WASHINGTON — A JP Morgan Chase executive called Monday for scrutiny of how financial regulations, imposed in the aftermath of the financial crisis, limit liquidity during times of slower trading and lower volume in the market.
Sandra O’Connor, chief regulatory affairs officer at JP Morgan Chase & Co., pointed to capital requirements faced by large banks as a limitation on market liquidity. O’Connor, speaking at the National Association for Business Economics Policy Conference, said the spread between buy and sell offers in the market has been relatively tight, a sign of liquidity in the market. But O’Connor said that the overall pace and size of trading has seen a downturn.
“Trading volumes are lower, trade sizes are smaller, and turnover is substantially slower,” she said.
O’Connor emphasized the effect of increased capital requirements on the behavior of banks and the assets they hold. With banks bound to hold higher quantities of liquid assets like U.S. Treasury bonds, O’Connor said, various institutions employ similar strategies and fewer assets are available for trading.
“You have a lot more buy-and-hold activity and a lot more homogeneous positioning,” she said.
Liquidity, a measure of how easily market participants are able to sell large quantities of a security without changing its price, affects volatility. When fewer parties are willing to trade, there are fewer bids available, which can increase swings in price as sellers match with whatever buyers are available. And when banks are required to hold increased capital to reduce risk, they effectively take assets off the market, said Norbert Michel, financial regulations research fellow at the Heritage Foundation.
“We’re forcing certain institutions to hold some liquid assets and pretty much do nothing with them but hold them,” Michel said in a phone interview.
Increased capital requirements came in response to the 2008 financial crisis – part of a package of regulations designed to make big banks better cover their risk. Basel III, a regulatory framework created by the Basel Committee on Banking Supervision, requires that banks hold capital equal to 8 percent of risk-weighted assets.
And in the United States, a 2014 Federal Reserve rule mandates that banks with over $250 billion in assets hold lower-risk securities equal to the bank’s net spending in a month. While these requirements limit the number of Treasury bonds and similar low-risk assets available in the market, they give large financial institutions a reserve of money to draw from in a downturn.
“We want banks to have a lot of liquidity,” said David Wessel, director of the Brookings Institution’s Hutchins Center on Fiscal and Monetary Policy. “We want banks to have a lot of stuff in their portfolios that they can sell even in bad times.”
There are also signs that the market has been able to handle regulatory changes.
Markets have remained relatively stable and able to bounce back from shocks, despite liquidity concerns, according to, Andreas Lehnert, deputy director of the Federal Reserve Board’s Office of Financial Stability Policy and Research.
“A variety of different metrics look good,” including bid-ask spread and stable trade volume, said Lehnert, who also spoke at the conference. “Not only do they look good, but they also appear to be actually resilient.”
And bank lending has not been hurt by the new requirements, says a 2014 working paper from the Bank for International Settlements. Rather, banks have been holding safer assets in lieu of holding the debt of other financial institutions, reducing the chances of a chain-reaction failure.
“We do not find evidence that the tightening of liquidity regulation had an impact on the overall size of bank balance sheets or a detrimental impact on lending to the non-financial sector either through reduced lending supply or higher interest rates on loans,” the paper stated.
Without further adjustment, markets will have to work around capital requirements.
Banks will continue buying up the assets they need to remain compliant, the Heritage Foundation’s Michel said, driving other market participants to higher-risk assets. And Brookings’ Wessel said less liquid markets will move investors away from buying large quantities of a security on the assumption that they can sell them later.
“You basically have to have a buyer in hand,” Wessel said.
