How a simple regulatory change could be the US Treasury market’s salvation

It is likely we will see downward pressure on US Treasury yields if the proposed changes to US banking regulation go ahead. The primary motivation for change stems from the US administration’s significant desire to lower interest rates in the face of a higher deficit and increased interest cost burdens the government face.

What is the supplementary leverage ratio

After the 2008 financial crisis, global regulators introduced a series of reforms aimed at improving the resilience of the banking sector. Among these regulations was the supplementary leverage ratio (SLR), introduced in 2014, which comes under the Basel III framework.

The SLR is a supplementary regulation, designed to be a backstop on top of the traditional ‘risk-weighted assets’ (RWA) system for banks. This RWA system is designed to force a bank to hold enough capital (cash and equity) against its assets (such as mortgages), to help them remain solvent in the event of stress. In simple terms, the more risk a bank takes, the more capital it must hold on its balance sheet to protect itself from risk of defaults. Under the traditional RWA framework, low risk assets, like Treasuries, are awarded 0% capital charge. This means a bank can hold as many as they like, and not have to retain capital on their balance sheet against them. This makes sense because they are not considered a risky asset. In comparison, assets such as corporate loans can carry a capital charge that ranges from 20% to 150% depending on the borrower’s credit rating.

The SLR, however, is a blanket rate applied across all assets a bank holds, regardless of the asset risk level. It is set at 3%, however in the US, banks considered global systemically important banks (G-SIBs) have a 5% requirement (an extra 2%). The higher SLR (known as the enhanced SLR) applies to US G-SIBs to ensure the largest, most interconnected banks maintain a stronger capital buffer to absorb potential losses and reduce systemic risk. The blanket application of this SLR, means that even though we consider Treasuries to be ‘risk free’, G-SIBs bank capital gets tied up whenever they own Treasuries.

It is estimated major US banks hold about $1.7 trillion in Treasuries. Under the 5% SLR, this translates into an additional $85 billion in required capital.

Lowering the rate will encourage banks to own more US Treasuries

Regulators are concerned that current rules discourage banks from holding low-risk assets like Treasuries by treating them the same as riskier assets, and they can see an opportunity in reducing the rate. Theory suggests that if you remove or lower the enhanced SLR % requirement for G-SIBs, it will free up bank capital and encourage them to own more treasuries on their balance sheet.

This is why US financial authorities, including the Federal Reserve, proposed a significant recalibration of the SLR, aiming to reduce the enhanced requirements imposed on the nation’s largest banks, with the current proposal to reduce it to 3.5%-4.5%. The changes are not limited to Treasuries, so the reduction will apply to all assets held by the bank . An alternative idea involves just excluding Treasuries from the SLR calculation. This would effectively remove the capital charge on these low-risk assets, making it easier for banks to hold them without breaching leverage limits. We think it is most likely to see an overall reduction in the enhanced SLR rate, but not for it to be removed entirely.

Treasuries play a big role in market liquidity and government financing, so the motivation for this change, and most immediate impact of it, centres on Treasuries. Under the Trump administration, we think there is an effective ‘US Treasury Put’, because with such a high level of public debt, interest rates need to remain under control. This seems to be the biggest incentive for the change, and President Trump has clearly voiced his desire for lower rates.

If banks have the capacity and willingness to own more Treasuries, it is likely that yields would see downward pressure.

The change should push yields down, but nothing is guaranteed

Bond yields are expected to fall if the changes are pushed through, but it’s a debated topic if that will be the case, and certainly debated by how much. Recalibrating the SLR was clearly motivated by the US administration’s recognition that interest rates are key to fiscal sustainability, and the reform is an admission that debt is now a genuine concern for them. Banks already hold significant quantities of Treasuries on their balance sheets, limiting how much additional buying can occur and the US budget bill is expected to add over $2 trillion to the deficit. This will increase the future debt issuance, and the term premium demanded by investors, putting notable upward pressure on yields. Scepticism also remains over whether banks will deploy their freed-up capital toward Treasuries or instead, toward shareholder returns.

On May 27th 2025, Treasury Secretary Bessent said they are close to moving on the SLR, and it could lower yields because banks are being penalised for holding Treasuries, by the leverage charge. He thinks that for holding the risk- free asset, it should be reduced, and it could bring yields down by ‘tens’ of basis points.