Treasury's Bank Plan Tightens Regulations by Loosening Them

The initial reaction to the U.S. Treasury Department’s report on scaling back financial regulation focused on the high-level assertions that excessive and badly designed rules were hurting the economy. The report is part of a long-running debate and is not likely to change many minds. Buried among its 149 pages, however, are specific details that are likely to influence the course of financial regulation. One of the more interesting points concerns the enhanced Supplementary Leverage Ratio, or eSLR. It illustrates how the report manages to tighten regulation by loosening it.

There are two approaches to limiting leverage. The older one uses standard accounting, but there are three problems: No adjustment is made for differences in volatility among assets, offsetting exposures that reduce risk increase leverage, and off-balance-sheet exposures are ignored. The result is accounting-based limits that encourage banks to hold the riskiest, highest-return assets, to hedge nothing, and to push exposures off the balance sheet.