By the Fed’s count, JPMorgan Chase may need about $22 billion in extra capital to meet its tougher new standards for keeping banks safe. That sounds like a lot, but in the context of the bank's hugely profitable business, it’s not a high hurdle to overcome.
A cursory look at how bank capital levels are calculated, and JPMorgan’s multibillion-dollar quarterly earnings, drains quite a bit of drama from the story.
The Fed on Tuesday announced new capital rules for U.S. banks, due to take effect in 2019, that are meant to be slightly stricter than international rules, known as Basel III. Capital is one way banks can fund their business. Debt is the other. Capital can be raised by selling stock or by keeping money the bank has earned. That money never has to be repaid to shareholders, unlike debt which must eventually be paid back to lenders. More capital and less debt makes banks less vulnerable to declines in the value of their assets.
JPMorgan's estimated $22 billion capital hole, according to the new Fed standards, is based on what are known as "risk weighted assets." Some assets (think U.S. Treasury debt) are less risky than others (think subprime mortgage bonds). Banks need to have more or less capital to account for that risk.
Change how you define "risk," or change how much capital you think a bank needs to have for each asset, and suddenly that $22 billion capital hole changes -- maybe dramatically. The bank could also change that capital hole by changing the mix of assets it holds, or shrinking its operations, or pulling back on business in certain countries.
"It's a whole question of measures," Stanford finance and economics professor Anat Admati, who has long advocated much higher capital levels at banks, told The Huffington Post. "There are so many knobs you can turn" to meet new capital requirements.
There is also a far simpler way JPMorgan, which earned $5.6 billion in its latest quarter, could make up a capital shortfall: keep more of its earnings. It would take just a year of such quarterly profits to raise $22 billion in capital, assuming JPMorgan retained all its earnings.
Of course, the bank doesn’t do that. In its latest quarter, JPMorgan paid $3 billion of its earnings to shareholders. Still, that left $2.6 billion to be retained and added to the bank’s capital.
That means JPMorgan could keep on its current earnings trajectory, leave its dividend and buyback plans alone, and still make up its capital shortfall in just two and a half years (ten quarters), without ever raising additional equity from the stock market.
As Admati said, “what does $22 billion really mean? That’s not a lot of money for them.”
The bank’s chief financial officer said as much on Wednesday, saying the new capital requirements would mean only "surgical" changes at the bank.
A JPMorgan spokesman declined any additional comment.
$22 billion is a headline grabbing number, but it’s an easily surmountable one. “I hate it when they talk about shortfalls,” Admati said, “because there are presumptions made.” Change those presumptions, and the number changes. Put the number in context, and it looks a lot smaller.