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Deutsche Bank Sees Bank Stock Rally Adding to Repo Market Strain
(Bloomberg) -- A rally in bank stocks since the end of September could force the largest US institutions to further pull back activity in the market for repurchase agreements or foreign exchange derivatives, according to Deutsche Bank.
Banks’ share prices are used to calculate a part of the regulatory scores for the global systematically important bank (GSIB), which are taken at the end of the year to determine their surcharge, or amount of capital banks need to maintain on their balance sheets. The higher the score the more cash banks are required to hold. Banks tend to pare derivatives and repo market activities in order to lower potential scores before year-end.
“The pressure to reduce year-end activities would likely be most acute for banks whose GSIB indicators grew during the year, putting them at risk of a higher surcharge for future years,” strategists that include Steven Zeng wrote in a note published Friday.
For the five GSIBs with significant prime brokerage businesses, their scores are at risk of rising between 2.5 and 6.6 points, based on their share price as of Nov. 21 market close, they said.
Deutsche Bank estimates those GSIBs would need to reduce their repo activity by $95 billion or foreign exchange activity by $290 billion to fully offset the impact of their stock price appreciation on their score.
The rate on overnight repo for year-end — or loans collateralized by Treasuries — and those backed by mortgage-backed securities soared in recent weeks. Some of this is due to a surge in repo levels on Sept. 30 that stemmed more from primary dealers’ balance-sheet congestion than the Federal Reserve’s quantitative tightening. At the same time, a recent surge in equities has increased demand for repo collateralized by stocks, further adding to funding constraints. Wall Street is preparing for even more volatility on the final trading day of 2024.
More than half of the eight GSIBs could be pressured, according to Deutsche Bank, with JPMorgan Chase & Co. and Bank of America already facing the highest surcharges, based on their estimated third quarter scores. Goldman Sachs, Morgan Stanley and Citigroup are near the top of the upper threshold in their respective buckets.
BofA, Citi, JPMorgan and Morgan Stanley declined to comment, while Goldman did not provide comment before publication.
JPMorgan’s estimated GSIB score has already jumped 160 points since last year in the third quarter, placing it in the top surcharge bucket of 5.5% if the score is maintained at the end of the year. In order to “settle” for a smaller 50 basis point increase, the bank would have to reduce its repo activity by at least $160 billion, according to Deutsche Bank.
Last month, JPMorgan CEO Jamie Dimon on Bloomberg Television acknowledged that the bank “is going to have a trillion dollars of cash and unable to intermediate in Treasury markets or repo markets completely conservatively” because it is required to hold that cash in central bank reserves.