Question

What is Basel 3 and what was it designed to accomplish in the financial services sector? What were JP Morgan’s concerns regarding the pending changes in regulation as Basel 3 was to be implemented? As Dodd-Frank act was to be implemented? (Reference from JP Morgan Case study)

Answer 1

The iBasel iIII ireforms ihave inow ibeen iintegrated iinto ithe iconsolidated iBasel iFramework, iwhich icomprises iall iof ithe icurrent iand iforthcoming istandards iof ithe iBasel iCommittee ion iBanking iSupervision. iFor ibackground, iset iout ibelow iare ithe imain ipublications ithat idescribe ithe ichanges ito ithe iBasel iFramework ithat iwere iagreed ias ipart iof iBasel iIII.

iThe imeasures iaim ito istrengthen ithe iregulation, isupervision iand irisk imanagement iof ibanks.

iMembers iare icommitted ito iimplementing iand iapplying istandards iin itheir ijurisdictions iwithin ithe itime iframe iestablished iby ithe iCommittee.

i i i i i i i i i i i i i iThe iDodd-Frank iAct iis ia icomprehensive iand icomplex ibill ithat icontains ihundreds iof ipages iand iincludes i16 imajor iareas iof ireform.

Simply iput, ithe ilaw iplaces istrict iregulations ion ilenders iand ibanks iin ian ieffort ito iprotect iconsumers iand iprevent ianother iall-out ieconomic irecession. iDodd-Frank ialso icreated iseveral inew iagencies ito ioversee ithe iregulatory iprocess iand iimplement icertain ichanges.

Some iof ithe imain iprovisions ifound iin ithe iDodd-Frank iAct iinclude:

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· Every ibank iwith imore ithan i$50 ibillion iof iassets imust itake ian iannual i“stress itest,” igiven iby ithe iFederal iReserve, iwhich ican ihelp idetermine iif ithe iinstitution icould isurvive ia ifinancial icrisis.

· The iFinancial iStability iOversight iCouncil i(FSOC) iidentifies irisks ithat iaffect ithe ifinancial iindustry iand ikeeps ilarge ibanks iin icheck.

· The iOffice iof iCredit iRatings iensures ithat iagencies iprovide ireliable icredit iratings ito ithose ithey ievaluate.

· A iwhistle-blowing iprovision iin ithe ilaw iencourages ianyone iwith iinformation iabout iviolations ito ireport iit ito ithe igovernment ifor ia ifinancial ireward. i

Tt                                   the iDodd-Frank iAct, iofficially icalled ithe iDodd-Frank iWall iStreet iReform iand iConsumer iProtection iAct, iis ilegislation isigned iinto ilaw iby iPresident iBarack iObama iin i2010 iin iresponse ito ithe ifinancial icrisis ithat ibecame iknown ias ithe iGreat iRecession. iDodd-Frank iput iregulations ion ithe ifinancial iindustry iand icreated iprograms ito istop imortgage icompanies iand ilenders ifrom itaking iadvantage iof iconsumers.

The itrading ilosses iresulted ifrom ian iattempt ito iunwind ia iprevious ihedge iinvestment, ialthough ithe iprecise idetails iremain iunconfirmed. iThe ilosses ioccurred iin ipart ibecause ithe iCIO ichose ito iplace ia inew icounter-hedge iposition, irather ithan isimply iunwind ithe ioriginal iposition. iIn i2007 iand i2008, iJP iMorgan ihad ibought ian iindex itied ito icredit idefault iswaps ion ia ibroad iindex iof ihigh-grade icorporate ibonds. iIn igeneral, ithis iindex iwould itend ito iprotect iJP iMorgan iif igeneral ieconomic iconditions iworsened i(or isystemic irisk iincreased) ibecause ithe iperceived ihealth iof ihigh-grade ifirms iwould itend ito ideteriorate iwith ithe ieconomy. iIn i2011, ithe iCIO idecided ito ichange ithe ifirm’s iposition iby iimplementing ia inew icounter itrade. iBecause ithis inew itrade iwas inot iidentical ito ithe iearlier itrades, iit iintroduced ibasis irisk iand imarket irisk, iamong iother ipotential iproblems. iIt iis ithis isecond i“hedge ion ia ihedge” ithat iis iresponsible ifor ithe ilosses iin i2012.

iThe iOffice iof ithe iComptroller iof ithe iCurrency i(OCC) iis ithe iprimary iprudential iregulator iof ifederally ichartered idepository ibanks iand itheir iALM iactivities, iincluding ithe iCIO iof iJP iMorgan, ieven ithough iit iis ilocated iin iLondon. iThe iFederal iReserve iis ithe iprudential iregulator iof iJP iMorgan’s iholding icompany, ialthough iit iwould itend ito idefer ito ithe iprimary iprudential iregulators iof ithe ifirm’s isubsidiaries ifor isignificant iregulation iof ithose ientities. iThe iCIO imust icomply iwith iFederal iDeposit iInsurance iCorporation i(FDIC) iregulations ibecause iit iis ipart iof ithe iinsured idepository. iThe iSecurities iand iExchange iCommission i(SEC) ioversees iJP iMorgan’s irequired idisclosures ito ithe ifirm’s istockholders iregarding imaterial irisks iand ilosses isuch ias ithe itrades. The iheads iof ithese iagencies icoordinate ithrough ithe iFinancial iStability iOversight iCouncil i(FSOC), iwhich iis ichaired iby ithe iSecretary iof iTreasury.

The itrading ilosses imay ihave iimplications ifor ia inumber iof ifinancial iregulatory iissues. iFor iexample, ishould ithe iexemption ito ithe iVolcker iRule ifor ihedging ibe iinterpreted ibroadly ienough ito iencompass igeneral iportfolio ihedges ilike ithe iJP iMorgan itrades, ior ishould ihedging ibe ilimited ito imore ispecific irisks? iAre icurrent iregulations iof ilarge ifinancial ifirms ithe iappropriate ibalance ito iaddress iperceptions ithat isome ifirms iare itoo-big-to-fail?

iJP iMorgan ichanged iits ivalue iat irisk i(VaR) imodel iduring ithe itime iof ithe itrading ilosses. iSome iare iconcerned ithat iVaR imodels imay inot iadequately iaddress ipotential irisks.