JPMorgan faced failure in risk controls, regulators say

June 6, 2012 09:42 AM

June 6 (Bloomberg) -- JPMorgan Chase & Co.’s trading loss of more than $2 billion points to failures in the bank’s risk- management practices, U.S. regulators told lawmakers today.

Comptroller of the Currency Thomas J. Curry said the losses raise “questions about the adequacy and rigor” of the bank’s risk operation, particularly of the unit which experienced the losses, the chief investment office.

“We believe that the issue at JPMorgan Chase is one of inadequate risk management within the office of the chief investment office,” Curry told lawmakers. The agency is looking to see if “similar gaps exist in any other area of JPMorgan’s risk management architecture,” he said.

The hearing before the Senate Banking Committee was the first public airing of the roles played by the OCC, the Federal Reserve, the Federal Deposit Insurance Corp. and the Treasury Department before May 10, when JPMorgan Chairman and Chief Executive Officer Jamie Dimon disclosed the trading losses tied to credit derivatives.

“We are looking at whether there were gaps within our assessment of the risks and the risk controls in place in the CIO office,” Curry told lawmakers.

Senator Tim Johnson, the South Dakota Democrat who leads the committee, said losses at the largest and most profitable U.S. bank shows that “no institution is immune from bad judgment.”

Dimon Testimony

Dimon, who is scheduled to testify to the Senate panel on June 13 and to the House Financial Services Committee on June 19, is under pressure from lawmakers and regulators to explain the trades, which he has called “flawed, complex, poorly reviewed, poorly executed and poorly monitored.”

Jennifer Zuccarelli, a spokeswoman for JPMorgan, declined to comment on the remarks of regulators.

Senator Richard Shelby of Alabama, the top Republican on the committee, said after the hearing that Curry’s testimony, which came as the OCC was still conducting its review of the losses, didn’t answer all of his questions.

“Maybe Mr. Dimon will explain what’s going on,” Shelby told reporters. “Sooner or later we need an explanation. Was it managing risk or was it something else?”

Capital Requirements

Fed Governor Daniel Tarullo said in his prepared testimony that the central bank has been assisting in the oversight of JPMorgan’s “efforts to manage and de-risk the portfolio in question.”

Tarullo, who pointed to the importance of “robust bank capital requirements,” said the Fed, as the primary regulator for JPMorgan’s holding company, has been looking to see if there are weaknesses in risk management or control. He said the Fed hasn’t found similar risks, though the review is “not yet complete.”

Lawmakers, split along party lines, tried to square JPMorgan’s losses with a provision in the Dodd-Frank Act to ban proprietary trading by banks that benefit from FDIC deposit insurance and Fed borrowing.

Senator Jeff Merkley, an Oregon Democrat and co-author of the so-called Volcker rule, argued that the goal of the ban was to reduce risk, not increase it. He asked Curry whether trades by one trader in the bank’s chief investment office -- nicknamed the “London Whale” because his positions grew so large -- met that goal.

Whale’s Thoughts

“Do you think that Bruno Iksil, the London Whale who ran JPMC’s European strategic investment unit, woke up each day trying to mitigate the risk from excess deposits invested between loans and bonds?”

Curry said the while it is “premature” to reach any conclusions on whether JPMorgan’s trades would have violated the Volcker rule, “the episode will certainly help focus our thinking on these issues.” As to Iksil’s role, Curry responded to Merkley by saying he would “not necessarily” conclude that the trader was operating solely to mitigate the firm’s risk.

The final version of the Volcker rule, which is still being revised, should prohibit hedging that “does not reduce risks related to specific individual or aggregate positions held by a firm,” Treasury Deputy Secretary Neal Wolin said in his prepared remarks.

The JPMorgan loss shows the need for banks’ senior managers to have effective risk models and accountability for failure, and for regulators to have clear understanding of banks’ exposures and risk-management systems, Wolin said.

‘Substantive Guidelines’

Tarullo said the Volcker rule will put in place “substantive guidelines” to distinguish between hedging and proprietary trading.

“If a firm said we are doing this because it is a hedge they would be required to explain to themselves, importantly, as well as to the primary supervisor, what the hedging strategy was” and make sure it didn’t create new exposures, he said.

Senator Jack Reed, a Rhode Island Democrat, raised the issue of the OCC’s oversight of how JPMorgan measured its “value at risk,” or VaR. Dimon, in a May 10 call with investors, said the chief investment office used a new model that later proved to be “inadequate.”

SEC Chairman Mary Schapiro said in congressional testimony last month that the agency is “very focused” on determining whether JPMorgan appropriately disclosed changes it made during the first quarter to the VaR calculation. A company’s VaR is a measure of how much the company estimates it could lose on trading on 95 percent of days.

Risk Models

Curry said that while the agency “would likely have been aware” of changes to the company’s internal risk models, there is no explicit regulatory approval requirement to make changes.

Tarullo, who garnered support from lawmakers in both parties for his emphasis on the needs for stronger capital requirements, said that because the euro crisis has been brewing for some time, the Fed has been able to “regularize” a system of oversight to track U.S. financial institution exposures in Europe.

“What we have been able to do is put in place a system that allows us to check the positions and exposures of individual firms” against aggregate data, he said.

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