JPMorgan loss shows risks in safe-haven banks

Safe-haven banks - a category which also includes Britain's HSBC Holdings Plc - are few and far between and have attracted a flood of client deposits, saddling them with the task of putting the money to work in a market where interest rates are close to zero.

The job of managing this liquidity is a normally staid function which sits close to a bank's treasury department.

But in the case of JPMorgan's Chief Investment Office (CIO) - roughly 40 traders plus support staff - the unit had become an increasingly important money-spinner for the Wall Street bank, possibly blinding management to the vast risks it carried.

That was brought home to JPMorgan Chief Executive Jamie Dimon last week, when he admitted to having egg on his face as a result of the CIO's huge losses stemming from a series of disastrous derivatives trades.

The losses have raised questions over how a bank which had been held up as a model of risk management good practice could have come unstuck.

The answer, some experts say, lies in the way the CIO was set up.

A CIO-type unit may not be subject to the same position limits as those that apply to the bank's trading divisions, said Julia Black, a professor at the London School of Economics.

Supervision may not be as tight and personnel may not have the same level of trading expertise, she added.

"I don't know whether any of these were the case in JPMorgan, but if I were regulating it or if I were on its board, then those are the types of questions I'd want to know answers to," said Black, a specialist in financial regulation.

Part of JPMorgan's problem was the sheer scale of its excess deposits of more than $400 billion. Its deposits jumped by almost $200 billion in 2011 to $1.1 trillion, leaving its share of loans to deposits at 64 percent, one of the lowest in the world, and down from 75 percent at the end of 2010.

A loan to deposits ratio below 100 percent means a bank has more cash from deposits than loans outstanding, a sign of conservative financing.

Other banks with a hefty cash surplus include big Canadian names such as Royal Bank of Canada and Scotiabank, as well as Japanese banks such as Mitsubishi UFJ and Sumitomo Mitsui.

In the United States and Europe, the picture is mixed.

Wells Fargo's last customer loans-to-deposits ratio was 88 percent, while HSBC's was 75 percent, Standard Chartered's 76 percent and Deutsche Bank's 69 percent.

JPMorgan's CIO head Ina Drew retired on Monday in the wake of the losses and sources have said Achilles Macris, who ran the business in Europe, was also on his way out.

The departures come after years of success. The unit generated $6.8 billion in revenue from the second quarter of 2010 to the first quarter 2012, according to a note last week by British analytics firm Tricumen.

"So, while Jamie Dimon would doubtless like to wish away this incident, we suspect he would not want to wish away the unit," Tricumen said.

The maximum amount of money JPMorgan expected the unit could lose in one day - the so-called Value at Risk, or VaR, measure - is comparable to that in its entire investment bank, the bank's annual report shows.

For instance, at the end of last year, VaR in the unit stood at $77 million, while that in its combined trading and credit portfolio in the investment bank was $76 million.

The numbers also show why VaR figures have come under pressure as a risk gauge, as they are far lower than the losses the unit may rack up as a consequence of the debacle, which could reach $3 billion or more.

Many banks have parked excess deposits at central banks or bought government bonds, which are low risk and liquid but deliver little yield. They can make more from lending to other banks, but the euro zone crisis has shown that isn't risk-free either.

HSBC is one of the few banks which has combined risk and liquidity management functions in one unit. Most other banks have these functions spread throughout their different departments.

HSBC's unit, called Balance Sheet Management, has become a big earner, bringing in $1.3 billion in revenue in the first quarter of this year.

It has earned $13 billion in the past three years, though its income has fallen in each of the last two years as it struggled to replace higher-yielding positions. It is seen as conservatively run, and not allowed to invest in synthetic products, an analyst said.

JPMorgan was the more aggressive of the two by far, allowing its credit desk in London - run by Bruno Iksil, nicknamed "The Whale" - to dominate markets whenever it took positions.

Its losses have rekindled the debate about the Volcker rule, the draft U.S. law which would bar investment banks from proprietary trading, the risky practice of betting in financial markets with their own money to make a profit.

The investments in the CIO unit were at the same time hedges against losses in JPMorgan's credit portfolio, but these are often hard to discriminate from prop trades.

"It's not prop trading as such, you're hedging off against client positions ... (but) you trade as (if you are) a prop desk," said one person who had worked in the CIO unit.

But some bankers at rival organizations were doubtful that JPMorgan was furtively doing prop trading.

"Risk management for one of the biggest banks in the world is going to appear massive," said a senior banker at a rival organization, speaking on the condition of anonymity.

"From what you read about Jamie Dimon, he runs a pretty tight ship, so my guess is (would he) allow punting in the treasury function? No," the person said. "Would he be very aggressive at hedging? I bet that's what it is."

(Additional reporting by Christopher Whittall at IFR; Editing by Alexander Smith and David Holmes)