Fed's re-imposition of Capital requirement, that big banks hold capital against Treasury bonds and reserves, seems contradictory to its own goals

As many of you know, an year ago, the Fed had temporarily eased Capital Requirements for Big Banks, specifically for their super-safe assets, the Treasurys and Deposits held at the Fed.

April, 1, 2020: “The Fed said it would exclude for one-year Treasurys and deposits held at the central bank from banks’ supplementary leverage ratio calculation. The ratio measures capital—funds that banks raise from investors, earn through profits and use to absorb losses—as a percentage of loans and other assets.”

Fed Temporarily Eases Capital Requirements for Big Banks - WSJ

An year later, as that temporary reprieve expires, the Fed has decided not to extend it.

March, 19, 2021: “Friday’s decision means banks will lose the temporary ability to exclude Treasurys and deposits held at the central bank from lenders’ so-called supplementary leverage ratio. The ratio measures capital—funds that banks raise from investors, earn through profits and use to absorb losses—as a percentage of loans and other assets. Without the exclusion, Treasurys and deposits count as assets. That will likely force banks to hold more capital or reduce their holdings of those assets, both of which could ripple through markets.”

Federal Reserve to End Emergency Capital Relief for Big Banks - WSJ

Amit's Take: With both the monetary and fiscal stimulus finally working in tandem, the economic outlook is improving and the GDP growth expectations for this year have now been revised up to 6.5%. We are not out of the woods yet, and the risks persist. I am all for a stable and strong banking system with prudent checks and balances in place. However, this capital requirement particularly for the risk-free assets, i.e., the Treasurys and Reserves held at the Fed, doesn’t necessarily increase the stability of the financial system. On the contrary, it reduces the banks’ ability to lend more (contrary to Fed’s goals), or pushes banks to reduce Treasury holdings thereby pushing the rates even higher (contrary to Fed’s goals).

A well-reasoned POV by Greg Ip: “The case for that requirement is flawed.”

Fed’s Reversal on Bank Capital Requirements Serves No Purpose - WSJ