Fed to Examine How Banks Manage Deposits After JPMorgan’s Trading Loss

JPMorgan Chase & Co. (JPM)’s $2 billion trading loss has prompted the Federal Reserve Bank of New York to examine how banks in its district are managing cash after receiving a flood of deposits since the credit crisis, according to a person familiar with the matter.

New York-based JPMorgan’s trading loss, announced last week, occurred in its chief investment office, which oversees about $360 billion, the difference between deposits and what the bank lends. The New York Fed is reviewing the structure of investment units and similar businesses at other banks it regulates, said the person, who wasn’t authorized to discuss the matter publicly and declined to be identified.

Banks are struggling to manage an influx of deposits as investors take advantage of a bigger federal guarantee and the perceived safety of the largest banks. In 2008, President George W. Bush signed a bill that temporarily increased deposit- insurance coverage to $250,000 per depositor from $100,000. The Dodd-Frank Act overhauling financial regulation, which President Barack Obama signed in 2010, made the increase permanent.

“There’s not enough loan volume to drive earnings-per- share and to successfully reinvest all the liquidity,” said David Hendler, senior analyst at research firm CreditSights Inc. in New York. “So, in a way, it forced them to do this, and the trade got away from them,” he said, referring to JPMorgan.

Bank Portfolios

Total deposits at institutions insured by the Federal Deposit Insurance Corp. rose to about $10.2 trillion at the end of last year from $8.2 trillion in the third quarter of 2007. In the same period, total loans fell to $7.5 trillion from $7.7 trillion. Securities in bank portfolios rose to $2.9 trillion from $2 trillion, according to FDIC data.

Still, there are “other ways to deal with” the gap between loans and deposits, “and you don’t have to just take it in,” Hendler said. “You could create an opportunity cost for the depositor to go to some other bank.”

Bank of New York Mellon Corp. last year said it would charge institutional clients a fee for unusually high deposits as a flight to safety pushed money-market rates below zero and left the custody bank flooded with client cash.

New York Fed spokeswoman Andrea Priest declined to comment.

JPMorgan Chief Executive Officer Jamie Dimon said on a conference call with analysts on May 10 after announcing the loss that all banks have “these fairly large portfolios” that invest excess cash. Dimon had encouraged the unit to boost earnings by buying higher-yielding assets, including structured credit, equities and derivatives, ex-employees said in April.

‘100 Years’

“I should point out to all the folks on the phone, you could see — you can go to the 10-Q and see what people have in those portfolios,” Dimon said on the call, referring to quarterly report filings. “And some banks do some things, and some do others. But to invest those excess deposits, you buy securities. That’s been going on for 100 years in banking.”

Scott Siefers, a managing director at Sandler O’Neill Partners, a New York investment bank and brokerage firm that specializes in financial companies, said treasury management is usually a “mundane task” inside most banks.

“Investors and regulators don’t like to see banks using a securities portfolio as a major earnings driver,” he said. “There is a knee-jerk reaction that says the bank might be taking on some undue risk.”

Under Pressure

Still, banks are also under pressure to keep net interest margins high, Siefers said. Treasury managers are feeling the pressure to boost risk and earn returns because loan growth is tepid. At the same time, they are trying to avoid getting caught if interest rates head higher sometime in the next few years, he said.

Federal Reserve Governor Daniel Tarullo has overhauled the Fed’s supervisory approach from a bank-focused examination process to a broader systemic view that compares practices at several institutions at once. The main forum for such reviews is the Large Institution Supervision Coordinating Committee, or LISCC, which includes top supervisors from the Fed’s regional banks and also economists, financial-markets experts and computer modelers from the Fed Board.

“We have supplemented the traditional, firm-by-firm approach to supervision with a routine use of horizontal, or cross-firm, reviews to monitor industry practices, common trading and funding strategies, balance-sheet developments, interconnectedness, and other factors with implications for systemic risk,” Fed Chairman Ben S. Bernanke said in a speech last month in Stone Mountain, Georgia.

Capital Buffers

Federal Reserve Board spokeswoman Barbara Hagenbaugh declined to comment. She said earlier this week that the central bank, as JPMorgan’s holding-company supervisor, is studying organizational issues around the trading loss to ensure that they aren’t repeated in other areas of the bank. The loss underscores the importance of capital buffers, she said.

The Office of Comptroller of the Currency said this week it is examining JPMorgan’s activities and its transactions following the $2 billion loss.

“Our examiners are also evaluating risk management strategies and practices in place at other large banks to validate our understanding of inherent risk levels and controls of these risks,” said OCC spokesman Bryan Hubbard. The OCC oversees national banks, including JPMorgan Chase Bank N.A.

Dimon announced his bank’s “egregious” trading loss on May 10, two months after the biggest U.S. bank by assets passed a Fed stress test that put its loans and securities through a scenario of deep recession and a simulated global financial market shock. The bank’s flawed positions on synthetic credit holdings could result in an additional $1 billion loss or more as they’re wound down, Dimon said.

By Caroline Salas Gage and Craig Torres

Courtesy of Bloomberg News

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