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May 13, 2012 9:15 pm
The size and scale of the surprise $2bn loss at JPMorgan Chase last week is likely to accelerate plans by global regulators to force banks to improve their trading risk models – a move that could sharply push up costs and capital requirements for large banks worldwide.
While initial reactions to the JPMorgan loss last week focused on how it could reshape the US debate over implementing the “Volcker rule” ban on proprietary trading, the misstep by one of the world’s largest banks could have far broader consequences.
The Basel Committee on Banking Supervision, which sets global rules, has already sought a replacement for Value at Risk – the main measure of potential trading losses – and looked at additional capital requirements to cover potential damages that are not adequately measured by existing models.
That project was seen as a long-term effort when it was announced two weeks ago, but it has now gained urgency and could be pushed through more quickly, according to three people familiar with the committee’s thinking.
“There are shortcomings to VAR which suggest alternate measures like ‘expected shortfall’ are worth exploring, and regulators need to look harder at which risks are modelled and which ones might be too hard to model,” one of them said.
VAR measures how much banks could lose on their trading on most days. Expected shortfall focuses on capturing risk from rare but awful events.
A senior bank regulator from one of the 27 countries on the Basel Committee said the JPM loss could galvanise those regulators who also want to scrap the current practice of different, often lower, capital requirements for assets held for trading compared to those in the banking book.
“How can a hedging strategy turn into a huge trading loss? It doesn’t make any sense,” the regulator said.
As part of the loss announcement, JPMorgan revealed that it was sharply increasing the VAR figure for the chief investment office where the trading errors occurred. After initially reporting an average daily VAR figure of $67m for the CIO in the first quarter, JPMorgan said it would almost double the figure to $129m.
The bank said it was reverting back to an older version of its VAR metric after having switched to a new model earlier in the year. “There are constant changes and updates to models, [we are] always trying to get them better than they were before,” Jamie Dimon, chief executive of JPMorgan, said on an emergency call with investors and analysts last week. But the new model had proven “inadequate”, he said.
Bankers and analysts said the Basel committee’s “fundamental review” of trading book capital could have profound consequences for banks with large trading desks, particularly those in Europe which already use a great deal of internal modelling. The Basel group has said that if the models cannot be improved sufficiently, it may force more banks to use a “standardised” approach that sets capital requirements much higher.
Rewriting the rules will also be expensive, experts said. Exane BNP Paribas analysts have predicted that rewriting the models could cost $200m per bank.
But Annetta Cortez of Rate Validation Services, a provider of validated benchmark data, forecast that the new data requirements could push total costs much higher.
“This may force most banks to switch to standardised approaches, which, in some cases, could double their capital requirements,” she said. “As a result, certain asset classes may become unprofitable, forcing banks to overhaul their business models.”
White House calculates trading loss
JPMorgan’s $2bn trading loss looked like it could have been a gift to Barack Obama as the US president heads into a difficult
re-election campaign and defends his efforts to regulate Wall Street, writes Stephanie Kirchgaessner in Washington.
But his relationship with JPMorgan chief executive Jamie Dimon, which has been rocky at times but has included moments in which the president has singled Mr Dimon out for praise, could complicate the White House’s calculation.
The president’s likely Republican rival, Mitt Romney, is hammering Mr Obama for allegedly strangling the economy with excessive regulation.
Mr Obama’s campaign has said that rolling back Wall Street reform would be “reckless” and put the US at greater risk of another financial crisis, but it has not singled out the trading loss explicitly.
One industry observer said JPMorgan expected that the trading loss would become part of the broader regulatory debate in Washington but did not believe the White House would seize on it in the campaign because it would open the president up to criticism for being “too close” to the bank.
The person added that the two men had lunch in March earlier this year, where they discussed the economy and events in Europe.
In an interview with ABC News in 2009, the president said that Mr Dimon was doing a “pretty good job” running the bank’s enormous portfolio and later hired former JPMorgan executive Bill Daley as his chief of staff.
Democrat Elizabeth Warren, a frequent critic of Wall Street who is running for Senate in Massachusetts, called on Mr Dimon to resign from the board of the New York Federal Reserve bank. But those calls were not echoed by other prominent Democrats.
The White House did not immediately comment on critical remarks by Mr Dimon on the “Meet the Press” show, in which the chief executive was critical of Democrats for being “anti-business” and their “attacks on work ethic and successful people”.
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