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U.S. bankers seize on repo-market stress to push for softer liquidity rules

JPMorgan Chase CEO Jamie Dimon speaks at the North America's Building Trades Unions (NABTU) 2019 legislative conference in Washington

By Katanga Johnson and David Henry

WASHINGTON (Reuters) - Big U.S. banks are using the recent chaos in short-term funding markets as an opportunity to pressure the Federal Reserve to ease liquidity requirements they have long despised.

On Wednesday, a major industry lobbying group and the chief executive of the largest U.S. bank criticized Fed-imposed standards of how much idle cash banks must keep on hand, blaming a liquidity rule that is hated on Wall Street for causing market jolts in recent days.

"Banks have a tremendous amount of liquidity, but they also have a lot of restraints on how they could use that liquidity and how much they have to maintain at the Fed," JPMorgan Chase & Co <JPM.N> CEO Jamie Dimon said at an event in Washington hosted by the Business Roundtable, a corporate trade association he chairs.

Another group, the Bank Policy Institute, published an essay by its chief economist, Bill Nelson, who said policymakers should rethink liquidity requirements imposed since the 2007-2009 global financial crisis.

"The volatility this week should cause everyone to worry about how the financial system will behave the next time a financial shock places strains on market liquidity," Nelson wrote.

Their comments came after the Fed injected more than $125 billion into the overnight repurchase agreement market over two days. Banks rely on those contracts to fund short-term obligations, but had trouble finding the money they needed on Tuesday. That sent rates spiking to 10% from a little over 2%.

Market participants said a confluence of events caused the cash crunch. Corporations withdrew funds from money-market accounts to cover their tax bills. On the same day, banks and investors used idle dollars to absorb $78 billion in U.S. Treasury notes.

Another factor was the Fed's effort to shrink its balance sheet. Bank reserves parked there overnight – which can be made available to other banks if needed – are at their lowest level since 2011.

But bankers also pointed to the liquidity coverage ratio, or LCR, as an exacerbator of repo-market stress.

The rule requires U.S. lenders with more than $250 billion in assets to hold a large pool of high-quality, easily tradeable assets that can cover cash outflows during times of extreme stress.

Ironically, said Nelson, that meant lenders could not use those idle funds to back overnight trades during this week's stress.

"Rather than having the Fed lend to banks in stress once every generation or so at some (very minimal) risk to taxpayers, current solutions tend towards the Fed acting as a regular market participant at direct risk to taxpayers," he wrote. The Bank Policy Institute had warned in recent weeks that money markets looked poised to encounter volatility, due in part to the liquidity rule. Its members include JPMorgan, Bank of America Corp <BAC.N>, Citigroup Inc <C.N> and Wells Fargo & Co <WFC.N>, the four largest U.S. banks.

At a press conference on Wednesday, Federal Reserve Chair Jerome Powell disputed the idea that the LCR needed to change.

"It's not impossible that we could come to a view that the LCR is calibrated too high, but that's not something we think right now," he said.

The Fed is in the process of reviewing its capital and liquidity rules after Congress passed a bank deregulation bill in 2018. The central bank's vice chairman, Randal Quarles, is leading the effort.

Under a "tailoring" proposal it drew up, banks with less than $700 billion in assets could see their liquidity requirements drop by as much as 30%. But standards for globally systemic banks like JPMorgan are not expected to change meaningfully.

Bankers have complained often and loudly about the LCR's impact on profits since its implementation in 2015. They have also met frequently with Quarles to push their views on liquidity and capital requirements since President Donald Trump appointed him.

His most recently available calendars show meetings and calls with executives or board members from JPMorgan, Citigroup, Goldman Sachs Group Inc <GS.N>, Capital One Financial Corp <COF.N>, Bank of New York Mellon Corp <BK.N>, State Street Corp <STT.N>, as well as representatives of the Bank Policy Institute, the American Bankers Association, the Financial Services Forum and the Institute of International Finance.

At the event on Wednesday, Dimon said the Fed did the "right thing" when it intervened in the repo market. But he emphasized that structural issues need to be fixed.

"It's not a big deal given that it happened in good times," he said. "If we don't fix the underlying problem, it will hurt the economy in bad times."

(Reporting by Katanga Johnson in Washington; Additional reporting by David Henry in New York and Pete Schroeder in Washington; Writing by Lauren Tara LaCapra; Editing by Michelle Price, Franklin Paul and Lisa Shumaker)