If President-elect Donald Trump follows through on his promise to deregulate the bank industry by "dismantling" the Dodd-Frank Act, few banks would benefit as much as JPMorgan Chase (NYSE:JPM).
There are a number of reasons for this, but certainly one of the biggest stems from the increased freedom JPMorgan Chase would gain to allocate the assets on its balance sheet in a more profitable manner.
Under Dodd-Frank, banks must dedicate an inordinately large share of their assets to low-yielding, high-quality liquid assets as opposed to higher-yielding, but less liquid loans. This weighs on the amount of money, "net interest income," that a bank is able to generate from its asset portfolio, which tends to account for around half a big bank's net revenue.
In JPMorgan's case, it holds $539 billion worth of high-quality liquid assets, equating to a little over 21% of its total assets.
The rationale for the rule makes sense. One of the lessons we learned in the financial crisis -- and it's a lesson we've learned in every banking crisis over the past century and a half -- is that banks tend to fail not for lack of capital, but rather from a want of liquidity.
As soon as a bank's customers get even the slightest inkling that it's in trouble, they rush to withdraw their deposits. If a bank doesn't have a sufficient amount of highly liquid assets on its balance sheet to meet that demand, it has to shut its doors even though it may be more than adequately capitalized -- i.e., solvent.
This was the case at Bear Stearns, which was teetering on the brink of failure in 2008 until JPMorgan Chase stepped in to rescue it, albeit with a $30 billion loan from the U.S. government. As Patricia Crisafulli wrote in a short biography of JPMorgan Chase CEO Jamie Dimon:
Industry observers say they believe that Bear Stearns was adequately capitalized. ... The problem, however, was that Bear Stearns faced a run on the bank as funds were withdrawn and sources of short-term financing dried up.
But the flipside of liquidity is the fact that a bank earns much less money investing in liquid assets than it does by investing in illiquid assets. For instance, as I've noted elsewhere, the $409 billion that JPMorgan Chase kept as an average balance in deposits at other banks last quarter yielded only 0.44% on an annualized basis compared to its average loan which yielded 4.23%.
If you do the math, this means that for every $100 billion that JPMorgan Chase allocates from highly liquid assets into loans, it'll generate something like $1 billion worth of additional interest income each quarter. That's a very rough estimate to be sure, but you get the point.
In short, if Trump makes true on his promise to deregulate the bank industry, banks like JPMorgan Chase stand to earn a lot more money.
John Maxfield has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.