Jamie Dimon Sees Rough Times Ahead for Smaller Banks, Predicting Interest Rates as High as 7 Percent

JPMorgan Chase & Co President and CEO Jamie Dimon testifies during a U.S. House Financial Services Committee hearing titled “Holding Megabanks Accountable: Oversight of America’s Largest Consumer Facing Banks” on Capitol Hill in Washington on Sept. 21, 2022. Elizabeth Frantz/Reuters

JPMorgan CEO Jamie Dimon, predicts rough times ahead for regional banks and warns of more deposit runs, as future interest rate hikes become increasingly likely.

Dimon warned at a May 22 Q&A Investor Day meeting at JPMorgan Chase that interest rates were likely to go higher from here and rise to as much as 7 percent.

He noted that there was much uncertainty about the health of regional banks and that rising yields in the money market have led to a steady outflow of deposits, bringing their balance sheets to dangerous levels.

A combination of Federal Reserve rate hikes and quantitative tightening is adding more fuel to the regional bank crisis.

JPMorgan controls more than 13 percent of the nation’s deposits, with a lock on 21 percent of all credit card spending.

Under Dimon, the banking giant has gobbled up more of the lending market with each small bank failure, since the financial panic in March.

JPMorgan investors were told that they should expect to benefit from rising interest rates because of its recent acquisition of First Republic Bank.

Dimon told meeting attendees, that net interest income this year would be revised from $81 billion to $84 billion, after the bank bought out the profitable operations of its smaller competitor in a deal with the FDIC.

Dimon Predicts Even Higher Interest Rates

Dimon addressed the central bank’s raising of the overnight rate and said there was still too much liquidity in the system.

The JPMorgan CEO said that the credit situation will probably get worse and that higher interest rates are likely, contradicting popular opinion that the Fed has reached the upper limit of its policy hikes.

However, he assured investors that the U.S. economy was fine for now and that a “mild recession” would not hit until later in the year.

“Everyone should be prepared for rates going higher from here,” Dimon said, adding that capital is already tightening up and that the Fed funds rate would surge past its current level of 5 percent, to as high as 6 or 7 percent.

“There’s a chance you could have rates ticking up and not just 3.78,” said Dimon, calling 7 percent interest rates an “outlier but possible.”

Fed’s Quantitative Tightening Policy May Cause Another Bank Liquidity Crisis

With the Fed Funds rate at 5.25 percent and with Treasuries and money market funds offering similar yields, smaller banks are now buckling under the pressure.

This could spark another disastrous bank deposit run from both checking and saving accounts.

Meanwhile, the Fed’s quantitative tightening policy is causing its monetary reserves to shrink and drying up the supply of available liquidity for banks, said Dimon.

The JPMorgan chief said that higher capital charges from the Fed would hurt the smaller banks, but not their larger peers like JPMorgan.

He said that smaller banks face more problems on the deposit side, as they are less likely to absorb a financial blow from a lack of liquidity.

The American banking sector had benefited from low loan defaults over the last few years, due to almost zero interest rates and the flood of government stimulus money during the pandemic.

For two decades, lenders were encouraged to buy up low-yielding securities, but the vulnerable regional banks are now being squeezed, as yields soar and fixed-income and loan prices plunge.

Deposits will now have to shift into treasuries, or face liquidation in a future bank run, said Durden.

“We haven’t been through Quantitative Tightening. So we really don’t know what’s going to happen to deposits at all. And that’s why I’ve been quite concerned about that. I’m probably more concerned about quantitative tightening with anybody in this room,” warned Dimon.

“We’ve never had QT before. It just started, okay? And you see huge distortions in the marketplace already.”

“We’ve never had the Fed in the market like this ... They have $2.3 trillion basically lent out to money funds. And I don’t know the full effect of that. And obviously, that’s a direct deduction from deposits are rolling out it made sense to do,” he said.

“So I think people should build into their mindset that they may have to move deposit beta more than they think and manage that. So I mean, if I was any bank or any company, I'd be saying, can you handle higher interest rates and surprise in deposits, etc?” Dimon continued.

Commercial Real Estate Sector Exposed To Credit Crunch

Before the failure of Silicon Valley Bank set off the recent bank crisis, uninsured deposits were generally not seen as a problem, said Dimon, but the regulatory moves made in response will lead to tighter credit for smaller lenders.

This will in turn lead to even tighter credit from lenders to customers.

“You’re already seeing credit tighten up because the easiest way for a bank to retain capital is not to make the next loan,” he explained.

As banks raise the bar for lending, the commercial real estate sector is expected to suffer the most from tighter credit, which may spread to the wider economy.

About 80 percent of commercial real estate loans are granted by the regional banks, which have been rattled by the monetary policy of the Fed and the outflow of capital, according to Goldman Sachs.

“There will be a credit cycle. My view is it will be very normal” with the exception of real estate, Dimon said, and that “there’s always an off-sides.”

He explained that “the off-sides in this case will probably be real estate. It’ll be certain locations, certain office properties, certain construction loans. It could be very isolated; it won’t be every bank.”

Commercial properties in upscale markets, like San Francisco and New York, are already losing money, as workers increasingly prefer to work remotely.