A proposal by global regulators to change how the largest banks report key risk metrics at the end of the year could deal a blow to their U.S. short-term funding businesses, marking the latest development in an ongoing battle over tighter capital rules.
The largest global banks are required to hold more capital than others, with a surcharge calculated annually from Dec. 31 values of certain risk measures. In an effort to minimize the capital hit, some banks adjust their businesses at year-end to lower these numbers, a practice known as “window dressing.”
JPMorgan Chase and Bank of America, for instance, reported lower risk measures at the end of last year compared to earlier in 2023, avoiding additional surcharges of over $8 billion each, according to Reuters calculations.
Last week, the Basel Committee on Banking Supervision, a global watchdog, cracked down on window dressing, proposing that banks use the average of values over the reporting year for most risk metrics, rather than year-end snapshots. This move aligns with a similar proposal by the U.S. Federal Reserve a few months earlier.
While window dressing is a well-known phenomenon, its mechanics are complex, with various factors influencing banks’ decisions. A closer look at how JPMorgan and Bank of America lowered one risk measure sheds light on some of these factors and the potential impact of the proposed change.
This specific measure is influenced in part by the banks’ activity in the repurchase agreements (repo) market, where investors borrow against Treasuries and other collateral for the short term.
Interviews with banking sources and a review of bank disclosures indicate that daily averaging, as proposed, would make it harder for the largest banks to profit from the U.S. repo business, while increasing costs for participants like foreign hedge funds.
This shift could have broader implications, potentially affecting Treasury markets and making it more costly for the government to issue debt. However, the proposal also offers benefits, such as bolstering global financial stability by providing regulators with a more accurate picture of banks’ risk profiles and potentially smoothing out repo market functioning.
The proposal is among several regulatory measures in recent months seeking to tighten capital rules and enhance market resilience. While some industry proposals have faced push-back, the Basel Committee’s proposal is currently in a comment period.
It remains uncertain whether the changes will be implemented as proposed, with banks advocating for measures based on month-end or quarter-end figures instead of daily averages. Banks have also raised broader concerns about the surcharge measurement, arguing that it does not account for economic growth, inflating capital requirements without changes in risk profiles.
Pushing back against suggestions of manipulation, banking sources emphasize the multitude of variables beyond their control. Rising stock prices and year-end slowdowns in activity are among the factors cited.
The proposal could significantly impact U.S. banks, which employ window dressing tactics, although differences in methodology make it challenging to analyze non-U.S. banks in the same manner. Nonetheless, the proposed changes signal a potential shift in capital rules and funding strategies, with broader implications for financial markets and stability.
