SLR and Systemic Risk

The SLR is admitted to be a patch for a leaky system with many unintended consequence. Why limit borrowing to hold reserves? Or short dated T bills? If you want stability, demand equity.

systemic risk might not just be from the banking system, but from non-banks (e.g. hedge funds) that rely on banks for leverage

SLR is bad for market liquidity and somewhat supportive of large bank capital buffers. It would be better for both market liquidity and financial stability to reduce SLR and increase risk based capital requirements.

I believe there would be little impact in the short-term but in the medium to longer term the reduction in eSLR increases risk because balance sheets will likely expand relative to capital given the rule change.

Depends on the extent to which it has been binding.

See Liang and Zhu
-see background information here

The changes would decrease capital requirements of GSIB subsidiaries by 27% and this would naturally increase systemic risk unless risk-weighted capital models are accurate enough today to justify de-emphasizing the leverage backstop, which they are NOT.

GSIBs were very resilient during the last (SVB) crisis partially due to their larger capitalization; relaxing capitalization constraints exposes them more. U.S. households and firms do not seem to lack credit or other intermediary services.
-see background information here
-see background information here

The main effect is likely to make it a bit more attractive to conduct low-risk, low return activities that are at present rendered unattractive.

The stability would be enhanced by increasing bank equity funding by making regulations on leverage, including the eSLR, countercyclical, high in good times and lower in bad times to support "market function" then. Lowering it now is at best futile, at worst risky.

Modest evolution (about 1ppt reduction in SLR) with minor reduction in TLAC around 5%, which will free up some more lending capacity for banks.