A flood of cash has pushed U.S. bank balance sheets to some important size limits, so more stimulus could have a mixed effect on bank stocks

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Oct. 5, 2020 7:00 am ET

Stimulus measures from the Federal Reserve and the U.S. Treasury may be necessary to keep the economy afloat. But it is increasingly clear that they also carry some downside for big banks.

One effect of government action has been to swell the balance sheets of top U.S. lenders with deposits, which isn’t necessarily favorable to them. Take the special capital requirements imposed on the biggest U.S. banks—known as global systemically important banks, or G-SIBs. The size of a bank’s G-SIB buffer, or the amount of additional capital it must hold, is determined by a score, and one of the most important inputs in the score is a bank’s total exposure, or size. As a consequence of things like the Fed’s asset buying, Paycheck Protection Program lending, and a corporate dash for cash, many banks have grown in size, even as they have pulled back on some activities like card lending.

Accordingly, G-SIB scores rose by 0.27 percentage point on average for eight top U.S. banks from the end of last year through the second quarter. That is more than double the typical increase in recent years, according toGoldman Sachs Group GS +0.81% analysts’ figures. At these levels, four banks— Bank of America, Citigroup, Goldman Sachs and JPMorgan Chase —are currently at risk of increasing their future capital requirement percentages by 0.5 point.

Buffer Zones

Capital requirement surcharge for global

systemically important banks

Source: Company filings

JPMorgan

Chase

Citigroup

Morgan

Stanley

Goldman

Sachs

Bank of

America

Wells Fargo

0%

0.5

1

1.5

2

2.5

3

3.5

4

Usually banks are able to manage down these scores by year-end, when the buffer requirement is actually set. But what’s notable this year is that banks in the second quarter had already done some of that management, including pulling in derivatives exposure, according to a review of the second-quarter scores byBarclays money-market strategists. So while scores were mostly flat from the first to second quarter, that masked a 5% jump in banks’ aggregate exposure measure—far more than the typical 0.5% quarterly jump, according to Barclays.

Managing down a bank’s size can be a harder lever to pull, since it could involve sacrificing client relationships. And it may get even harder should the Fed expand asset purchasing, which brings more cash to banks, or if there were expanded bank-intermediated government lending.

“The Fed’s efforts to restart the economy could bias banks’ G-SIB scores higher,” Barclays’ strategists wrote. More stimulus from the U.S. Treasury could also start to shift its cash at the Fed into the banking system, according to Barclays.

The Fed and other regulators have made moves to ease the pressure on banks’ size, such as excluding Treasurys and Fed deposits from key calculations of a bank’s leverage. But those rules don’t apply to the buffer scores. What’s more, taking advantage of them may not be costless. Banks can use these exclusions at the level of their bank subsidiaries, but then they must limit payouts from those units to the parent, which ultimately can affect dividends paid out to shareholders, according to analysts at Goldman Sachs.

The Fed has just extended restrictions on banks’ dividend and buyback payouts for another quarter. But if their balance sheets swell and capital requirements rise, banks may not be able to boost payouts as much as they’d like anyway—especially if more stimulus is being pumped into the economy. An upside to the Fed’s maintaining the restriction may be that it allows banks more time to build capital through earnings and could prime them for bigger payouts once the restrictions end.

Stimulus can of course help banks’ credit-loss picture if millions of borrowers are given a financial lifeline, and could also boost earnings if loan demand is sparked. In the long term, a better economy is what’s most important for bank stocks. But recovery-by-stimulus can still put more strain on banks’ returns in the near term. What’s more, bank actions to manage their systemic-risk scores are often a big factor in late-year funding-market dynamics.

For the biggest banks, things are rarely straightforward.

Write to Telis Demos at [email protected]