UPDATE 1-Fed does the 'right thing' in supporting repo market -JPMorgan's Dimon

Katanga Johnson

Dimon@ (Adds detail and context)

WASHINGTON, Sept 18 (Reuters) - JPMorgan Chase & Co Chief Executive Jamie Dimon credited the U.S. Federal Reserve on Wednesday with doing the "right thing" in supporting the overnight funding needs of banks after borrowing costs suddenly spiked on Monday.

The Fed, for the first time since the 2007-2009 financial crisis, injected more than $125 billion over the last two days into the overnight repurchase agreement markets that banks rely on for short-term funding.

Dimon, who spoke to reporters at an event hosted by the Business Roundtable in Washington, said he did not believe the funding squeeze problem that prompted the Fed to act was a cause for immediate concern. But he said it highlighted underlying structural issues with the market that should be fixed.

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

He also used the opportunity to criticize the Fed's bank liquidity rules which he said exacerbated the problem.

Interest rates in U.S. money markets shot up to as high as 10% for some overnight loans on Tuesday amid a cash crunch, and the Fed was expected to step in to support the market again on Wednesday.

The exact cause of the turmoil is unclear, but market participants believe a confluence of events conspired to cause the crunch. One, corporations withdrew funds from money market accounts to cover quarterly tax bills, and on the same day banks and investors who had purchased $78 billion in weekly U.S. Treasury notes had to settle those trades.

Another contributing factor is that the Fed's efforts to shrink its portfolio means bank reserves parked at the central bank overnight, which can be made available to other banks if needed, are at their lowest level since 2011.

Dimon tried to assuage concerns that the crunch could cause broader instability in the banking system, saying banks have a "tremendous amount" of liquidity, but are constrained in how they can use it when rates consistently fluctuate.

He also argued that liquidity rules imposed on U.S. banks are impeding lenders from using abundant liquidity in a profitable way by requiring banks to hoard more liquid assets. Policy, not interest rates, are drying up a bank's source of funding, he said.

"Im not concerned about it. What if it happens when we are in the middle of a recession? Thats when I would worry about it," he said. 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."

The Fed did not immediately respond to a request for comment. The central bank is currently undergoing a review of its capital and liquidity rules after Congress passed a bank deregulation bill in 2018.

Dimon's comments echoed arguments made by Washington lobby group the Bank Policy Institute, which earlier this month warned money markets would suffer a spike in volatility exacerbated by the Fed's liquidity coverage ratio rule.

"Part of the story Monday and Tuesday was how banks and broker-dealers have become slower to respond to financial dislocations because regulations have required banks to hold high levels of capital against low- or no-risk assets," the group wrote in a blog post on Wednesday. (Reporting by Katanga Johnson, writing by Pete Schroeder; Editing by Michelle Price, Franklin Paul and Tom Brown)