JPMorgan’s trading loss has raised vexing questions about risk management at America’s largest financial institution. While the bank led by Jamie Dimon avoided many of the problems that plagued competitors, the way JPMorgan looks after its large liquidity reserves needs a revamp. One rival, HSBC, may offer some pointers on how.
The UK bank’s $2.5-trillion balance sheet is even larger than JPMorgan’s $2.3 trillion. Both lenders have attracted deposits during the crisis, leaving them with large amounts of surplus liquidity. JPMorgan’s chief investment office (CIO), who is responsible for the trading losses that could rise to as much as $5 billion, oversees a $360 billion portfolio that has quadrupled in size since 2007. At the end of March, HSBC had $402 billion in financial investments, and a further $153 billion parked with central banks.
Though the value of HSBC’s reserves is sensitive to interest rates, the bank tries to take minimal credit risk. At the end of 2011, two-thirds of its financial investments were in bonds issued by governments or state-backed agencies. It has also recently shifted assets out of euro zone sovereign debt and into central banks. In contrast to JPMorgan, which appears to have been caught out by movements in credit default swaps, HSBC does not use credit derivatives to manage reserves.
Disclosure is another difference. HSBC periodically publishes the income it generates from Balance Sheet Management. This can be a lot: in the first half of 2009, the unit generated income of $3.35 billion — eight per cent of the bank’s total. JPMorgan is less transparent: based on analysis of the bank’s regulatory filings, Tricumen estimates CIO’s revenue was $6.8 billion over the past two years. But this is barely visible to the outside world, rendering it difficult for investors to value properly.
The final difference is governance. Ina Drew, the departing head of JPMorgan’s CIO, reported directly to Dimon. By contrast, HSBC’s unit is monitored by both its investment bank chief and chief financial officer, and the board must approve big policy changes.
HSBC’s approach isn’t foolproof: sovereign debt is proving to be far from risk-free. And the bank’s approach to its reserves did not extend to its US subprime lending division, which racked up losses during the crisis. However, as JPMorgan considers how to avoid future mistakes, it could do worse than take a look at HSBC.
