Key Highlights

• We are not convinced SLR reform will have a great impact on yields
• SRF operations will commence in the mornings at the end of June
• Legitimizing the SRF is a key goal of Fed communications

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SLR relief: a panacea?

EXHIBIT #1: DEALERS’ BALANCE SHEETS STUFFED WITH USTS

_{Source: Federal Reserve Bank of New York}

Recent chatter about Supplemental Leverage Ratio (SLR) reform has intensified, with Treasury Secretary Bessent saying several times recently that regulatory constraint could be scrapped in relatively short order. Many, including Bessent himself, have argued that eliminating the SLR would allow large GSIBs to be more active in the Treasury market and be in a better position to intermediate, particularly in times of stress. In addition, supporters of this action contend that if large banks’ Treasury holdings are less constrained, they can own more bonds, helping relieve upward pressure on yields. We’re less convinced that SLR reform is a panacea for the Treasury market, even if it does improve liquidity and intermediation, particularly during volatile periods.

As a percentage of total bank assets, dealer holdings of USTs are just off their recent highs, at about 15% of the banking sector. In Exhibit #1, we show that periods of balance sheet expansion take pressure of dealer holdings and periods of QT do the opposite, forcing banks into the market to intermediate Treasurys. How much more will such banks wish to add to the balance sheets if even capital charges are reduced, or in some cases like the SLR, eliminated altogether?

Furthermore, memories of the banking sector stresses in the spring of 2023 are still fresh. Declining values of many banks’ portfolio holdings led to shrinking balance sheet, liquidity stresses, and deposit flight. In a higher rate world – and a more volatile one – loading up of long duration Treasurys may not be an appealing portfolio strategy. If anything, it might force banks who wish to increase their UST holdings to buy more bills rather than coupons, providing less-than-hoped-for relief on long-end yields.

Will it encourage banks to make more loans, no longer constrained by onerous capital requirements? This is also unclear, as loan demand is declining and lending standards have tightened. While large banks will cheer the move, it’s not clear to us that they will radically change behavior with the SRL’s demise or recalibration.

Standing repo facility to be “stood up” in the mornings

EXHIBIT #2: SRF HAS SO FAR BEEN DOMINATED BY SMALL OPERATIONS

_{Source: Federal Reserve Bank of New York}

Another change to the bond market was announced last week, when the New York Fed announced that the Standing Repo Facility (SRF), mostly unused since it was set up in the summer of 2021, would conduct morning liquidity operations starting on June 26. Like SLR reform above, many participants and commentators have been urging such a move for a while now, arguing that many counterparties’ daily funding needs occur in the morning, well before the SRF’s current operations take place, from 1:30 p.m. to 1:45 p.m. each day. Note that the Fed is maintaining its afternoon operations as well.

Capped at $500bn, the SRF serves as a backstop in money markets should upward pressure in repo markets spill over into the fed funds market. It’s barely been used since its establishment, with most operations that have taken place rarely exceeding $100mn or so. These are likely test trades to gauge its operational abilities. See Exhibit #2.

Although the Fed has tried to encourage its use and envisions the SRF as a legitimate liquidity provider, we have heard anecdotally that not unlike the discount window, potential counterparties to the facility associate some stigma with it. The Fed’s own March 2025 Senior Financial Officer Survey of banks’ balance sheet management intentions cited “public disclosures of counterparty information” as the largest negative factor in determining SRF use, not much unlike the discount window.

The Fed reduced its pace of quantitative tightening at its March 19 meeting, reducing redemptions from $25bn per month. There have been concerns that the Treasury’s ongoing debt ceiling machinations – which included spending funds out of its General Account (TGA) – were potentially obscuring liquidity metrics, not least of which was the total amount of systemwide reserves. Furthermore, repo rates have been elevated during month- and quarter-end periods, suggesting that liquidity could be getting challenged during periods of high cash demand.

Exhibit #3 shows that broad general collateral repo rates have tended to rise during such periods, particularly around year-end 2024 (when the SRF was temporarily open to morning operations precisely for this reason), as well as, say, the end of September 2024 during quarter-end. In these cases, the GC rate was above that of the interest paid on reserve balances, indicating it was actually economical during those periods to obtain funding off market. The biggest take-up of the SRF, indicated in Exhibit #2 was on September 30, 2024, at some $2.5bn. 

EXHIBIT #3: REPO HAS BEEN ELEVATED AT MONTH- AND QUARTER-END

_{Source: Bloomberg, Federal Reserve Bank of New York, Federal Reserve Board of Governors}

We don’t know if the SRF will be needed in a systemic form, but the Fed is taking great pains to ensure the SRF is ready to be used and that it is indeed a legitimate backstop. One of the other negative factors impacting SRF use that was cited in the CFO survey was the fact that so far there has so far been low aggregate take-up of SRF operations. This indicates a chicken and egg situation: counterparties are reluctant to use SRF because it’s relatively unused, and that’s in large part due to what we think is its perceived stigma, something the Fed wishes to eliminate. Another factor cited was the lack of balance sheet netting with reverse repos, which has also been discussed and frequently brought up when trying to make the SRF more attractive and a legitimate source of bank funding.

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