Financial ETFs Drop as Fed Allows Covid Capital Relief to Expire

Financial sector-related exchange traded funds were dealt a blow Friday after the Federal Reserve planned to end coronavirus pandemic relief that provided a temporary capital buffer for big banks.

On Friday, the SPDR S&P Regional Banking ETF (NYSEArca: KRE) fell 0.9%, Financial Select Sector SPDR (NYSEArca: XLF) dropped 1.0%, Fidelity MSCI Financials Index ETF (NYSEArca: FNCL), was down 0.8%, and iShares U.S. Financials ETF (NYSEArca: IYF) declined 1.1%.

The Fed said Friday it would allow a year-long reprieve for how big banks account for ultra-safe assets like Treasury securities to expire at the end of the month, the Wall Street Journal reports. Consequently, banks will lose the temporary ability to exclude Treasuries and deposits held at the central bank from lenders’ so-called supplementary leverage ratio. In other words, Treasuries and deposits will count as assets going forward.

“Because of recent growth in the supply of central bank reserves and the issuance of Treasury securities, the board may need to address the current design and calibration of the SLR over time to prevent strains from developing that could both constrain economic growth and undermine financial stability,” the Fed said in a statement.

The Fed previously adopted the exclusion rule to bolster the flow of credit to consumers and businesses and to support the strained Treasury market during the height of the coronavirus pandemic volatility.

Wall Street banks have been pushing for an extension of the rule, arguing that without the exclusion relief, banks could cut back on Treasury purchases, which would further add to the upward pressure on bond yields that spiked in recent weeks. Furthermore, some warned that they may come close to violating capital requirements over the months ahead, so they may be forced to buy fewer Treasuries or cutback on consumer deposits.

Consequently, banks could take a step back from their role as intermediaries in the Treasury market, or be forced to hold fewer deposits, which are used to purchase Treasuries or hold Fed reserves.

“Banks have had such a significant up move this year and this news has only acted as a catalyst for profit taking,” Art Hogan, chief market strategist at National Securities, told Reuters.

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