The market is clearly worried about the Federal Reserve's plan later this year to begin reducing 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), wherein it buys U.S. Treasury bills and mortgage-backed securities (MBS) from the open market to effectively pump money into and aid the economy in recessionary times.
QE is generally seen as supportive of the stock market because it is meant to keep the yields on safer long-term assets like U.S. Treasury bills, MBS, and various depository accounts lower, which leads investors into riskier assets like stocks.
But now, with the Fed ready to pull liquidity out of the economy in a process known as quantitative tightening (QT), investors are worried about the market, which is part of the reason there has been such a sell-off over the past six months.
Interestingly, though, QE has created some problems for JPMorgan Chase (JPM 0.06%). So, in theory, could QT help the country's largest bank? Let's take a look.
Easing a key regulatory capital requirement
QE has, in part, contributed to deposits flooding the banking system since the pandemic started. Check the balance sheet of pretty much any bank, and you'll see that deposits are elevated. This can especially be seen at JPMorgan Chase.
JPM Total Assets (Quarterly) data by YCharts.
Total assets at JPMorgan Chase have ballooned from around $3.1 trillion in March of 2020 to close to $4 trillion now. Much of that increase is due to the rise in deposits, which have shot up from roughly $1.6 trillion to close to $2.6 trillion in the same time period. Normally, responsible asset growth is viewed as a good thing, as is growth in deposits, which are one of the most important characteristics of a bank stock.
But the growing balance sheet has created an issue with one of the many regulatory capital requirements JPMorgan Chase must abide by -- the supplementary leverage ratio (SLR), which is a measure of a bank's core capital expressed as a percentage of its total assets. Large banks like JPMorgan Chase must maintain an SLR above 5% or potentially be subject to limits on their capital returns to shareholders.
Data source: JPMorgan Chase. Chart by author.
At the end of the first quarter of this year, JPMorgan Chase's SLR was 5.2%. As the balance sheet gets bigger, so does the denominator in the SLR ratio. Banks had been getting relief on the SLR through an exemption early on in the pandemic, but in early 2021, regulators let the exemption expire, which led to a big drop in the SLR between the first and second quarters of 2021.
On the bank's recent earnings call, JPMorgan Chase CFO Jeremy Barnum noted that because the bank's balance sheet is so large now, 5.2% is actually a more decent buffer over the 5% threshold than some would think. He also said the bank has other levers it can pull to address the issue and that even if the bank were to dip below a 5% SLR, JPMorgan could still return a good amount of capital to shareholders.
In tandem with its recent earnings results, JPMorgan Chase announced that its board of directors had authorized another $30 billion stock buyback plan.
Because QE has contributed to deposit growth in the banking system, QT may very well pull some of the deposits out, thereby reducing the bank's total assets and increasing its SLR to a number that management no longer has to worry about.
Isn't losing deposits bad?
There aren't too many times you will 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 of deposits, only about $1.1 trillion are deployed into loans.
So, if QT does, in fact, remove some deposits from the banking system, JPMorgan will, over time, see its SLR rise. However, excess liquidity could end up draining slowly, so it won't necessarily happen overnight.
