By now, most of you have either read or heard about the securities trading losses suffered by JP Morgan Chase Bank a few weeks ago. The first thing you should know is that this loss did not or does not put the banking system at risk.
In fact, it doesn’t even put JP Morgan Chase Bank at risk. I am certainly not an apologist for JP Morgan Chase, but according to articles I read in banking trade publications, the activity that caused the losses was, ironically, a strategy called “hedging,” which is an attempt to limit losses in a loan portfolio.
All banks implement strategies to protect themselves from losses caused by changes in interest rates. Whether this strategy was used according to the rules put in place will be a matter for the banking regulators to determine.
That being said, from a Kansas “traditional community banking” perspective, I have two basic concerns surrounding this loss. My first concern is that this will result in even more stringent government intrusion for the banking industry.
The Dodd-Frank legislation passed almost two years ago included a provision called the “Volcker Rule.”
This provision put restrictions on the investment trading activities of a bank. While this was aimed at the big Wall Street banks, it has implications for traditional community banks as well. The Volcker Rule, as currently proposed, may affect “core” banking activities, including asset/liability management.
The proposed rule could also limit certain hedging activity related to mortgages or other lending activities.
Banks are required to protect themselves from interest rate risk, and they need adequate tools to do that. The Volcker Rule will already require banks to implement extensive compliance regimens to monitor liquidity management activities. We don’t need even more government red tape.
My second main concern about this is the focus it has put back on the existence of an unwritten and inconsistently followed policy by the U.S. government (by both political parties) called “too big to fail.”
Too big to fail comes into play when a large Wall Street mega bank is in danger of failing and the government steps in with a bailout because of the “systemic risk” to the overall economy. One of the central purposes of the Dodd-Frank Act was to end the “too big to fail” doctrine, which unfortunately was not accomplished by the enacted legislation.
The Kansas Bankers Association is advocating that new tools and programs provided under the Dodd-Frank Act be used to end “too big to fail” insofar as they can, leading to the orderly resolution of failing financial institutions. The existence of “too big to fail” policies is expensive to the economy and to the government. It unfairly benefits large institutions over smaller ones and encourages miscalculation of risks.
It distorts investment, causing investors to misprice risk, and mutes market discipline.
While the “too big to fail” doctrine is perceived to exist, systemic risks will build up.
There are currently 304 banks chartered in Kansas. All of them are traditional banks with a community banking business model. Their job is to take their customers’ deposits and then lend out those funds to other customers. That basic banking function is the basis for our economic activity, the “creation of money.”
There are those who would like to see the banking industry even more highly regulated. Recent research shows that, for the typical bank, more than one out of every four dollars of operating expense goes to pay the costs of government regulation.
That is money that is not available for loans and other activities in the community. Everyone should be hoping and advocating for an efficient, not overly regulated, banking system. An efficient banking system creates economic activity, which is desperately needed at this time.
Most of the changes and technological advances in banking over the past several years have benefited customers greatly by providing more convenience. Those advances have costs associated with them. When businesses are not fairly compensated for services they perform, those services stop being available. The consumer pays the ultimate cost in loss of that service.
Traditional banking needs to be strengthened and encouraged because, as in years past, we will be the engine that drives any economic recovery. Traditional bankers are just like every other small businessman and businesswoman trying to keep their communities strong.