House Representatives Press FRB to Change Leverage Ratio
Commentary by Steven Lofchie
U.S. House Representatives Mike Conaway (R-TX) and Colin Peterson (D-MN) urged Board of Governors of the Federal Reserve ("FRB") Chair Janet L. Yellen to (i) "recognize the exposure-reducing effect of segregated margin in the context of the off-balance sheet exposures of the Basel III Leverage Ratio" and (ii) "provide an explanation for why segregated customer margin does not reduce the bank's actual off-balance sheet exposure, especially as CFTC regulations circumscribe the manner in which it may be invested."
Representatives Conaway and Peterson expressed their concern that "if the leverage ratio remains unchanged when the 2018 compliance period begins, [then] a central pillar of Title VII of Dodd-Frank, the mandate to centrally clear derivative trades, will be thwarted." (The Representatives' letter references the section of the Dodd-Frank Act that is titled "Wall Street Transparency and Accountability.")
The representatives asked Chair Yellen to respond to their concerns by November 20, 2015, and urged her to address the topics they raised at the upcoming meeting of the Basel Advisory Committee.
Commentary
It is hard to understand the FRB's rationale for treating margin held in segregation by a swap dealer as the equivalent of an unsecured borrowing by a swap dealer. Perhaps the FRB believes that requiring more capital is better, even if, from the standpoint of risk, the requirement cannot be justified.
However, the argument that more is better does not make the economy any safer, since the increased capital requirement results in higher costs that must be passed on to commercial users, and discourages commercial users from hedging business risks. Raising the pricing of derivatives arbitrarily in order to reduce their use increases risk in the economy by raising the costs of risk management.