Banks Too Big to Manage

Richard Sharp, a member of the Bank of England's Financial Policy Committee (FPC), said the so-called London Whale losses at JPMorgan Chase & Co. illustrate the financial-stability risks posed by firms “too big to manage.”

JPMorgan's report on the losses is “very chilling” in revealing how information “can get distorted” as it passes through management layers, Sharp said in a parliamentary testimony today in London. Money laundering in places such as Mexico at HSBC Holdings Plc and rogue trading at UBS AG are among other examples, he said.

“Risks aren't understood where they need to be understood within the organization,” Sharp said. “That obviously begs a question how the regulator can be on top of that if even the organization itself can't be on top of that risk?”

Sharp discussed the banks as he explained to lawmakers his concerns on operational risks to financial stability. He was one of three newly appointed FPC officials appearing in pre-appointment hearings before they take up their role on the panel charged with using macroprudential tools to address broad threats to the financial system.

When asked about his concerns on governance at banks, he said non-executive members of banks' risk committees may lack the ability to assess large pools of financial instruments. The FPC's next meeting is on June 18 and the semi-annual Financial Stability Report will be published June 26.

“I worry that the auditors are ill-equipped,” Sharp said. “The JPMorgan experience indicates that even the executives were ill-equipped to see what was in a multi-trillion dollar portfolio.”

Leverage Ratio

Sharp, who used to work at Goldman Sachs Group Inc., said risks posed by these large financial institutions support the case for officials to be given a tool to adjust banks' leverage ratios, a measure of their debt-to-equity level.

“The simplicity of leverage is one of the most important tools” when firms are conducting “highly complex” transactions, Sharp said. “Simple leverage and capital protection needs to be in place to protect the nations within which they operate, the taxpayers of those nations, and the interests of the shareholders.”

The Basel Committee on Banking Supervision said in March that the biggest banks had an average leverage ratio of 3.8 percent versus a target of 3 percent ratio for banks' equity-to-debt. The measure is designed to be a backstop to capital requirements, helping to contain excessive indebtedness.

Sharp's remarks followed lawmakers' questioning of Clara Furse, former chief executive officer of the London Stock Exchange. Sharp said the FPC's toolkit should include leverage ratios, though he agreed with Furse that it's not “absolutely required now.”

Furse argued that leverage wasn't now an “urgent requirement” for the FPC. She drew fire from lawmaker Jesse Norman, who said her views meant he “will be thinking very seriously about whether I can possibly support this nomination.”

Martin Taylor, a member of the Independent Commission on Banking and a former adviser at Goldman, said during his testimony that the FPC's “frighteningly wide field of focus” gave it scope to make recommendations on leverage.

“We may be able to be influential on leverage without possessing the formal tool,” he said. “I do agree that the best thing is to have tools which one doesn't need to use because one has them.”

Taylor will “urge the Treasury to be sterner” about gross leverage in the financial system, he said, adding that he agreed with Sharp that a subdued banking industry may be more amenable to the imposition of constraints.

“The time to do this is when balance sheets are relatively restrained,” he said. “It's easier to put a cap on when the cap isn't too tight.”

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