We will successfully navigate the new global financial architecture (and we are well on our way to having fortress controls)
We have meaningfully simplified the company
While I have said that it is good housekeeping to keep our company as simple as possible, we have done an extraordinary amount of cleaning out this past year. More important, last year, we said that we would do it, and this year we actually did it. The chart below shows that we did it by shedding businesses, reducing products and materially de–risking by reducing certain types of clients that simply create too much risk in the new world. In total, we have reduced approximately $25 billion in assets through this effort. All of this makes the work of our compliance and control executives that much easier, as they can focus more on what’s important.
We are well on our way to having fortress controls
The intense effort over the last few years now is yielding real results and will go a long way in protecting the company in the future. When we are done, we hope not just to have met the heightened expectations of our regulators but to have exceeded them. In addition to successfully completing CCAR (which we will strive to do every year), there are other examples of tangible progress. Following are some of our accomplishments:
- Strengthened compliance. We have added approximately 8,000 people across the firm with a mission to strengthen our compliance capabilities. We have further aligned global leadership to drive focus and consistency across key risk areas such as AML/BSA (Anti–Money Laundering/Bank Secrecy Act), fiduciary risk, market conduct risk, employee compliance and privacy. We have enhanced our policies and implemented new procedures and technology support.
- New anti–money laundering systems deployed. We have implemented Mantas, an industry–leading transaction monitoring platform, for all U.S. dollar payment transactions. This provides a significant improvement in our transaction monitoring capabilities and allows us to decommission multiple less effective legacy systems. We also have upgraded our processes and technology support in AML investigations and sanctions. We have more to do, but a strong foundation is in place.
- Foreign correspondent banking review. Given the regulatory scrutiny around these activities, we have exited many relationships with foreign correspondent banks where we have risk–related concerns or where we needed to simplify our business. In addition to the relationship exits, we have improved our controls for foreign correspondent banking activities, including enhancing our technology to better monitor U.S. dollar correspondent bank transactions — which allowed us to implement 10 new transaction monitoring scenarios to better track millions of transactions each day.
- Enhanced controls in connection with payday lender practices. We reviewed our policies, systems and processes to decrease financial burdens on our customers and hinder payday lenders’ ability to engage in predatory collection practices. And then we did the following: eliminated multiple return item fees, enhanced our policy and systems for stop payment requests, and allowed account closure with a pending transaction and/or a negative balance. (NACHA rules originally did not allow a bank to close an account with a pending transaction. Consumers wanted to close the account to stop payday lenders from trying to take money from the account on a daily basis.) In addition, we are working with NACHA to develop new standards for the entire industry.
- Mortgage servicing improvements. As one of the United States’ largest mortgage lenders, some of our practices were not designed to handle the unprecedented increase in volume that occurred as a result of the financial crisis. Therefore, we reviewed the areas that needed enhancement and took the appropriate actions. We focused on improving our operating model, we dedicated more than 10,000 employees to assist customers that were having difficulty making payments, and we improved our communications with customers to provide better counseling and more clarity about the options available. We also invested more than 280,000 hours of our technology employees’ time to improve our Mortgage Servicing business, including enhancing the loan modification application to improve the systems that track and manage customer complaints and responses.
- Model review. More than 300 employees are working in Model Risk and Development. In 2014, this highly specialized team completed over 500 model reviews, implemented a system to assess the ongoing performance of the 1,000+ most complex models in the firm, and continued to enhance capital and loss models for our company.
Fortunately, most of our strategies stay essentially the same
Many banks will have to make some fairly drastic changes to their strategies, and because various banks are facing different overarching constraints, those strategies may be dramatically dissimilar. We are fortunate that our strategies will remain essentially the same, which allows us to avoid the upheaval, both internally and externally with clients, that often comes when strategies need to be changed dramatically.
However, a small percentage of our products and services will require some surgery (more on that later). In addition, because some companies are making large strategic moves, we would expect to see an ongoing shift in market shares and pricing. It is possible that we will benefit from both of these trends.
While uncertainty remains, the contours to the new rules are largely known, and we have made enormous progress adapting to them
The chart below describes the new rules and regulations with which we need to comply. And remember, these new rules affect each product, business, legal entity and client. Every requirement has a few hundred detailed rules around it to which we need to adapt. While it is a lot of work, we believe we will be able to successfully accomplish all of it. We have spoken about many of these rules and requirements in the past so we won’t go into greater detail here, other than on the new G–SIB capital rules, which will have some material effects on some of our businesses.
Intense effort is going into understanding and adapting to the new G–SIB capital rules.
Last year, we described how we had to manage the company to satisfy several new constraints (all of the liquidity, leverage, capital and CCAR requirements). To do this, we were pushing these new rules and requirements all the way down to the product and client levels. The G–SIB capital rules are a new constraint that we also need to manage to, and for JPMorgan Chase, they possibly are the most important constraint, though this may change over time. Therefore, we also need to push the new G–SIB rules to the product and client levels.
Unlike RWA, which lets one measure the risk embedded in each asset and, thus, the capital needed to hold against it, G–SIB is multivariate. G–SIB is not a simple calculation. It requires thousands of calculations, and it does not look at just assets — it looks at products, services, assets, type of client (i.e., international and financial or corporate) and collateral type, among others in order to determine capital levels.
G–SIB will have its highest impact on non–operating deposits, gross derivatives, the clearing business in general and certain clients, particularly financial institutions, including central banks. At the end of the day, we believe that we can manage through this process and reduce our capital requirements while maintaining our core franchises. To the extent that these changes materially impact clients, we will do it thoughtfully and carefully and help them find appropriate alternatives.
G–SIB is not a direct measure of risk.
The G–SIB calculations show that JPMorgan Chase is the most Global Systemically Important Bank, and, therefore, we have to hold more capital than any other bank in the world. Some of our shareholders believe that this designation implies that before the additional capital is held, we may be the riskiest institution, too. But G–SIB is not a true measure of risk, like RWA or CCAR. (And as shareholders have mentioned to me, many of these measures do not indicate how they would look at risk; i.e., margins, earnings diversification and actual performance in tough times, in addition to criteria such as capital and liquidity.)
In fact, parts of G–SIB are very risk insensitive — for example, it does not measure our actual and largest risks in credit markets (still our largest exposures) — and it adds a lot of capital for some activities that have absolutely no risk involved. One example will suffice: We take non–operating deposits (deposits that are very short term in nature from investors so they can manage their short–term cash needs) from central banks and large financial institutions. We have approximately $350 billion of non–operating deposits, a large portion from financial institutions, which we immediately turn around and deposit at the Federal Reserve, and this is risk–free to us. We mostly do this as an accommodation to large institutions that need to move extensive sums of money around and we generate minimal earnings from this activity. We recently announced that we are going to reduce these deposits by $100 billion, which in the context of the firm’s broader actions will reduce our common equity requirements by approximately $3.5 billion. (Since these changes involve some of the largest financial institutions in the world, we are doing this very carefully and are trying to make sure that clients have access to alternatives such as access to money market funds and direct access to Federal Reserve facilities.)
We hope to learn a lot more about the G–SIB calculations. Many questions remain, which we hope will be answered over time such as:
- It is unclear (it has not been made transparent to us) how and why these calculations are supposed to reflect systemic risk. In addition, they are relative calculations, which means that even if we and everybody else all reduced these exposures, our surcharge would not change, while presumably systemic risk would drop.
- It is unclear how these calculations take into consideration the extensive number of new rules and regulations that are supposed to reduce systemic risk (i.e., total loss–absorbing capacity, net stable funding ratio, liquidity coverage ratio, supplementary leverage ratio and the new Recovery & Resolution rules).
- It is unclear why the U.S. regulators doubled the calculations versus everyone else in the world, particularly since the U.S. banking system, as a percentage of the U.S. economy, is smaller than in most other countries.
G–SIB is important, and we take it seriously. The G–SIB capital surcharge, however calculated, is an important part of our capital needs. And since we are outsized, relative to our competitors (our capital surcharge currently is estimated as 4.5% of risk–weighted assets, yet many of our competitors are between 2%–4% of risk–weighted assets), we will be more comfortable when the surcharge is reduced. We already have begun to lower the surcharge by 0.5%, and, over time, expect to do more than that. Marianne Lake and Daniel Pinto gave details on this topic in their Investor Day presentations. The regulators have made it clear that these are important measures of global systemic risk, and they have given us a clear road map to how we can reduce these exposures — and we are going to take that road.
We must and will meet the regulators’ demands on Recovery & Resolution — whatever it takes
A critical part of eliminating “Too Big to Fail” is meeting the regulators’ demands on Recovery & Resolution. The Recovery Plan is the first line of defense in a crisis situation and serves as the road map for how to prevent the firm from actually failing. It gives the regulators the comfort that the firm has done sufficient upfront planning and analysis and has an outline for how the firm could recover if confronted with a severe financial crisis. The plan essentially helps the regulators understand the comprehensive set of alternatives and actions available to enable the firm to fully recover and prevent a failure. Resolution Plans, on the other hand, are the playbooks for how the company can be restructured or unwound in an orderly way in the event of a failure so that other banks and the general economy would not suffer. The plans outline for the regulators a set of strategies, necessary information and detailed plans by legal entity. For instance, JPMorgan Chase has reported that it has 34 legal entities and branches housing the vast majority of the firm’s essential operations and businesses. Each legal entity has to be understood by the regulators and must have distinct intercompany agreements and a comprehensive plan in place to manage the legal entity in the event that it needs to be resolved. We have taken these requirements very seriously as evidenced by the more than 1,000 people working diligently on the extensive Recovery & Resolution requirements. In addition, we are working to reduce the number of entities we have and to simplify our structure and inter–entity arrangements. We need to satisfy all of our regulators on these plans, and we will do whatever it takes to meet their expectations.
There have been two critical developments toward giving governments and regulators comfort on Recovery & Resolution, which, according to some key regulators, will effectively end Too Big To Fail and will be completed in 2015. First, the regulators have almost finished plans around total loss–absorbing capacity, which will require large banks to hold a lot of additional long–term debt, which could be converted to equity in the event of a failure and thereby enable the firm to remain open to serve customers and markets. Second, the industry agreed to put in place specific rules and guidelines on how to deal globally with derivatives contracts of a failed institution. This gives regulators and governments the knowledge that, in a failure, derivatives contracts can be properly managed and will not make the situation worse.
The industry will be stronger and safer because of all of the new regulations, and the future is bright for well–run banks
There is no question that, today, the global banking system is safer and stronger — possibly more so than it has ever been. That is not to say that the changes do not create a whole range of challenges, complexities and new risks (which we will talk about in the next section). But at the end of the day, the system will be safer and more stable than ever. I may sound a little like Voltaire’s optimistic character Dr. Pangloss for saying this, but I am hopeful that in the next five to 10 years, high– quality banks will be thriving in their work to support economies and help society.