The Global Systemically Important Banks (GSIBs) have historically been relative safe havens in times of rapidly deteriorating banking conditions in the U.S. These financial institutions, with higher statutory capital standards, are generally better prepared to weather regional or sector-specific banking shocks given the diversity in their operations and asset portfolios.
What’s a GSIB?
For background, the GSIB nomenclature was created in the wake of the 2008 global financial crisis (GFC) as a means to increase capital requirements for the largest and most systemically important banks globally. Under the Basel III framework, these banks are ranked into several buckets with associated levels of additional minimum capital requirements. The Financial Stability Board updates the list of GSIBs annually.
Although no banks are currently ranked in bucket 5, the most restrictive in terms of additional capital requirements, banks in that bucket would be required to carry additional common equity loss absorbency as a percentage of risk-weighted assets of 3.5%.
The following lists the GSIBs by bucket as of the most recent update in November, 2022:
Source: Financial Stability Board, November 2022
Stronger Balance Sheets
Narrowing in on the largest U.S. banks - Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wells Fargo - we can display (see chart below) that these GSIBs have much stronger balance sheets than other U.S. peers. This positions them to better weather any potential rolling banking crises that might occur at the regional or sector level, even though this means that in the good times they may post lower return on equity and net interest margins.
There are two measurements of capital ratios that we are going to look at. The first is the common equity tier 1 (CET1) capital ratio, which was instituted by the Basel III regulations. It was set at a minimum of 4.5% in the Basel III framework. CET1 includes common shares, retained earnings and a few other items, according to the Bank for International Settlements. Additional Tier 1 capital, which makes up the rest of Tier 1 not included in CET1, is made up of capital that absorbs losses before the bank goes under. So for example, certain types of contingent convertible bonds that convert to equity under distressed situations to provide an additional capital cushion would count as Tier 1 capital.
The average CET1 ratio of the big six U.S. banks was 13.1 at the end of 2022 and their total tier 1 capital ratios were 14.8. This compares favorably to the average capital ratios of financial sector ETFs as follows:
Source: Bloomberg, March 2023
Note: XLF represents the Financial Select Sector SPDR ETF and we exclude BlackRock and State Street from the calculation as extreme data outliers; KRE represents the SPDR S&P Regional Banking ETF; KBWB represents the Invesco KBW Bank ETF.
Why Does this Matter?
It’s not just an academic exercise to look at the balance sheet health of these banks. Bloomberg reported that on March 13, the first business day after the failure of Silicon Valley Bank (SVB), JPMorgan Chase saw billions of dollars of deposit inflows, while they noted that Bank of America, Citigroup and Wells Fargo were seeing higher-than-usual deposit volumes. There are also reports of several startups that were SVB banking clients that have or are planning to move to the big banks. Consumers are clearly valuing the health of these banks’ balance sheets in times when there remains a great deal of uncertainty over the health of smaller peers.
Not all Peaches and Cream
Still, risks remain for the big banks as well as the broader banking ecosystem. Although banks have taken various degrees of credit and duration risk in their asset portfolios, most are sitting on some degree of mark-to-market losses on their bond portfolios given the increase in market interest rates the last 12 months.
For background, banks are allowed to carry bonds and other assets at cost - not at market value - provided they deem them “held to maturity” assets, meaning they intend to hold them to maturity. However, when SVB had to sell some of its assets to shore up its capital, it had to reclassify bonds as “available-for-sale,” mark them to market value and book a loss associated with the difference between cost and market values.
JPMorgan Asset Management attempted to estimate the impact of mark-to-market accounting on various banks’ Tier 1 capital ratios if they were forced to do so:
If it had to account for mark-to-market losses, SVB was clearly an outlier and would have reported zero Tier 1 Capital! Others would also be exposed if they had to do so as per this analysis.
Fortunately, the Fed stepped up with an emergency lending program in which banks can, instead of selling these bonds on the market, use qualified assets as collateral for loans at par value. This way, they can get access to capital for these assets without having to mark losses. Although the size of the Bank Term Funding Program (BTFP), at only $25 billion, isn’t that large, the signaling power from the Fed is strong. Along with access to the discount window, most banks should have access to capital if needed, which should help stem potential runs on large banks. Still, the failure of SVB and Signature Bank shows that regulators are not going to let mismanagement get bailed out, but rather protect depositors and ensure smooth operations for those that are relatively well-capitalized.
The information contained in this blog is for informational purposes only and does not constitute financial, investment, tax or legal advice. The information expressed herein reflects the opinion of Roundhill Investments (“Roundhill”) on the date of production and are subject to change at any time without notice due to various factors, including changing market conditions. Where data is presented that is prepared by third parties, such information will be cited, and these sources have been deemed to be reliable. Roundhill is separate and unaffiliated from any third parties listed herein and is not responsible for their products, services, policies or their content. All investments are subject to varying degrees of risk, including the risk of the loss of capital, and there can be no assurance that the future performance of any specific company, strategy or product referenced directly or indirectly in this blog will be profitable, perform equally to any corresponding indicated historical performance level(s), or be suitable for your portfolio. Past performance is not an indicator of future results.
