For Regulators, JP Morgan’s $2 Billion Loss Is Really Not A Big Deal

News of JP Morgan’s $2 billion bad bet rocked the industry last week. After all, how could a bank of its stature make such a big mistake? And where were the regulators in all that?

Well here’s the thing: Regulators checked out JP Morgan just a couple of months ago, and found that the bank was doing fine. And if they were to go back in time and carry out those tests again, they would probably say the same thing again.

When the Fed put JPMorgan through its annual stress test in March, it determined that the bank could safely survive a loss much greater than the $2 billion it has so far reported, while still having enough capital to remain solvent.

The reason for this is that through its stress tests, the Fed focuses on capital and liquidity, rather than on managing individual trades that could lead to losses equivalent to The London Whale’s massively bad bet.

And besides stress tests, the Fed has not produced any alternative way of truly guaranteeing the stability of the financial system.

In fact, JP Morgan’s massive loss may have rocked the financial markets, but it is still unclear whether any regulators even detected that something risky had been going on behind closed doors at the bank’s New York or London offices – even though the public at large knew about the London Whale’s large bets from widely circulated articles by the Wall Street Journal and Bloomberg that were published in early April.

Britain’s regulator, the FSA, did flag the bank's internal controls in 2010 when it fined JP Morgan 33 million pounds for failing to segregate client month from its own in the UK. But some experts point out that by and large, regulators don’t have the manpower or sophistication to keep up with the banks.

"The regulators also have no idea about what is going on,” Reuters reported IMF chief economist and MIT professor Simon Johnson as saying on Friday. “Attempts to oversee these banks in a sophisticated and nuanced way are not working," he said.

The Volcker Rule is due to take effect this summer, but some say that the JP Morgan incident could prove that policing proprietary trading is simply impossible.

Meanwhile, some experts, like Jaret Seiberg, a senior policy analyst at Guggenheim Partner actually point out that JP Morgan’s loss is a “positive story” in that the bank did not suffer any disruption to its lending operations. "In other words, the system worked," he told Reuters.

Now, Jamie Dimon has said sorry. JP Morgan investment chief Ina Drew has just resigned. And the regulators – at least publicly, are soldiering on.

In fact, today, bank regulators released their latest stress test guidance for big banks asking institutions to conduct an analysis of whether they would survive based on a variety of scenarios such as the failure of a major counterparty or a natural disaster.

The regulators, including the Federal Reserve, announced four principles for how to conduct a stress test including one that requires "multiple" stress test approaches. Other scenarios banks could consider include a severe recession, a localized economic downturn or a sudden change in interest rates.

The guidance comes after Citigroup, Ally Financial, MetLife and SunTrust Banks failed March’s stress test conducted on 19 big banks (the one that JP Morgan passed with flying colors) which looked at whether they would maintain sufficient capital during a recession with 13 percent unemployment and a 50 percent drop in stock prices.

Perhaps regulators should listen more closely to the banks they are regulating. They might be surprised. A Sybase survey we reported on recently showed that banks worldwide are requesting more frequent - and more efficient - stress testing.

The survey revealed that 46 percent of North American banks believe stress testing should be conducted once every six months. Almost all the 185 banks interviewed had major reservations over the efficiency of current stress tests.

Read: Call-Out To Regulators: Banks Just Can’t Get Enough Stress Testing to learn more.]

Ultimately, JP Morgan’s $2 billion-plus loss won’t cripple the bank, but it does now provide regulators with the opportunity to fight – or perhaps just embrace - tighter rules and testing, given that that is what to a certain extent many banks seem to want.

As Rep Barney Frank, said a few days ago:"This regrettable news from JPMorgan Chase obviously goes counter to the bank's narrative blaming excessive regulation for the woes of financial institutions.”

He added: “JP Morgan Chase, entirely without any help from the government has lost, in this one set of transactions, five times the amount they claim financial regulation is costing them. The argument that financial institutions do not need the new rules to help them avoid the irresponsible actions that led to the crisis of 2008 is at least $2 billion harder to make today.”

Melanie Rodier has worked as a print and broadcast journalist for over 10 years, covering business and finance, general news, and film trade news. Prior to joining Wall Street & Technology in April 2007, Melanie lived in Paris, where she worked for the International Herald ... View Full Bio