By David Henry
NEW YORK (Reuters) – JPMorgan Chase & Co
Rates in the $2.2 trillion market for repurchase agreements rose as high as 10% on September 17 as demand for overnight cash from companies, banks and other borrowers exceeded supply.
While not seen as an sign of distress as it was during the collapse of Bear Stearns and Lehman Brothers in 2008, the spike did prompt the U.S. Federal Reserve to promise to lend at least $75 billion each day until Oct. 10 to relieve the pressure.
Analysts and bank rivals said big changes JPMorgan made in its balance sheet played a role in the spike in the repo market, which is an important adjunct to the Fed Funds market and used by the Fed to influence interest rates.
Without reliable sources of loans through the repo market, the financial system risks losing a valuable source of liquidity. Hedge funds, for example, use it to finance investments in U.S. Treasury securities and banks turn to it as option for raising suddenly-needed cash for clients.
Publicly-filed data shows JPMorgan reduced the cash it has on deposit at the Federal Reserve, from which it might have lent, by $158 billion in the year through June, a 57% decline.
Although JPMorgan’s moves appear to have been logical responses to interest rate trends and post-crisis banking regulations, which have limited it more than other banks, the data shows its switch accounted for about a third of the drop in all banking reserves at the Fed during the period.
“It was a very big move,” said one person who watches bank positions at the Fed but did not want to be named. An executive at a competing bank called the shift “massive”.
Other banks brought down their cash, too, but by only half the percentage, on average.
For example, Bank of America Corp
Overall deposits at the Fed from banks have come down over the past year as a consequence of the central bank’s decision to gradually reduce the vast holdings of bonds it had acquired to bolster the economy after the financial crisis. As the Fed has run off its bond portfolio, its deposits from banks have also declined.
“All of the banks were doing this to a degree,” said one Wall Street banking analyst, requesting anonymity because he was not authorized to speak on the record, adding: “JPMorgan does look like an outlier here”.
(GRAPHIC – Bank reserves held at the Fed: https://fingfx.thomsonreuters.com/gfx/mkt/12/6761/6692/Pasted%20Image.jpg)
In the past JPMorgan would have gladly seized the opportunity to lend cash in the repo market, where loans are backed by the best collateral, often U.S. Treasury securities.
But on Sept. 17 even as the majority of repo loans were being made at 5% and above, twice the usual rates, JPMorgan was limited in how much of its remaining cash it could provide because of regulatory and other constraints, a person familiar with the trading said.
The spike in rates reflected extra demand for cash, which was widely anticipated due to corporations requiring cash to make scheduled tax payments and banks and other firms needing it to buy newly-issued U.S. Treasury securities.
Without the constraints on JPMorgan, the rate wouldn’t have spiked to 10%, the person said.
JPMorgan made the biggest draws from the Fed late last year and bought securities, winning praise from analysts for locking in fixed interest rates before Federal Reserve cuts. Buying the securities also offset pressure on JPMorgan’s mortgage loan portfolio from falling rates.
JPMorgan also needs cash for sudden demands by corporate depositors and to meet government requirements for reserves on checking account deposits.
It must also comply with rules adopted since the financial crisis which require banks to keep additional cash in case they fail and the government needs to transfer their operations in viable condition to other firms. Banks do not disclose how much of this so-called resolution cash they must hold, but some analysts believe the amount is significant.
Another post-crisis regulation imposes a capital surcharge on banks that are most important to the global financial system and it gives JPMorgan particular reason not to make repo loans going into the last three months of the year.
That is especially true for repos with firms from abroad, which include U.S. branches of foreign banks and Cayman Islands-registered hedge funds.
Such loans could push JPMorgan’s surcharge higher, requiring it to carry an additional $8 billion of capital, a Goldman Sachs research note said.
JPMorgan’s capital surcharge is already the highest of any U.S. bank, which means its must make more profit from its business to produce the same return on shareholder equity.
Goldman analysts see the repo market pressures continuing under the regulatory constraints and what they believe is a shortage of extra cash on deposit at the Fed.
The Federal Reserve has said it is considering bolstering the market in the longer term by encouraging banks to build up their cash deposits. It has also discussed opening a standing repo facility to be a reliable source of cash loans.
(Reporting by David Henry in New York. Additional reporting by John McCrank. Editing by Paritosh Bansal and Alexander Smith)