US regulators are set to lighten the supplementary leverage ratio (SLR) rule, which restricts how much Treasury securities banks can hold. This change aims to boost liquidity in the $29 trillion Treasury market and reduce borrowing costs for the government. The SLR was created after the 2008 financial crisis. It requires banks to keep a specific amount of capital based on their total leverage, including Treasuries. The proposed change would allow banks to exclude Treasuries and central bank deposits from this calculation, enabling them to hold more without increasing their capital requirements.

Review of eSLR for Major Banks

US regulators, including the Federal Reserve and the FDIC, are reviewing adjustments to the enhanced supplementary leverage ratio (eSLR) for major banks. The proposal could lower the capital requirement for bank holding companies from the current 5% to between 3.5% and 4.5%. Operating subsidiaries of these banks may also see their requirements drop from 6% to the same range. The sources discussing these changes prefer to remain unnamed due to confidential discussions. This article outlines how American regulators plan to make it easier and less expensive for large banks to hold government debt. The focus is on the SLR, a capital rule that decides how much capital banks must hold based on their total assets, including low-risk ones like US Treasuries. After the 2008 crisis, this rule aimed to lower risk in the financial system by ensuring banks kept strong balance sheets. However, it also made some banks hesitant to hold Treasuries because it increased their leverage exposure and capital costs. Now, regulators are considering easing this rule by modifying the enhanced SLR that applies to larger institutions. They plan to remove Treasury securities and deposits at central banks from the formula that determines the ratio. This would give banks more freedom to purchase and hold government bonds without needing to increase their required capital. Ideally, this change would encourage participation in Treasury markets, which have seen reduced liquidity in recent years. By lowering the capital ratio to a range of 3.5% to 4.5%—down from 5%—holding companies would face less stringent requirements. Their operating arms could also reduce their ratio from 6%, allowing them to align their capital loads with the actual risks of their assets. This could enable dealers to maintain larger inventories of Treasuries, which is timely given the expanding $29 trillion Treasury market due to ongoing federal deficits.

Impact on Fixed Income Derivatives

For those involved in fixed income derivatives, these changes will have significant effects. When primary dealers can absorb more government bonds, liquidity improves, benchmark yields may stabilize, and hedging costs can adjust as well. The focus here is how the flexibility at the dealer level impacts pricing across the rates markets, affecting Treasury basis, repo spreads, and swap curves. Although the easing is not yet finalized, the trend is evident. Regulators seem inclined to support stronger intermediation in Treasuries, which could narrow bid-offer spreads, enhance hedging execution, and facilitate larger transaction volumes. As we anticipate how market-makers will respond, we can expect a broader balance sheet footprint and more competitive pricing in the cash bond market and its derivatives. The relaxation of the previous stricter SLR also changes the incentives for bank treasuries and risk desks. With fewer constraints, risk-weighted return requirements change, making previously unviable positions worth reconsidering. Liquidity not only improves in depth but also in resilience, especially during volatile times when having capital flexibility is critical. From our perspective, trade structuring will shift, particularly for trades that involve leverage or consume balance sheets. Strategies like compression trades, rolling strategies, and term funding arbitrage will take on new payout structures as bank desks adjust pricing tiers according to this new framework. The overall effect could lead to a modest steepening of curves if dealer capacity rises quickly, or a flattening in the short term if new bond supply is adequately absorbed. Yellen’s department will likely pay close attention to these changes—not in terms of strategy, but in terms of results, as they directly affect how financing rates for the government evolve. For us, it’s essential to recognize where transaction volumes are likely to increase and which instruments will be repriced as balance sheet constraints ease. Whether dealing in Treasury forwards or volatility-sensitive positions, the baseline assumptions about constraints have shifted noticeably. This reality directly influences execution costs, margin frameworks, and risk transfers in the upcoming quarter. Create your live VT Markets account and start trading now.

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