January 16, 2014 11:48 am

US banks take on more risk as new rules bite

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US banks shrank their holdings of safe securities by more than 3 per cent last year, a development that is likely to further stoke the debate about whether new rules are encouraging them to buy riskier assets.

At the end of last year, America’s banks held $1.81tn worth of US Treasuries and mortgage-backed securities (MBS) that are guaranteed by the US government, down from $1.87tn at the beginning of 2013.

The prospect of higher interest rates and a wave of new regulation has pushed banks to sell off some of their holdings of US government debt in favour of buying riskier securities with higher returns, according to analysts.

While the Basel Committee of banking regulators eased some aspects of its new “leverage ratio” rules this week, it will still require banks to hold more regulatory capital against high-quality assets, effectively making it more expensive for the institutions to hold safer securities and potentially pushing them into riskier assets.

Regulators say that the leverage ratio is still a valuable tool to gauge the strength of banks, since it ignores the perceived riskiness of assets and instead measures capital against total securities and loans on balance sheets

“We expect banks’ demand for Treasuries – particularly longer term – and MBS to be negatively impacted,” said Priya Misra, analyst at Bank of America Merrill Lynch. “The leverage ratio rule creates a preference for higher-yielding assets.”

Banks’ collective holdings of other securities – including mortgage bonds that are not guaranteed by the US government and other types of structured financial products – jumped 5.2 per cent to $915.9bn at the end of 2013, according to Federal Reserve data.

The decline in these safe assets is a stark shift for America’s banks.

Since 2009, banks’ holdings of Treasuries and agency MBS grew by 18 per cent and 37 per cent, respectively, as they sought to reduce exposure to risk on their balance sheets.

JPMorgan Chase, the biggest bank in the US by assets, said in its annual results released this week that it had added $66bn of “new investments” to its portfolio in the second half of the year – mostly mortgage products and municipal bonds.

The investments should help JPMorgan take advantage of higher interest rates as the Fed begins to wind down its emergency bond purchases, the bank said.

New Basel III rules that came into effect in the US at the start of the year also mean that changes in the price of securities held by big banks as “available-for-sale” (AFS) will feed into their regulatory capital ratios for the first time.

Already, many of the biggest banks have been reclassifying some of their AFS securities to “held-to-maturity” (HTM) to limit volatility in their accounts.

SNL Financial estimated that the biggest US banks increased the size of their HTM portfolios by 26 per cent between the second and third quarter of this year.

JPMorgan said on Tuesday that its held-to-maturity securities had grown to $24bn and “will continue to grow” in the coming months.

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