This Article was originally a guest post on the Intelligent HQ website.
As Federal regulators and lawmakers are renewing the focus on financial regulation in the wake of a multibillion-dollar trading loss at JPMorgan Chase & Co. Ian Greenstreet weighs in on the debate.
1. The key question is what should the permitted activities of a deposit taking bank be; particularly one that is too big to fail such as JP Morgan and one that is implicitly underwritten by the tax payer? Should banks like JP Morgan be permitted to take depositors’ money and invest them in derivative positions or should a deposit taking bank be confined to lending type activities (trade finance, loans , collateralised lending). The Volcker rule attempts to address some but not all of these issues?
2. Was there adequate communication to the stakeholders of the risks being taken- Stakeholders include for example, shareholders and regulators? What proportion of the capital, balance sheet, market capitalisation, profit were the stakeholders prepared to accept as a loss ? Did they know that in 2010 a large proportion of the Bank’s profits were earned by this unit and therefore it may not have been unusual for a loss to have taken place in future years?
3. Was the taking of credit derivative positions seen by stakeholders as a core activity of the Bank? Was this activity seen as consistent with the peers of JP Morgan or a substantially different activity? Was it communicated? If not should the activity have been scaled back?
4. Measurement of risk – Were there any concentration limits or notional limits put in place? Did stress testing take place to identify plausible, severe worst case scenarios to avoid such nasty surprises? ( stress testing should take account of concentration, liquidity and correlation…)
5. Experience shows that an over dependence of mathematical models is dangerous? Was this the case here?
This event is likely to provide additional support for some of the new regulations being considered for the banking and financial industry.