Could the Fed’s balance sheet reduction help JPMorgan Chase?

The market is clearly worried about the Federal Reserve’s plan later this year to start shrinking its balance sheet, which has ballooned to $9 trillion in assets. Since the Great Recession, the Fed has used a mechanism known as quantitative easing (QE), in which it buys US Treasuries and mortgage-backed securities (MBS) on the open market to effectively inject money and help the economy in times of recession.

QE is generally considered to be good for the stock market as it aims to hold down yields on safer long-term assets such as US Treasuries, MBS and various deposit accounts, leading investors to move lower. riskier assets like stocks.

But now, with the Fed ready to withdraw liquidity from the economy in a process known as quantitative tightening (QT), investors are worried about the market, which partly explains the reason why there has been such a sale in the last six years. month.

Interestingly, however, QE has created some problems for JPMorgan Chase (JPM 1.41% ). So, in theory, could QT help the biggest bank in the country? We’ll take a look.

Relaxation of a key regulatory capital requirement

QE has, in part, contributed to deposits flooding the banking system since the start of the pandemic. Check the balance sheet of almost any bank and you will see that deposits are high. This can be seen in particular at JPMorgan Chase.

JPM Total Assets (Quarterly) data by YCharts.

JPMorgan Chase’s total assets have grown from around $3.1 trillion in March 2020 to nearly $4 trillion now. Much of this increase is due to the rise in deposits, which grew from around $1.6 trillion to nearly $2.6 trillion over the same period. Normally, responsible asset growth is seen as a good thing, as is deposit growth, which is one of the most important characteristics of a bank stock.

But the growing balance sheet has created a problem with one of the many regulatory capital requirements that JPMorgan Chase must meet – the supplemental leverage ratio (SLR), which is a measure of a bank’s core capital expressed as a percentage. of its total assets. Big banks like JPMorgan Chase must maintain an SLR above 5% or potentially be subject to limits on their capital returns to shareholders.

JPMorgan Chase additional leverage ratio.

Data source: JPMorgan Chase. Table by author.

At the end of the first quarter of this year, JPMorgan Chase’s SLR was 5.2%. As the balance sheet grows, the denominator of the SLR also increases. Banks had obtained SLR relief through an exemption at the start of the pandemic, but in early 2021 regulators let the exemption expire, leading to a sharp decline in SLR between the first and second quarters of 2021.

During the bank’s recent earnings call, JPMorgan Chase Chief Financial Officer Jeremy Barnum noted that with the bank’s balance sheet so large now, 5.2% is actually a more decent buffer above the threshold of 5% than some think. He also said the bank has other levers to address the issue and that even if the bank were to dip below a 5% SLR, JPMorgan could still return a healthy amount of capital to shareholders.

Alongside its recent results, JPMorgan Chase announced that its board had authorized another $30 billion share buyback plan.

Since QE has contributed to the growth of deposits in the banking system, QT could very well withdraw some of the deposits, thereby reducing the bank’s total assets and increasing its SLR to a number that management no longer has to care.

Isn’t losing deposits bad?

There aren’t too many times you’ll hear about banks having too many deposits – normally that’s what you want. But some of these big banks like JPMorgan simply have more deposits than they know what to do with. Of its nearly $2.6 trillion in deposits, only about $1.1 trillion is deployed in loans.

So, if QT does remove some deposits from the banking system, JPMorgan will, over time, see its SLR increase. However, excess cash may eventually slowly deplete, so it won’t necessarily happen overnight.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.

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