The Supplementary Leverage Ratio
The Supplementary Leverage Ratio (SLR) requires G-SIBs to hold at least 5% Tier 1 capital against their total leverage exposure — defined as on-balance-sheet assets plus certain off-balance-sheet exposures, with no risk-weighting. Unlike risk-based capital ratios, the SLR treats a $1 billion Treasury position identically to a $1 billion junk-loan portfolio.
During normal times this bluntness is a feature — it prevents banks from gaming risk models to minimize capital requirements while accumulating leverage. But it creates a severe constraint specifically on Treasury market intermediation: bank-affiliated broker-dealers face a hard balance sheet cost for holding or warehousing Treasuries in their dealer books, regardless of how safe those assets are.
Impact on Repo Markets and Balance Sheet Reduction
The SLR constraint on dealer intermediation matters for the Fed's balance sheet because the repo market is the primary mechanism through which the Fed can accelerate the absorption of Treasury securities during QT. When dealers cannot efficiently warehouse Treasuries — because the SLR penalises balance sheet expansion — repo spreads widen, Treasury market liquidity deteriorates, and the Fed may be forced to slow QT or maintain a larger ON RRP facility.
An SLR exemption for Treasuries would increase dealer capacity to absorb securities being released from the Fed's SOMA portfolio, allowing QT to proceed at a faster pace without destabilising Treasury market functioning. Indirectly, this widens the range of feasible balance sheet reduction paths.
Precedent: COVID-19 Temporary Exemption
The Fed implemented exactly such an exemption temporarily from April 2020 through March 2021, excluding reserves and Treasuries from the SLR denominator for bank holding companies. The exemption was allowed to expire in March 2021 over financial stability concerns about reducing regulatory capital requirements during an uncertain period. Opponents argued the exclusion would encourage excessive risk-taking by freeing up capital that banks might redeploy into riskier assets.
The current proposal is narrower: exempt only Treasury securities (not reserves) to specifically target dealer intermediation capacity, minimising the risk of capital redeployment into riskier assets. Some proposals also limit the exemption to securities held in registered dealer entities rather than bank holding companies broadly.
Financial Stability Trade-offs
The paper acknowledges this option involves genuine trade-offs. Freeing up SLR capacity could encourage banks and dealers to increase leverage, including in ways unrelated to Treasury intermediation. The net effect on financial stability depends on whether the additional capacity is deployed productively (Treasury market-making) or in riskier activities.
The paper rates this option as having an unquantified aggregate effect because the balance sheet reduction occurs indirectly through improved market functioning and faster feasible QT pace, rather than through a direct mechanical reduction in reserve demand — making precise estimation methodologically challenging.
Effect is indirect: improved dealer capacity enables faster QT pace. Not included in the paper's aggregate $1.2–2.1T estimate.