JPMorgan Chase poses the greatest risk to the financial system if it were to fail, followed by Citigroup, Bank of America, and Morgan Stanley.
The “systemic importance” of the top 33 U.S. bank holding companies (by asset size) was evaluated by staffers of the Treasury Department’s Office of Financial Research. The staffers scored the banks on size, complexity, global activity, and dominance in certain customer services. The staffers also applied an OFR financial “connectivity index” to the data to measure interconnectedness.
The analysis shows that the largest U.S. banks generally scored highest for all systemic risk indicators, but had relatively low Tier 1 leverage ratios compared with smaller banks.
Several of the largest banks scored high in systemic importance because they dominate specific businesses, such as payments and asset custody services, the authors wrote. Others scored high in complexity because of their trading and derivatives businesses.
“Basel Committee-recommended capital buffers would still leave U.S.” global systematically important banks “with generally lower capital ratios than other large U.S. banks,” they wrote.
In the OFR report, JPMorgan Chase had the highest “systemic risk score” of 5.05%. Citigroup scored 4.27%; Bank of America, 3.06%; and Morgan Stanley, 2.6%.
JP Morgan Chase scored the highest across many of the risk categories, including interconnectedness, complexity, and size. JPM has the largest amount of total exposures in the banking system, which consists of “total assets plus the net value of certain securities financing transactions plus credit derivatives and commitments as well as counterparty risk exposures.”
Because JP Morgan Chase has a has a large amount of foreign assets and large intrafinancial system liabilities, the authors said, it is a potential source of “spillover risk.” “If a large loss in value in foreign assets caused such an institution to fail, the losses could be transmitted to the rest of the U.S. financial system,” the researchers wrote.
Citigroup also has a large amount of foreign assets and intrafinancial system liabilities.
The OFR paper introduced a contagion index that combines connectivity with measures of a bank’s size and leverage. The researchers explained the contagion index as follows: “The larger the bank, the greater the potential spillover if it defaults; the higher its leverage, the more prone it is to default under stress; and the greater its connectivity index, the greater is the share of the default that cascades onto the banking system.”
Five of the U.S. banks had particularly high contagion index values — Citigroup, JPMorgan, Morgan Stanley, Bank of America, and Goldman Sachs.
While the study was fairly comprehensive, the researchers said that their indicators failed to capture some dimensions of banks’ systemic importance and risk exposures.
“One is the extent to which a bank engages in maturity and liquidity transformation,” the researchers wrote. “Funding long-term illiquid assets with short-term liabilities can make a bank resolution more difficult.”
A second dimension, they said, “is the extent to which a bank’s home sovereign relies on the bank for funding activities and financial services; this type of reliance can contribute to a bank’s systemic importance.”