ABA Banking Journal
No Result
View All Result
  • Topics
    • Ag Banking
    • Commercial Lending
    • Community Banking
    • Compliance and Risk
    • Cybersecurity
    • Economy
    • Human Resources
    • Insurance
    • Legal
    • Mortgage
    • Mutual Funds
    • Payments
    • Policy
    • Retail and Marketing
    • Tax and Accounting
    • Technology
    • Wealth Management
  • Newsbytes
  • Podcasts
  • Magazine
    • Subscribe
    • Advertise
    • Magazine Archive
    • Newsletter Archive
    • Podcast Archive
    • Sponsored Content Archive
SUBSCRIBE
ABA Banking Journal
  • Topics
    • Ag Banking
    • Commercial Lending
    • Community Banking
    • Compliance and Risk
    • Cybersecurity
    • Economy
    • Human Resources
    • Insurance
    • Legal
    • Mortgage
    • Mutual Funds
    • Payments
    • Policy
    • Retail and Marketing
    • Tax and Accounting
    • Technology
    • Wealth Management
  • Newsbytes
  • Podcasts
  • Magazine
    • Subscribe
    • Advertise
    • Magazine Archive
    • Newsletter Archive
    • Podcast Archive
    • Sponsored Content Archive
No Result
View All Result
No Result
View All Result
ADVERTISEMENT
Home Community Banking

COVID Makes the Case for Smarter Capital Measures

March 25, 2021
Reading Time: 5 mins read
Leveraged Lending Is Rising, But Bank Exposure Is Limited

By Hu Benton and Hugh Carney
ABA Viewpoint

Banks have been a stabilizing force during the economic downturn caused by the global pandemic, acting as safekeepers of deposits, conduits for government relief programs and liquidity providers to their customers. Those positive actions are helping people and businesses weather the pandemic, while maintaining strong bank capital levels, but they are also leading to an unintended negative side effect—declining leverage ratios for banks of all sizes. As a result, healthy banks large and small could be prevented from providing the support that the recovery needs right now. They might even be forced to turn away deposits.

Some rules that keep our system safe under normal circumstances by carefully measuring and offsetting risk have performed well despite the distorting effects of the pandemic economy, while others simply don’t work in the current environment. And banks—small and big alike—are struggling to absorb an unprecedented flood of deposits as the federal government has approved multiple rounds of economic stimulus totaling more than $5.3 trillion. Whether the funds have gone to individuals, businesses, or state and local governments, that stimulus has landed in bank accounts. Under normal circumstances, deposits are the lifeblood of bank lending, but nothing is normal right now.

Despite this unprecedented deposit surge, risk-based capital ratios, which calibrate capital to the likelihood an obligor will default, have remained strong as banks have invested deposits in safer assets such as Treasuries; but leverage ratios, which measure capital relative to all assets regardless of risk, are on the decline due to the unusual economic conditions caused by COVID-19. To illustrate, the largest banks are required to hold 5 percent capital against all assets, including the safest of the safe. In times like now, where we have seen a “flight to safety” from depositors, this leverage ratio has become what’s known as a binding constraint, instead of a safety net. Aware that some of the existing rules might restrict banks from using their balance sheets to support the economy during the pandemic, last spring bank regulators temporarily eased the supplementary leverage ratio, or SLR, for large banks and the community bank leverage ratio, or CBLR, for smaller banks.

That sensible relief is coming to an end, however, just when another $1.9 trillion is flowing into the economy. Federal regulators announced last week they will let the temporary SLR changes expire March 31, and the CBLR relief is already being phased out and is set to expire at the end of this year. As that temporary relief begins to sunset, it is worthwhile to consider whether inflexible bank leverage ratios are doing more harm than good to an economy facing an uncertain recovery.

Deposit influx

Figure 1. Click to enlarge.

Starting in March 2020, when stay-at-home orders put the economy into a partial state of suspended animation, consumers and corporations alike sought the safety of the banking system: Congress’ massive fiscal stimulus package sent a flood of direct payments into consumer and small business bank accounts; businesses shored up their own liquidity by drawing down credit lines; and savings balances grew as consumers reduced their spending. All told, more than $3.3 trillion in deposits flowed onto bank balance sheets in 2020, with increases averaging between 21 percent and 27 percent. While each institution’s experience has been unique, the flood of deposits has affected banks of all sizes.

Capital ratios

Figure 2. Click to enlarge.

When investing deposits in liquid and safe assets—for example, buying Treasury securities—a bank’s risk-based capital ratio remains steady because the assets receive a zero percent risk weight. During the past year, bank risk-based capital levels reached new heights, rising 1.33 percentage points.

Yet even though the industry’s risk-based capital levels have been increasing, as deposits have surged, Tier 1 leverage ratios—which compare the amount of capital to the size of assets—have been declining. Investments in Treasury and agency securities and central bank deposits actually reduce a bank’s leverage ratio, because all assets are treated the same, regardless of their risk profile. Super-safe assets are counted just the same as other assets—and banks are expected to hold a capital buffer against them, even when there is essentially no risk of loss.
Which brings us to today. We are learning that leverage ratios can create a disincentive for banks to accept deposits during a crisis. This is why regulators provided temporary leverage-ratio relief at the onset of the pandemic, and why politics should not cloud prospects for an extension until federal stimulus exits the system.

Figure 3. Click to enlarge.

It’s especially disappointing that declines in Tier 1 leverage ratios have been most pronounced for banks that have gone the extra mile to ensure their customers have access to funds, including through federal programs like PPP. Unfortunately, one well-intentioned program that was designed to avoid penalizing banks participating in PPP was poorly calibrated. Banks that pledged their PPP loans—which were fully guaranteed by the Small Business Administration—to the Federal Reserve’s Paycheck Protection Program Liquidity Facility were allowed to exclude those loans from both their leverage ratio and risk-based capital calculations. The interest rates offered by that facility, however, led most banks to conclude that it was not cost effective, so they declined to participate in the PPPLF. The market spoke loudly, with less than 10% of PPP loans by volume excluded from leverage ratios.

Figure 4. Click to enlarge.

While it is appropriate for regulations to be written for normal economic circumstances, it is also appropriate to extend regulatory flexibility during times of crisis. At this historic moment, it is worth considering the unintended consequences of leverage ratios—for banks of all sizes. Policymakers should not penalize banks for stepping up and taking deposits—a core banking function—while consumers, businesses and governments value safety over yield. Even Federal Reserve Chairman Jerome Powell acknowledged the unintended consequences when he testified at a March 23 House hearing and told lawmakers, “Because of the substantial increase in reserves and treasuries, the leverage ratio has rapidly becoming the binding constraint from a capital standpoint and that wasn’t our intention at the Fed from the beginning. We like risk-based capital to be binding because it forces banks to manage their risks more carefully.”

Figure 5. Click to enlarge.

Instead, the banking agencies should evaluate how regulations are applied in national emergencies and other stress environments. Initially, they were responsive, providing temporary flexibility related to asset thresholds, deposit insurance assessments, the CBLR and the SLR. But in declining to provide an extension for SLR flexibility beyond March 31, regulators will force some large banks to make balance sheet changes that could run counter to the needs of the recovery and put more pressure on an already-saturated banking system. Community banks will be left to absorb the runoff, yet they themselves will face similar challenges under the CBLR unless regulators extend that temporary flexibility. Time is of the essence to address the CBLR, especially as large banks make hard choices in anticipation of March 31.

To its credit, the Fed has indicated it will seek public comment “relatively soon” on recalibrating the SLR going forward to reflect the experience of the past year. As it does so, it would be prudent for bank regulators to consider this key question: Should leverage ratios (SLR, Tier 1, and CBLR) exclude safe assets that have grown on bank balance sheets simply as a result of banks serving their traditional role as a haven during financial stress? For anyone interested in seeing banks large and small continue to support the recovery, the answer should be yes.

Hu Benton is VP for banking policy at ABA. Hugh Carney is SVP for prudential regulation at ABA.

ABA Viewpoint is the source for analysis, commentary and perspective from the American Bankers Association on the policy issues shaping banking today and into the future. Click here to view all posts in this series.

ADVERTISEMENT
Tags: ABA ViewpointCommunity bank leverage ratioRegulatory capital
ShareTweetPin

Related Posts

ABA urges FCC to combat illegal call spoofing

ABA urges FCC to impose call authentication requirement for non-IP networks, mandate IP transition

Compliance and Risk
July 16, 2025

ABA joined six trade associations in urging the FCC to adopt a proposal to create a new call authentication requirement designed to limit criminal access to the U.S. calling network.

ABA faults banking regulators for confusing CRA rule rollout

Banking agencies propose to rescind Community Reinvestment Act rule

Community Banking
July 16, 2025

The Federal Reserve, FDIC and OCC issued a joint proposal to rescind the Community Reinvestment Act final rule adopted in 2023.

Bank economists grow more optimistic about business credit, soft landing

Beige Book: Economic activity ticks up

Economy
July 16, 2025

Economic activity increased slightly from late May through early July, with five Federal Reserve districts reporting slight or modest gains, five with flat activity and the remaining two experiencing modest declines in activity, according to the fifth Beige...

ABA banker: Long-term Farm Bill would boost ag economy

ABA banker: Long-term Farm Bill would boost ag economy

Ag Banking
July 16, 2025

The agricultural provisions in the recently enacted budget reconciliation bill will provide a strong backstop for agricultural producers, but a long-term Farm Bill is still needed, Clint Hood, SVP for Synovus Bank in Dublin, Georgia, told House lawmakers.

CFPB releases mortgage servicing proposal, overhauls loss mitigation framework

FHFA releases FAQ about Fannie, Freddie credit score change

Compliance and Risk
July 16, 2025

FHFA released an FAQ on the recent announcement that Fannie Mae and Freddie Mac will expand credit scoring options. Fannie and Freddie have also created webpages about the planned implementation of the policy.

Industrial production rose in March

Industrial Production rose in June

Economy
July 16, 2025

Industrial production (IP) rose 0.3% in June after remaining unchanged in April and May. For the second quarter as a whole, IP increased at an annual rate of 1.1%.

NEWSBYTES

ABA urges FCC to impose call authentication requirement for non-IP networks, mandate IP transition

July 16, 2025

Banking agencies propose to rescind Community Reinvestment Act rule

July 16, 2025

Beige Book: Economic activity ticks up

July 16, 2025

SPONSORED CONTENT

Navigating Disruption in Ag Lending – Why Tariffs Are Just the Tip of the Iceberg

Navigating Disruption in Ag Lending – Why Tariffs Are Just the Tip of the Iceberg

July 1, 2025
AI Compliance and Regulation: What Financial Institutions Need to Know

Unlocking Deposit Growth: How Financial Institutions Can Activate Data for Precision Cross-Sell

June 1, 2025
Choosing the Right Account Opening Platform: 10 Key Considerations for Long-Term Success

Choosing the Right Account Opening Platform: 10 Key Considerations for Long-Term Success

April 25, 2025
Outsourcing: Getting to Go/No-Go

Outsourcing: Getting to Go/No-Go

April 5, 2025

PODCASTS

Breaking down the bank-related provisions in the big budget bill

July 10, 2025

Podcast: Inside ABA’s new Treasury Check Verification System API

June 25, 2025

Podcast: Staying close to clients amid tariff-driven volatility

June 18, 2025
ADVERTISEMENT

American Bankers Association
1333 New Hampshire Ave NW
Washington, DC 20036
1-800-BANKERS (800-226-5377)
www.aba.com
About ABA
Privacy Policy
Contact ABA

ABA Banking Journal
About ABA Banking Journal
Media Kit
Advertising
Subscribe

© 2025 American Bankers Association. All rights reserved.

No Result
View All Result
  • Topics
    • Ag Banking
    • Commercial Lending
    • Community Banking
    • Compliance and Risk
    • Cybersecurity
    • Economy
    • Human Resources
    • Insurance
    • Legal
    • Mortgage
    • Mutual Funds
    • Payments
    • Policy
    • Retail and Marketing
    • Tax and Accounting
    • Technology
    • Wealth Management
  • Newsbytes
  • Podcasts
  • Magazine
    • Subscribe
    • Advertise
    • Magazine Archive
    • Newsletter Archive
    • Podcast Archive
    • Sponsored Content Archive

© 2025 American Bankers Association. All rights reserved.