We here continue our series of analyses of the policy and market impact of Treasury’s far-reaching reform report, focusing now on proposed changes to the U.S. liquidity framework for large banking organizations.  As noted in our assessment of Treasury’s approach to capital regulation (see Client Report CAPITAL216), the liquidity discussion is based on the cumulative impact of the capital standards along with other relevant rules.  Treasury concludes that these interactions have led covered banks to hold 24 percent of their balance sheets in eligible high-quality liquid assets (HQLAs).  This is down somewhat from the percentages we noted in our cumulative-impact assessment last year, with the drop (about six percentage points) likely due to lengthened funding maturities that reduce HQLA requirements.  Treasury concurs with our assessment of the impact of the capital and liquidity interaction:  reduced balance-sheet capacity leading to less lending than would otherwise be possible under applicable capital rules as well as to a shift in loan composition.  Treasury’s recommendation that the leverage-ratio denominator be revised to exempt central-bank reserves and Treasury securities is in part designed to correct for this.

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