The clock is ticking on a temporary relaxation of a key capital rule, and executives at JPMorgan Chase & Co. took its case for an extension to the Street in its fourth-quarter 2020 earnings report.
As the Federal Reserve bought up trillions of dollars of Treasurys last spring to combat market malfunctioning — helping to fuel a corresponding explosion in bank balance sheets — regulators temporarily excluded banks' holdings of government bonds and deposits at the central bank from the denominator of the supplementary leverage ratio.
A broad measure of capital adequacy, the SLR weighs Tier 1 capital against assets and off-balance-sheet exposures, without adjustments for risk, and generally applies to banks with more than $250 billion of assets. Regulators said the temporary relaxation, due to expire at the end of March, would help banks to keep lending as their balance sheets ballooned with deposits, noted that Treasurys and reserves carry no credit risk, and argued that bank capital levels were generally strong. The move also helped keep a big pool of buyers in the market for a rapidly expanding stock of federal debt.
Nine months later, much of the rationale still applies. Bank balance sheets have continued to expand as the Fed buys $120 billion of bonds a month. Bank capital levels have generally increased under restrictions against share repurchases. Investors and officials are concerned about demand in the market for Treasurys and the possibility of a taper tantrum, when the Fed eventually pulls back on its bond purchases, but many forecasters do not expect that to happen for another year.
In a paper calling for steps to strengthen the supply of liquidity in Treasury markets in December, Nellie Liang, who has reportedly been offered the post of undersecretary for domestic finance at the Treasury Department, and Patrick Parkinson, a special adviser to the Bank Policy Institute, the big-bank lobbying group, argued that the SLR exclusion for reserves should be made permanent, but not the exclusion for Treasurys because of interest rate risk. They said regulators should consider raising the SLR minimum because of the exclusion.
However, some such as Sen. Elizabeth Warren, D-Mass., and Sen. Sherrod Brown, D-Ohio, who have generally pushed for stricter capital standards, have opposed the exclusions, arguing that regulators have a poor record of estimating risks, and that the SLR is an important protection against misfires in risk-based rules. In October 2020, Fed Vice Chair for Supervision Randal Quarles emphasized that the exclusions are temporary, and that making them permanent was not then under discussion.
JPMorgan said the expiration of the exclusions would not fundamentally alter how it operates but could force it to start turning away massive amounts of deposit inflows.
Monetary easing has put the SLR on a trajectory to become the bank's binding capital constraint, executives said on its earnings call in January. They pressed the case for extending the exclusions or making them permanent, saying the bank would consider issuing additional preferred stock or retaining more common equity if it does not deflect new deposits.
Rapid quantitative easing, along with soft loan demand, "has resulted in bank balance sheets which are larger but more liquid and less risky," JPMorgan CFO Jennifer Piepszak said. As the bank has in the past, she also pressed for changes to capital surcharges for global systemically important banks that would keep them from increasing because of economic growth. "These two areas, GSIB and leverage, are top of mind for us in 2021," Piepszak said.
With interest rates so low, additional deposits would produce negative returns once the bank is required to hold additional capital, Piepszak said.
"We don't want to do it, it's just very customer-unfriendly to say, 'Please take your deposits elsewhere,'" said Chairman and CEO Jamie Dimon. But he added that large corporate clients have other options such as money market funds.
JPMorgan estimated that its SLR was 6.9% in the fourth quarter of 2020 after excluding its holdings of Treasuries and reserves, down from 7% in the third quarter but up from 6.3% the year prior. Without the relief, the bank said its SLR would have been 5.8%, compared with a minimum of 5%.
Citigroup Inc. also pushed for changes to the GSIB and SLR rules on its fourth-quarter 2020 earnings call. The bank is managing its "balance sheet and deposits and capital ... with full knowledge" that SLR relief is due to lapse at the end of March, CFO Mark Mason said. "The Fed has been clear in terms of their view that there's enough capital in the system, and so we're hopeful that as kind of things evolve, that some consideration is given to that."
Citi estimated that it had a 7% SLR in the fourth quarter, and it would have been 109 basis points lower without the exclusions, compared with 6.21% the year prior.
By contrast, Bank of America Corp. Chairman and CEO Brian Moynihan said in January that his bank did not need the temporary SLR relief and the ratio does not act as a constraint. BofA estimated its SLR was 7.2% in the fourth quarter, or 6.2% without the exclusions, compared with 6.4% the year prior.
Rounding out the Big Four, Wells Fargo & Co., which estimated its SLR at 8.1% for the fourth quarter, did not discuss the ratio on its January earnings call. But the bank has already said it is steering away wholesale deposits because of an asset cap imposed by regulators due to a series of consumer abuses.
Economists at BofA Global Research have predicted that the exclusions will lapse as scheduled because of "a less regulatory-friendly Biden administration," among other reasons, contrary to expectations among clients who think they will be extended because there is merit in doing so. "Client pushback on our view appears centered on the argument that the Fed exemption 'should' [versus] 'will' continue," they wrote in a note on Jan. 26.