“Does that mean that we have bad markets?”
This still doesn’t show who or what triggered the fire in the repo market in mid-September when overnight lending rates more than quadrupled and briefly hit 10%, but it confirms who sat there and watched the fire and fanned it though they could have extinguished it.
During the earnings call today, JPMorgan Chase CEO Jamie Dimon told analysts that the bank had $120 billion in cash on deposit at the Fed in the morning of those days, and that during the day, those deposits would fall to $60 billion as JPM would draw money out of that account for its daily business purposes, and that by the evening that cash balance would go back to $120 billion. “We have a checking account at the Fed with a certain amount of cash in it,” is how Dimon explained this.
Banks earn interest on cash they deposit at the Fed. When the repo rates blew out in mid-September, the interest on excess reserves (IOER) was 2.1%. At the end of the FOMC meeting on September 18, the IOER was lowered to 1.8%. JPM could have made more money lending to the repo market at 5% or more.
While this amount – fluctuating between $120 billion and $60 billion – was “still huge,” it wasn’t enough from a regulatory point of view to lend into the repo market, Dimon said.
At the end of 2018, a similar thing happened. Repo rates spiked to 6% while banks dressed up their balance sheets for regulatory purposes, and rather than lending to the repo market, kept their cash at the Fed. But JPMorgan withdrew cash it had on deposit at the Fed and lent it massively into the repo market to make some extra money. And this calmed the market down.
But at the end of 2018, JPMorgan “had more cash than we needed for regulatory requirements,” Dimon told analysts today (transcript of the earnings call via Seeking Alpha). So as “repo rates went up,” JPMorgan withdrew cash from “the checking account which paid IOER” and lent it to the repo market. “Obviously makes sense, you make more money.”
But this year in mid-September, JPMorgan’s cash account at the Fed fluctuated between $120 billion and $60 billion “during the course of the day,” he said and added:
“That cash, we believe, is required under resolution and recovery and liquidity stress testing. And therefore, we could not redeploy it into the repo market, which we would’ve been happy to do. And I think it’s up to the regulators to decide if they want to recalibrate the kind of liquidity they expect us to keep in that account.”
He is blaming the regulators. But it shows that JPMorgan’s cash on deposit at the Fed had been drawn down to the range of $120 billion to $50 billion, when a year ago it was much higher.
“There are a lot of reasons why those balances dropped to where they were. I think a lot of banks are in the same position, by the way,” he said.
Banks are free to offer higher interest rates to attract fresh cash that would then give them leeway to lend to the repo market. There is still some competition for deposits in the industry, Dimon also said, but it’s way down from what it was last year. And so, because banks such as JPMorgan, aren’t trying hard enough to pull in fresh cash by offering higher interest rates, their reserves are running a little low.
“But I think the real issue, when you think about it, is: Does that mean that we have bad markets, because that’s kind of hitting a red line in that checking account,” he said.
“You’re also going to hit a red line in LCR, like HQLA, which cannot be redeployed either,” he said.
LCR means Liquidity Coverage Ratio. HQLA are High Quality Liquid Assets, at the top of which are the excess reserves (cash) that banks keep on deposit at the Fed. LCR is defined as HQLA divided by total net cash flow.
These regulatory requirements that Dimon is moaning and groaning about were put in place to prevent a rerun of the drama that occurred when the US banking system was in the process of collapsing during the Financial Crisis.
“So to me, that will be the issue when the time comes,” he said. The bank could sit on cash that is parked at the Fed, and “when the time comes” cannot deploy it into the repo market or into other areas that might be blowing out, because the Liquidity Coverage Ratio and the amount of High Quality Liquid Assets (such as excess reserves) might fall below the regulatory minimum.
“It’s about how the regulators want to manage the system, and who they want to intermediate when the time comes,” he said.
In other words, the Fed needs to decide if it wants the big banks to lend when “the time comes” – such as when the time came in mid-September – or if it wants the banks to keep their cash on deposit at the Fed, and have the New York Fed’s trading desk step in and sort out the market.
However, if JPMorgan had raised its interest rates on CDs and savings accounts earlier this year, instead of lowering them, it would have attracted plenty of cash that it could have lent to the repo market when time came in September. But offering higher interest rates is anathema to banks – and they only do it under duress of competition. And if the Fed promises rate cuts, the whole industry backs off competing for deposits, and some banks, such as JPMorgan, ended up drawing down their reserve balances.