Backdoor Bailout: Pandemic-Related Assistance to Biggest Banks
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October 2020 Backdoor Bailout: Pandemic-Related Assistance to Biggest Banks Overview reserves against their retained earnings for capital purposes. This impact is moderate Unlike in the 2008 financial crisis, the currently but will increase in significance if Coronavirus crisis does not so far appear to there is in an extended recession. have threatened the solvency of major banking institutions. While it’s true that the • The revival of bond and equity markets largest banks currently look solvent in the face thanks to Federal Reserve assistance have of economic stress, this is in significant part also driven tens of billions in additional because they have benefited greatly from trading and investment banking profits at regulatory forbearance and from Federal the nation’s largest banks. These profits, Reserve intervention in financial markets. which are so large that they seem clearly This important part of the story has been connected to the extraordinary levels of frequently overlooked or played down. public support from the Fed for trading Further, their continuing solvency over an markets, also function to boost big bank extended recession is considerably more solvency. doubtful than is currently acknowledged — and much more dependent on continued • When these factors are taken into help from the government. account, the nation’s six largest banks are already much closer to statutory leverage This report, based on analysis of regulations limits than is generally acknowledged. For and bank financial reports by Americans for example, if not for supernormal trading Financial Education Fund and Risky Finance, profits and regulatory exemptions, lays out some of the clearest ways in which the Citibank would have had a supplementary nation’s six largest banks have benefited from leverage ratio of 5.3% as of June, 2020, regulatory forbearance and the Federal just 30 basis points above the legal limit of Reserve’s financial market interventions.* Key 5%, as opposed to the 6.7% it reported. conclusions include: Below, we discuss these issues in more detail. • During the second quarter of 2020, major banks were permitted to remove almost Regulatory Forbearance — $2 trillion from their balance sheets for Treasuries and Central Bank the purposes of calculating compliance with key leverage capital thresholds. Deposits On April 14, 2020, regulators issued a rule • Banks also benefited from $20 billion in that exempted U.S. Treasuries and central direct capital relief due to a two- year bank cash deposits for a period of one year moratorium on counting new loan loss from measurements of the bank’s size * Americans for Financial Reform Education Fund is a coalition working for stronger financial regulation that includes consumer, civil rights, investor, retiree, community, labor, faith based, and business groups. A list of AFR Education Fund member organizations is available at https://ourfinancialsecurity.org/about/coalition-members/. Risky Finance (www.riskyfinance.com) is a market data analysis and visualization platform that analyzes banking and financial market data. Backdoor Bailout: Pandemic-Related Assistance to Biggest Banks October 2020 (financial exposure).1 This exemption impacts 5% SLR ratio, this meant the banks had to calculation of the bank’s supplementary hold almost $100 billion less in their own leverage ratio (SLR). The SLR measures the capital. amount of the bank’s own equity relative to the total amount of assets it owns, to Regulatory Forbearance — Loan determine whether it can absorb any losses Loss Reserves that might occur without a public bailout. The nation’s largest banks are required to maintain At the end of March regulators issued a rule a minimum of a 5 percent SLR, meaning that that delayed by two years the requirement for they must hold an amount of their own equity banks to count certain types of loan loss capital equal to at least 5% of the total reserves against their earnings.2 By artificially financial exposure they have in the markets. increasing measured earnings, this gave the banks additional funds they could use to Exempting holdings of Treasuries and satisfy their equity investment requirements. positions with central banks from the total The rule specifically exempts increases in loan financial exposure metric used in the SLR loss reserves put in place to address the means that the banks measured exposure was failures of loan loss reserving observed during much lower for purposes of determining how the financial crisis (the so-called “current much capital they had to hold to satisfy the expected credit loss” or CECL approach). 5% SLR requirement. Specifically, in the However, for our purposes the key issue is second quarter of 2020 this rule permitted the that it permits banks to effectively “double nation’s six largest banks to remove $1.96 count” their loan loss reserves as both current trillion in exposures from their assets, earnings and reserves against losses, thus meaning that they did not have to hold equity permitting an artificial enhancement in their capital against these positions. (Figure 1 shows apparent solvency. the exposures removed for each bank). At a In Q2 2020 this Fig. 1: Nearly $2 Trillion in Big 6 Bank Assets Exempted Under SLR Rule exemption allowed the six (in billions, Q2 2020) largest banks to add an additional $19 billion to their reported bottom $619 line and therefore to their estimated capital reserves. This is a meaningful amount, but more $403 $388 important than its immediate impact in the second quarter is the long-term effect of this $219 $183 regulatory forbearance $153 over the course of the recession. As the Covid- 19 economic impact JP Morgan Bank of Citigroup Wells Fargo Goldman Morgan Stanley America Sachs 2 Americans for Financial Reform Education Fund continues, more and more loans may need to Fig. 2: Big 6 Banks' Trading and Investment be written down and loan loss reserves will Revenues 2020 and Pre-Pandemic Average increase. This regulatory exemption will mean (in billions) that bank capital and earnings may be deceptively inflated even as loan performance $35.2 declines. Increased Earnings due to $26.4 Federal Reserve Support for $21.0 Financial Markets The Federal Reserve balance sheet – a measure of their support for financial markets -- has increased by $3.5 trillion over the last year due to massive asset purchases. That’s well over twice the $1.3 trillion the Fed Five Quarter Average First Quarter 2020 Second Quarter 2020 flooded the markets with during the 2008 (Q4 2018 to Q4 2019) financial crisis. Combined with the promise of a direct Federal Reserve backstop for credit pre-pandemic average for five quarters from markets that was made by the CARES Act, Q4 2018 through Q4 2019 (see Figure 2). this is an unprecedented level of direct support for financial markets. On the assumption that in the absence of Federal Reserve intervention, trading and Unlike in the 2008 crisis, the largest banks are investment banking revenues would have not nominally the core recipients of much of been at or below their Q4 2018-Q4 2019 this intervention, which is directed at average, this implies that at least $19.6 billion securities trading markets more generally. in additional revenues during the first half of However, the major banks are the most 2020 were available to the six largest banks. important dealers in these trading markets, Gains were especially large for the major which have boomed since the peak of Federal trading banks, JP Morgan, Goldman Sachs, Reserve intervention in March and April. and Citigroup. Federal Reserve programs such as the Primary Dealer Credit Facility (PDCF) also advanced cheap credit to primary dealers, Impact of Forbearance and which include the major banks, in order to Interventions on Bank Leverage support trading operations.3 Ratios The result is that the major banks are In combination, the above forms of regulatory indirectly supported by Federal Reserve forbearance and capital market interventions financial market support. This can be clearly significantly assisted the ability of the major seen in the level of trading and investment banks to portray themselves as comfortably banking revenues received in the first half of solvent even in the face of the Covid-19 crisis. 2020, since market interventions began in The broadest measure of bank solvency is the March. Q2 2020 trading and investment Supplementary Leverage Ratio (SLR), which banking revenues were 67% higher than their 3 Backdoor Bailout: Pandemic-Related Assistance to Biggest Banks October 2020 from 1.99% (199 basis Fig. 3: Reported vs. Adjusted Supplementary Leverage Ratios (Q2 2020) points) above the regulatory minimum leverage threshold to 7.52% just 0.84% (84 basis 7.29% points) above the 7.05% threshold. 6.83% 6.66% 6.69% 6.56% Conclusion 6.32% Regulatory reporting 5.96% shaped by permissive deregulation and 5.43% massive Federal 5.34% 5.30% Reserve intervention in JP Morgan Goldman Citigroup Morgan Stanley Bank of Wells Fargo the markets makes the Sachs America major banks look SLR as reported SLR adjusted for regulatory relief and additional revenues comfortably solvent in the face of the Covid- as described above measures the bank’s own 19 crisis. But a closer equity held against losses as a fraction of its look at the situation shows banks in a total financial exposures. The SLR provides a significantly shakier position than currently summary metric of losses the bank can take acknowledged. before becoming insolvent. Furthermore, in an extended recession banks Figure 3 below shows the SLR for each of the will come under even more capital pressure. six major banks before and after adjustment This is apparent in the Federal Reserve for the three factors above. The unadjusted coronavirus stress tests, which show banks SLR is simply the SLR as reported by the nearing regulatory minimums for risk-adjusted bank in Q2 2020.