Big Bank Risk Management – JPMorgan was Warned
Banking and Risk Management
An Analysis by Jerry Hudspeth
SUMMARY: CtW Investment Group, a labor-backed shareholder group, last year warned JPMorgan Chase & Co that its risk management committee was not up to the task.
“We are deeply concerned that the current three-person risk policy committee, without a single expert in banking or financial regulation, is simply not up to the task of overseeing risk management at one of the world’s largest and most complex financial institutions,” an April 1, 2011, letter from CtW said.
CtW urged replacing Futter, one of the three members of the risk committee on JPMorgan’s board, and increasing the committee’s authority and oversight responsibilities.
“Without an overhaul of the committee’s mandate and membership, we are profoundly concerned for the committee’s ability to provide effective oversight of the risks being assumed across JPMorgan’s larger and more complex post-crisis operations,” the group said in a separate letter in March 2011.
A later letter indicated the group met with the head of JPMorgan’s risk committee that April, but the meeting did not alleviate all of CtW’s concerns.
Analysis by Firestorm Expert Council Member Jerry Hudspeth
Does the recent JPMorgan Chase & Co trading disaster indicate a lack of financial industry control, oversight and regulation?
The recent announcement by JPMorgan Chase & Company that it had lost at least $2 billion through “egregious mistakes” in trading has produced much comment and opinion regarding the cause, the financial industry impact and the needed response and solution.
Much of the initial criticism was targeted toward the JPMorgan Chase & Co Risk Management Committee, a three person risk policy committee charged with the task of overseeing all corporate risk management at JPMorgan Chase and Company.
CtW Investment Group, a federation of unions shareholders group, questioned the committee’s mandate and banking and financial regulation experience while other industry analysts questioned whether pertinent data and information was even getting to the risk committee.
Financial risk management is the practice of managing exposure to risk, particularly credit risk and market risk. Other types of financial risk include foreign exchange, sector, liquidity and inflation. Similar to general risk management, financial risk management requires identifying the sources of risks, measuring them, and installing plans to address them. As a necessary task, financial risk management focuses on when and how to hedge using financial instruments to manage costly exposures to risk.
Regulatory compliance, real-time data acquisition and analysis and accurate accounting and reporting are essential tools for effective risk management. These governance tools, along with fully vetted trading strategies by the oversight committee (example: traders should have control caps that require them to exit positions when their losses exceed certain pre-determined positions), applied to the global activity of the financial institutions chief investment office should provide an effective risk management solution.
Do we need more Government regulation?
Many financial analysts and economists thought that the Dodd-Frank enactment (June 2010) would bring the needed regulatory reform. Most financial analysts are now commenting and opining on the act’s inevitable demise. The reason, most successful financial reform legislation throughout the nation’s history tends to be simple, short and easy to administer.
The Dodd-Frank Act alone is nearly 1000 pages and very complex. Jonathan Macey, professor of corporate law at Yale Law School, stated in a recent article, “Laws classically provide people with rules. Dodd-Frank is not directed at people. It is an outline directed at bureaucrats and it instructs them to make more regulations and to create more bureaucracies.” “Like the Hydra of Greek Myth, Dodd-Frank can grow new heads as needed.”
There are no shortages of suggestions on how to repair this perceived flawed process including requiring banks to increase their cash reserves or re-instate the Glass-Stegall Act (1933-1999), a post-depression law that separated commercial banking (deposits and loans) from investment banking (derivatives/high risk). However; the industry consensus is that both of these suggestions are deemed to be long shots.
Notwithstanding that JPMorgan Chase and Co took far too much trading risk leading to a very aggressive hedging position, I believe their solution lies with the future actions of their newly appointed Chief Investment Officer (CIO) Matt Zames, who succeeded Ina Drew who resigned the office after the recent loss announcement. Mr. Zames, with a mandate from the Chase CEO, is committed to correct the investment and trading issues with solid risk management procedures, make some required structural changes and lead a team of senior corporate executives to monitor ongoing activities.