant growth weakness could bolster the above equity upside over the medium to longer term via inducing more QE and thus more liquidity creation.”
If a top analyst at America’s largest bank believes that quantitative easing is more important to the stock market than real tangible business activity–even during worldwide pandemic related economic lockdowns–than it only makes sense to assume that any kind of drastic changes to the SLR should also have some kind of impact on equity markets as well.
May 15, 2020, Federal Reserve Press Release
“For purposes of reporting the supplementary leverage ratio as of June 30, 2020, an electing depository institution may reflect the exclusion of Treasuries and deposits at Federal Reserve Banks from total leverage exposure as if this interim final rule had been in effect for the entire second quarter of 2020. Because the supplementary leverage ratio is calculated as an average over the quarter, this will have the effect of maximizing the effect of the exclusion starting in the second quarter of 2020. The agencies are not making similar adjustments to riskbased capital ratios because Treasuries and deposits at Federal Reserve Banks are risk-weighted at zero percent.
But again, I’m no expert, it’s just with fed policy playing such an important role in market valuations these days, it’s hard not to pay attention to what’s going on.
Cheers, and hope to hear your thoughts.
“The interim final rule is effective as of the date of Federal Register publication and will remain in effect through March 31, 2021.”