The Federal Reserve announced on Friday that it would not extend an important rule accommodation put in place last spring that helped banks continue to lend to small and medium-size businesses as the economic effects of the pandemic took hold.
The rule change last spring helped calm markets and encourage lending to small and medium-sized businesses.
The rule change allowed banks to exclude Treasury securities and deposits with the Federal Reserve from a capital requirement called the supplemental leverage ratio (SLR). The accommodation is set to expire on March 31, and the move is viewed as sensitive to the political commentary coming from Capitol Hill in recent weeks.
Last April, when the Fed lowered the SLR, it did so to help banks build liquidity, calm markets and allow them to continue lending throughout the economic shock of the pandemic. Some of this lending was done through programs like the Paycheck Protection Program, with anticipation that further lending would take place as the economy moved into a recovery.
Now, with the accommodation ending, banks are likely to shed their excess reserves and increased Treasury holdings.
In the weeks leading up to the expiration of the adjusted SLR, the largest banking institutions in the country began shedding some of those assets they had accumulated. According to Bloomberg, primary dealers have shed roughly $80 billion in Treasury holdings.
While the effects of the Fed’s decision may be seen more immediately in interest rate movements, the lagging effect that will require close monitoring is how financial and lending conditions change as the economy enters a period of robust rebound. A tightening of these conditions could have negative consequences on the small and medium-sized business that are now looking toward a return to more normal activity.
In the statement, the Fed noted it was sensitive to the financial and lending conditions in the aftermath of the decision and, in our interpretation, how those conditions may affect small and medium-sized enterprises.
“However, because of recent growth in the supply of central bank reserves and the issuance of Treasury securities, the Board may need to address the current design and calibration of the SLR over time to prevent strains from developing that could both constrain economic growth and undermine financial stability,” the Fed said in its statement.
We won’t know immediately how the Fed’s decision affects small and medium-sized enterprises, but the Fed’s statement leaves the door open to changing the ratio again if its decision impedes the economic recovery.
At such a time, the Fed – rather than lowering the SLR again – could change how it is computed. Such a change to the computation of the SLR may provide the necessary relief to spur financial and lending conditions if needed.
For more information on how the coronavirus pandemic is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.