| NEW YORK, June 9
NEW YORK, June 9 Large U.S. banks are finding
the billions of dollars they paid in recent years to settle
lawsuits and fix broken businesses are coming back to haunt them
in another place: their capital requirements.
Under the new global rules known as "Basel III," banks like
JPMorgan Chase & Co and Citigroup Inc must hold
more capital to account for potential losses from trading
scandals, regulatory probes and related issues.
Regulators are concerned that such potential problems, known
as "operational risk," can be severe enough to hobble banks. In
recent tests, the Federal Reserve estimated that losses from
operational risk and related problems reduced earnings during a
period of market turmoil by about a third.
"It speaks volumes that some of the most significant losses
banks have sustained in the last several years were attributable
not to the loans they made but rather to lapses in operational
risk management and the ensuing legal judgments, regulatory
fines and reputational damage," the U.S. comptroller of the
currency, Thomas Curry, said in a speech last month.
These losses have come at most big banks: JPMorgan Chase
lost over $6 billion on bad derivatives trades in 2012; large
mortgage lenders have struggled to foreclose on homes because
they could not find critical paperwork; and Bank of America Corp
has agreed to pay over $50 billion in crisis-related
Although Basel III rules were finalized for U.S. banks last
year, they are still coming to grips with the level of capital
they need to set aside after U.S. regulators in February said
eight big U.S. banks can use their own models to determine the
riskiness of their assets and operations.
For individual banks, the extra capital can be enormous.
Regulators told JPMorgan Chase it needed to hold over $30
billion in capital to offset operational risk exposures, almost
four times the level it needed in 2010 and around twice the
capital it holds for market risk, finance chief Marianne Lake
said in February. That $30 billion is about 20 percent of the
bank's current Basel III capital.
Executives argue that regulators' demands are excessive.
Bank of America finance chief Bruce Thompson told investors in
April the bank received no capital relief from businesses it
exited, like packaging and selling private-label mortgage bonds.
People familiar with regulators' thinking said that even if
banks have shed problematic businesses, they have often not
addressed factors like poor oversight of employees or vendors
that resulted in the losses.
Higher capital requirements reduce profitability,
encouraging banks to push their regulatory capital as low as
possible. The U.S. government had to rescue banks during the
financial crisis because many of them had insufficient capital.
Fed officials fear that the banks' ability to use their own
models allows them to understate risk, and instead they view the
Fed's own test of how assets perform under stress as the main
measure of safety.
But the "stress tests" also account for operational risk.
Even if the Fed shifts to another risk measure, banks will hold
more capital to account for it.
THE BIGGEST RISK
For years most U.S. banks paid scant attention to
operational risk because earlier versions of Basel neglected it.
Additionally, such risks, like the possibility of a rogue
trader, are highly unpredictable.
"Operational risk is really a bear to model," said Mayra
Rodriguez Valladares, managing principal of MRV Associates, a
Many banks now acknowledge that measuring and managing
operational risk has become a top priority.
"We probably are spending in orders of magnitude more time
exploring the whole area of risk, and particularly operational
risk" at the board level, Wells Fargo lead director Steve Sanger
said at the bank's May investor day.
Julie Solar, an analyst at Fitch Ratings, said, "It's going
to be an ever-escalating bar, and banks will have to spend more
money on operational risk management."
JPMorgan is talking to regulators over how much capital to
set aside for operational risk losses since the bank has already
addressed many of its legacy exposures through write-offs and
Finance chief Lake, speaking in February, said, "It's a
priority for us... to develop a framework (with regulators) that
will allow that capital to be properly adjusted to better
reflect current risk exposures."
(Editing by Dan Wilchins and Leslie Adler)