Where Banks Get Their Money

 | Jan 15, 2013 | 1:30 PM EST  | Comments
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On Monday, I wrote about the differences in the deposits at the big four U.S. money centers: Bank of America (BAC), JPMorgan Chase (JPM), Wells Fargo (WFC) and Citibank (C). Today we'll consider the money these same institutions can access the Federal Reserve in order to meet requirements for reserves as set forth by Regulation D.

Since the financial crisis of 2008, the relationship the money centers have with the Federal Reserve has become very complex. Here is my take on the most basic and normal operating interaction of lending money to the Fed and borrowing money from it.

When a bank has reserves that are greater than it needs it may choose to lend money to the Federal Reserve system with those funds then being made available to other banks to borrow in order to meet their reserve requirements. This is called "Fed Funds Sold".

Conversely, when a bank needs reserves, it can borrow them from other banks through the Fed in what is called "fed funds purchased."

On an ongoing basis banks will carry balances in both categories; that is that they are both lending money to other banks through the Federal Reserve system and borrowing from it at the same time. In general, a healthy bank will lend more money (fed funds sold) to and through this system than it borrows (fed funds purchased).

If a bank has a pattern over time of lending lesser money to the system and borrowing more money from the system it may indicate that the bank is having problems either with the quality of the assets on its balance sheet or in raising equity capital and deposits outside of the system, from the private sector.

In the case of Bank of America, JPMorgan Chase, Wells Fargo and Citibank, there are a variety of observations worth noting.

Since the 2008 financial crisis, Bank of America is the only one that has consistently carried a greater balance of funds borrowed from the system than it supplies to the system. Although both are declining, this indicates that Bank of America is most probably having problems raising capital from the private sector and raises concerns about the ongoing quality of the assets on its balance sheet.

JPMorgan Chase is by far the most active in both lending and borrowing through the system as it carries balances in both categories that are more than double the balances being carried by the other three money centers combined.

The following is a list of carried fed funds sold /purchased, as of the third quarter of 2012 for each institution: JPMorgan -- $280 billion/$190 billion, Citibank -- $75 billion/$21 billion, Wells Fargo -- $36 billion/$25 billion and Bank of America -- $19 billion/$62 billion.

It appears that JPMorgan is actively using this system to create an ongoing profitable "carry trade" for itself. The company is borrowing money from the system at a lesser cost of capital than it is earning by recirculating the borrowed funds back into the system to be loaned out to other banks at a higher rate.

Wells Fargo's relative lack of participation on either side is most probably simply an indication of its business focus on the private sector.

Although Citi has almost doubled the amount of capital it lends to the system, its balance sheet problems are probably precluding it from leveraging an arbitrage carry trade similar to what JPMorgan is doing.

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