JPMorgan Singled Out for Illiquid Funding

Gil C /

The big bank is the only systemically important US financial institution found to depend too heavily on wholesale sources of funding.

The US Federal Reserve Board on December 9 detailed its proposed capital surcharge for eight global systemically important US banks that depend heavily on short-term funding from sources other than retail demand deposits. But JPMorgan Chase was the only bank revealed to have a capital shortfall, $22 billion, on this basis.

Some analysts weren’t surprised at the revelation because JPMorgan’s asset size is so great that it could be expected to depend more heavily than other banks on such wholesale funding sources as repurchase agreements—or repos, which are short-term loans of Treasurys—and other securities.

Although $22 billion is no small sum, the bank has four years to plug the gap, and it can do so without raising equity and thereby diluting shareholders. Instead, it could alter its liability structure through a number of steps, individually or in combination, including changing its deposit mix, issuing long-term debt, increasing collateralized lending, reducing its activity in the repo markets and charging clients for the capital cost.

Of course, the last step could cost JPM corporate deposits and perhaps related business. And any of the others could reduce the bank’s profitability. That said, any or all of those steps could reduce the bank’s profitability because wholesale funding is a relatively cheap source of liquidity. On the other hand, regulators have cited the rapid deterioration in Lehman Brothers’ liquidity before its failure in September 2008 as a reason for imposing a particularly strict capital surcharge. Lehman depended heavily on the repo market for short-term funding only to find its counterparties denying it credit when it ran into trouble.

The Fed’s surcharge goes beyond the liquidity coverage ratio that international regulators will require big banks to maintain under Basel III, starting in 2019. For example, in contrast to its non-US counterparts, the Fed discounts the use of credit ratings in calculating banks’ so-called high quality assets for purposes of determining the surcharge.