Image source: Wikimedia Commons.
Starting last year, the Federal Reserve began to rank banks based on their importance to the economy and financial system -- their "systemic importance." Based on the inaugural ranking, JPMorgan Chase (JPM 3.02%) came in first among the 33 banks assessed by the Fed. Why is this? And does it even matter?
The obvious answer is that JPMorgan Chase is the biggest bank in America when measured by the size of its balance sheet. It finished the second quarter, which ended on June 30, with a little less than $2.5 trillion in assets -- mainly loans and investment securities like bonds that pay interest. The runner-up, Bank of America, had $2.2 trillion in assets.
Not surprisingly, this factors into the Fed's analysis. "A banking organization's distress or failure is more likely to negatively impact the financial markets and the economy more broadly if the banking organization's activities comprise a relatively large share of total financial activities," the Fed wrote last year.
Of the 12 indicators the Fed uses to gauge systemic importance, total exposure (a proxy for size, which includes more than just the assets on a bank's balance sheet) carries the most weight, accounting for 20% of a bank's ultimate score.
|
Systemic Indicator |
Indicator Weight |
|---|---|
|
Total exposure |
20% |
|
Cross-jurisdictional claims |
10% |
|
Cross-jurisdictional liabilities |
10% |
|
Intra-financial system assets |
6.67% |
|
Intra-financial system liabilities |
6.67% |
|
Securities outstanding |
6.67% |
|
Payments activity |
6.67% |
|
Assets under custody |
6.67% |
|
Underwriting activity |
6.67% |
|
Derivatives exposure |
6.67% |
|
Trading and AFS* securities |
6.67% |
|
Level 3 assets |
6.67% |
*Available for sale. Data source: The Federal Reserve.
Size is nevertheless only one reason JPMorgan Chase earned the highest score in the Fed's analysis of its systemic importance. The New York City-based bank also topped the rankings in eight out of the Fed's other indicators. And in the three others, it ranked second, second, and third.
|
Systemic Indicator |
No. 1 |
No. 2 |
No. 3 |
|---|---|---|---|
|
Total Exposure |
JPMorgan |
B of A |
Citigroup |
|
Cross-jurisdictional claims |
Citigroup |
JPMorgan |
Morgan Stanley |
|
Cross-jurisdictional liabilities |
Citigroup |
JPMorgan |
Morgan Stanley |
|
Intra-financial system assets |
JPMorgan |
Goldman Sachs |
Citigroup |
|
Intra-financial system liabilities |
JPMorgan |
Citigroup |
BNY Mellon |
|
Securities outstanding |
JPMorgan |
Wells Fargo |
Citigroup |
|
Payments activity |
JPMorgan |
Citigroup |
BNY Mellon |
|
Assets under custody |
BNY Mellon |
State Street |
JPMorgan |
|
Underwriting activity |
JPMorgan |
B of A |
Citigroup |
|
Derivatives exposure |
JPMorgan |
Citigroup |
Goldman Sachs |
|
Trading and AFS securities |
JPMorgan |
Morgan Stanley |
B of A |
|
Level 3 assets |
JPMorgan |
Goldman Sachs |
Citigroup |
Data source: The Federal Reserve's 2015 Indicators.
All of this matters because a bank's systemic importance is tied to the amount of capital it has to hold -- more important banks must hold more capital. And because capital dictates leverage, and leverage impacts profitability, this filters down to a bank's earnings.
In JPMorgan Chase's case, the Fed originally estimated it would have to leave an additional 4.5% of its tangible common equity lying fallow when compared to a regional bank that isn't classified as systemically important. The nation's biggest bank has since reduced this to 3.5%, but it still leaves JPMorgan Chase at a competitive disadvantage.
Fortunately, JPMorgan Chase has plenty of other advantages that have -- thus far -- more than offset the Fed's latest capital rules. It has scale. Efficiency. Market share on Wall Street and Main Street. And it's led by the indomitable Jamie Dimon.
