Regulators have spent the past few years ensuring that a repeat of the last crisis will not happen. However, as JPMorgan Chase CEO Jamie Dimon has highlighted in a letter to shareholders, these actions could only be serving to worsen the effects of the next crisis. And Brian Caplen thinks he may have a point...

We all know that the causes of the next financial crisis will be different from the causes of the last crisis. We also know that regulators regulate to prevent the last crisis not the next one – they can hardly do otherwise – and that some of the new rules may actually worsen the next crisis.

Most bankers steer well away from addressing any of these issues in public for fear of offending the regulators. JPMorgan Chase CEO Jamie Dimon is different. In a letter to shareholders, he conducts a ‘thought exercise’ to tease out the impact of a run on the market under the new rules.

While Mr Dimon concludes that banks are now stronger and more resilient, he also notes that more stringent regulations on liquidity, leverage ratios, risk-weighted assets and capital will make it more difficult for banks to be flexible and play a mitigating role in times of panic.

In other words, the banks may be more resilient but the markets could turn out to be even more wretched than the last time. As a result, the damage to banks might be less but the damage to other commercial entities such as companies and non-banks could be more. How so?

First there is liquidity – in the last crisis solid banks such as JPMorgan played a strong role in moving liquidity round the system. Deposits from weaker banks came in and loans were made against collateral at significant haircuts in order to support clients.

Under the new rules, Mr Dimon argues that no bank will want to be the first institution to report a liquidity coverage ratio (LCR) below 100% for fear of looking weak – even if the regulators allowed this. Incoming deposits might not be accepted because they would be considered non-operating deposits and would use up valuable capital under the supplementary leverage ratio, says My Dimon.

On the capital front, losses on investment securities will reduce capital and banks will be unlikely to buy and hold securities as they did in the last crisis because this would increase their risk-weighted assets. Clients drawing down revolving loans would also push up capital requirements.

Mr Dimon says: “…under the advanced Basel rules, we calculate that capital requirements can go up more than 15% because, in a crisis, assets are calculated to be even riskier. This certainly is very procyclical and would force banks to hoard capital.”

A shortage of freely available good collateral such as US treasuries, now held to maintain banks’ LCRs, is another difficulty.

All this leads Mr Dimon to conclude that the next crisis will involve “more volatile market movements with a rapid decline in valuations even in what are very liquid markets. It will be harder for banks either as lenders or market-makers to ‘stand against the tide’.”

It is not realistic for regulators to comprehensively revisit the new bank rules at this late stage – and may not be desirable. But the next conversation that needs to be had – as started by Mr Dimon – is if banks are now programmed to behave differently what impact does this have on markets and other commercial players?

We can either discuss this now and plan for it or find out the hard way in the next crisis.

Brian Caplen is the editor of The Banker.

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