On March 29, 2019, the board of the FDIC approved a notice of proposed rulemaking that would revise the supplementary leverage ratio (“SLR”) to exclude certain deposits placed at central banks from custodial banks’ SLR denominators, implementing section 402 of the Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”).  The OCC and Federal Reserve are expected to adopt substantially identical proposals.

The capital rules require advanced approaches banks[1] to maintain an SLR – the ratio of tier 1 capital to total leverage exposure – of 3 percent.  Total leverage exposure includes all on-balance sheet assets – calculated with no risk weighting – and certain off-balance sheet exposures.

In times of economic uncertainty or in low-interest rate environments, institutional clients may increase cash deposits at custodial banks rather than invest in riskier assets.  Because of the short-term nature of these deposits, custodial banks place significant amounts of this cash on deposit at the local central bank to mitigate liquidity, credit, and currency risk.  While central bank deposits entail virtually no credit or liquidity risk, they are nevertheless on-balance sheet assets that increase custodial banks’ total leverage exposure.  As cash on deposit surges, custodial banks’ SLRs may drop, which can incentivize custodial banks to turn away client deposits.

Section 402 of EGRRCPA addresses this dynamic by requiring the federal banking agencies to revise the capital rules to exclude from total leverage exposure funds of a custodial bank that are deposited with a central bank.  However, under the statute, any amount of such funds that exceeds the total value of deposits of the custodial bank that are “linked to fiduciary or custodial and safekeeping accounts” is not to be excluded from the denominator.  Section 402 defines “custodial bank” as any depository institution holding company “predominantly engaged in custody, safekeeping, and asset servicing activities,” as well as any insured depository institution subsidiary of such a holding company.

The statute thus leaves to the agencies the tasks of (1) providing an objective measure of a bank being “predominantly engaged” in custody and related activities, and (2) determining whether and how central bank deposits must be “linked” to fiduciary or custodial and safekeeping accounts to be excluded from the SLR denominator.

The proposal would resolve the first issue by deeming a depository institution holding company as “predominantly engaged” in custody, safekeeping, and asset servicing activities if the top-tier company in the organization has a ratio of assets under custody (“AUC”)-to-total assets of at least 30:1.  According to the preamble to the proposal, an AUC-to-total asset ratio of 30:1 is approximately equal to the midpoint of the range between the minimum observed for The Bank of New York Mellon, Northern Trust Corporation, and State Street Corporation (52:1) and the maximum observed for the other advanced approaches banking organizations (9:1), over the period from the second quarter of 2016 through the third quarter of 2018.  The proposal seeks comment on alternative standards for defining whether a bank is “predominantly engaged” in custody and related activities, such as a measure based on sources of the bank’s income.

The proposal would resolve the second issue by providing for a custodial bank to exclude from its total leverage exposure the lesser of (A) the amount of central bank deposits placed at qualifying central banks by the custodial banking organization (including deposits placed by consolidated subsidiaries), and (B) the amount of on-balance sheet deposit liabilities of the custodial bank (including consolidated subsidiaries) that are linked to fiduciary or custodial and safekeeping accounts.  A deposit account would be “linked” if it is provided to a client that maintains a fiduciary or custodial and safekeeping account with the custodial bank, and the deposit account is “used to facilitate the administration of” the client’s fiduciary or custody and safekeeping account.

Additionally, the proposal would define a fiduciary or custodial and safekeeping account as an account for which the custodial bank provides fiduciary or custodial and safekeeping services, as authorized by applicable federal and state law.  The preamble states that the agencies anticipate that the scope of the fiduciary or custodial and safekeeping accounts under the proposal would not deviate materially from the current scope of the fiduciary and custody and safekeeping accounts reported under Schedule RC-T of the Call Report, but the agencies have sought comment on whether to link the proposal’s definition to the Call Report instructions explicitly.

The proposal’s changes would also affect the calculation of total leverage exposure for purposes of the enhanced supplementary leverage ratio (eSLR) and total loss-absorbing capacity (TLAC) requirements that apply to U.S. global systemically important banking organizations that are custodial banks, as well as the Size indicator of the G-SIB Surcharge.  However, the changes would not affect the generally applicable Tier 1 leverage ratio.

Comments on the proposal are due 60 days from the date of its publication in the Federal Register.

[1]           Advanced approaches banking organizations are generally bank holding companies, savings and loan holding companies, and insured depository institutions with consolidated total assets of at least $250 billion or consolidated total on-balance sheet foreign exposures of at least $10 billion.