Blog LenderLaw Watch May 28, 2020

Bank Regulators Issue New Interim Final Rule Addressing COVID-19-Created Stressors

On May 15, 2020, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation (collectively, Regulators), proposed a new final interim rule “that temporarily revises the supplementary leverage ratio calculation for depository institutions,” in order to “strengthen the ability of” banks “to continue taking deposits, lending, and conducting other financial intermediation activities” during the COVID-19 pandemic.  The new final interim rule (New Interim Rule), which is subject to a 45-day notice and comment period and would remain in effect through March of 2021, is expected to increase the otherwise-diminished lending capacities of banks in the United States.

As first promulgated in 2014, the supplementary leverage ratio rules were meant to increase the liquidity requirements of large banks.  Under the supplementary leverage ratio rules, banks with more than $250 billion in total assets are required to hold a “leverage ratio” of at least 3% with their depository institutions, while “global systemically important banks” are required to hold 6%.  This ratio is calculated by dividing “a depository institution’s tier 1 capital”—which includes, among other things, retained earnings and qualifying common stock—by its “total leverage exposure.”  “Total leverage exposure” consists of balance-sheet items, less tier 1 capital, and plus other specified amounts (such as cash collateral for certain derivative contracts).  Under the New Interim Rule, eligible banks may elect to temporarily “exclude . . . U.S. Treasury securities and deposits at Federal Reserve Banks from the supplementary leverage ratio denominator.”  Banks that make this election would thus reduce the amount of capital that they would otherwise be required to hold under their presently expanding balance sheets.

Regulators have cited two main justifications for the New Interim Rule.  First, “disruptions in financial markets, and the resulting flight to liquid assets,” have led to an “inflow[] of deposits,” which have in turn expanded banks’ balance sheets.  Second, banks’ balance sheets have also seen increases due to “customer draws on credit lines and depository institutions’ holdings of significant amounts of U.S. Treasury securities.”  Regulators have noted that these “trends are expected to continue . . . while depository institutions and their customers respond to disruptions in the financial markets” stemming from COVID-19.  Adjustments to the supplementary leverage ratio rules are thus needed to address these balance sheet increases, which could otherwise “cause a sudden and significant increase in the regulatory capital needed to meet [the] leverage ratio requirement.”

The New Interim Rule seeks to lessen this would-be burden resulting from the balance sheet increases.  The rule is expected to have significant impact in this regard, with Regulators estimating that it could “temporarily decrease . . . capital requirements by approximately $55 billion for depository intuitions” if all those eligible opt in.  It is also “expected to increase leverage exposure capacity . . . by approximately $1.2 trillion,” which will in turn “strengthen the depository institutions’ ability to continue to accept customer deposits.”

The true impact of the New Interim Rule remains to be seen, as it is not yet clear how many of the eligible depository institutions will opt in.  While Regulators have noted downsides to the New Interim Rule, they expect them to be minimal—such as institutions incurring “very small” costs “associated with making changes to internal systems or processes for managing supplementary leverage ratio compliance.”  However, as explained above, the rule certainly has the potential to alleviate some of the stresses on banks that remain prevalent in a COVID-19 world.