This article in the Financial Times on Monday should have caught a lot of people’s attention. The topic was JP Morgan’s massive balance sheet shift this year. Reportedly, the bank has pushed more than 130 billion dollars worth of excess cash into long-dated bonds while cutting its loan book at the same time. Not only the nominal numbers are mind-boggling, with this move the bank’s bond portfolio increased by a whopping 50%. The action has allegedly been prompted by US capital rules.
It has also been alleged that JP Morgan’s aggressive dividend policy and shareholder buybacks would only be sustainable if the bank could free up capital while at the same time keeping its returns intact, and no better way to do that than shrinking the loan portfolio which requires a lot of capital to carry and switch to bonds where the capital regime is a lot more benign. Employing the excess cash on the balance sheet on top of it allows management to keep tabs on the bank’s profitability.
To put it into numbers, JP has shrunk its loan book by 4%, or 40 billion dollars, and used this amount and another close to 100 billion in cash to purchase bonds. The bank is now holding approx. 400 billion in bonds, an all-time high, while loans have never made it beyond the 1 trillion thresholds. It gives the public a better sense that banks in the US and probably any other jurisdiction aren’t necessarily driven by their own assessment of credit risk and respective return, but that they have to align with regulators’ parameters.
Whether this is beneficial for economies and societies-at-large is a different question. In our case, JP Morgan is caught between predominantly two forces – one, the shareholder pressure on management to return capital to them, and two, management’s balancing act to comply with bank regulators. Ironically, it results in a balance sheet structure that isn’t exactly in the eye of the beholder. Banks shouldn’t be carrying exorbitant amounts of US Treasuries and mortgage bonds but be focussed on the business of lending, no?
There is another potentially very undesirable aspect to such developments. By rotating assets out of loans and cash and into bonds in such quantity, all being done in the name of reducing the bank’s risk capital and committing to this year’s share buybacks and dividends to the tunes of a 30+ billion total, JP may inadvertently have drained liquidity from the interbank market and caused September’s repo crisis. We are vividly reminded of the time when overnight rates hit double-digit percentage numbers for a number of days.
The Fed had to step in to provide the missing liquidity. The bottleneck in the interbank market has still not been eliminated over the past 7 weeks, and an aggregate net injection of 250 billion dollars by the Fed has pushed the central bank’s balance sheet size back to in excess of 4 trillion. Jay Powell has anxiously argued that the measures would be short-term in nature and not constitute QE, but what else does one want to call it if the feed has adopted permanent features?
It appears the remnants of overregulation left by the aftermath of the financial crisis are eating their children. Private banks are forced to go along and be compliant with the imposed government framework, but they will do what’s right for them and their owners. If that meant that their behaviour induces collateral damage and triggers disequilibrium elsewhere, so be it. As we have witnessed time and again, the Fed can be relied on setting things straight, particularly if it is being held hostage by the big players.
