Sunday, May 27, 2012

JP Morgan risk management

JP Morgan has made a change in its risk management committee consequent to its trading loss that is now estimated at upwards of $2 bn, FT reports.

A lady, the president of the American Museum of Natural History, will make way for the former chairman of KPMG.  I don't see this as a reflection on risk management at JP Morgan but I certainly see it as a reflection on how seriously management takes its board. One should not be surprised. Lehman Brothers had a theatre impresario as member of its risk management committee prior to its failure; Citibank had a former spook from the CIA on its board. ( I say this from recollection).

Now, I do not subscribe to the view that merely because one is an expert in a subject, one is effective on the board. You can be the ultimately authority on risk management and still nod your head to whatever the management wants done. But for certain specialised roles, qualifications are a necessary, though not sufficient, condition.

About the $2 bn trading loss itself, it is a lapse, a bad call but it cannot in itself become a condemnation of top management. JP Morgan made a profit of $19 bn last year; it can afford to take a $2 bn loss, especially on a balance sheet of over $2 trillion. JP Morgan's return on equity has been higher than average, so shareholders have little to complain about. If Jamie Dimon is attracting unusual flak, it is because he made the cardinal sin of taking on regulators and policy-makers, he sounded a little too cocky, which is a bad idea for the head of a bank.

You could say that a loss of $2 bn today could become a loss of $20 bn tomorrow, that is why banks should not combine traditional banking activities with trading. But, then,  a bank can run up a loss of $2 bn on credit risk as well. So the JP Morgan loss also does not in itself become an argument for the Volcker rule.  The British proposal to ring-fence deposit-taking activities with higher capital may be a better answer than asking banks to shed trading and other activities. Restricting the scope of banking is not the answer to bank failure; restricting the size is a better way to contain the costs to the tax payer.


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