JP Morgan Chase 2010 Annual Report Download - page 110

Management’s discussion and analysis
110 JPMorgan Chase & Co./2010 Annual Report
LIQUIDITY RISK MANAGEMENT
The ability to maintain surplus levels of liquidity through economic
cycles is crucial to financial services companies, particularly during
periods of adverse conditions. The Firm’s funding strategy is intended
to ensure liquidity and diversity of funding sources to meet actual and
contingent liabilities through both normal and stress periods.
JPMorgan Chase’s primary sources of liquidity include a diversified
deposit base, which was $930.4 billion at December 31, 2010, and
access to the equity capital markets and long-term unsecured and
secured funding sources, including asset securitizations and borrowings
from FHLBs. Additionally, JPMorgan Chase maintains large pools of
highly-liquid unencumbered assets. The Firm actively monitors the
availability of funding in the wholesale markets across various geo-
graphic regions and in various currencies. The Firm’s ability to generate
funding from a broad range of sources in a variety of geographic loca-
tions and in a range of tenors is intended to enhance financial flexibility
and limit funding concentration risk.
Management considers the Firm’s liquidity position to be strong, based
on its liquidity metrics as of December 31, 2010, and believes that the
Firm’s unsecured and secured funding capacity is sufficient to meet its
on– and off–balance sheet obligations. The Firm was able to access the
funding markets as needed during 2010 and throughout the recent
financial crisis.
Governance
The Firm’s governance process is designed to ensure that its liquidity
position remains strong. The Asset-Liability Committee reviews and
approves the Firm’s liquidity policy and contingency funding plan.
Corporate Treasury formulates and is responsible for executing the
Firm’s liquidity policy and contingency funding plan as well as meas-
uring, monitoring, reporting and managing the Firm’s liquidity risk
profile. JPMorgan Chase centralizes the management of global funding
and liquidity risk within Corporate Treasury to maximize liquidity access,
minimize funding costs and enhance global identification and coordina-
tion of liquidity risk. This centralized approach involves frequent com-
munication with the business segments, disciplined management of
liquidity at the parent holding company, comprehensive market-
based pricing of all assets and liabilities, continuous balance sheet
monitoring, frequent stress testing of liquidity sources, and frequent
reporting to and communication with senior management and the
Board of Directors regarding the Firm’s liquidity position.
Liquidity monitoring
The Firm employs a variety of metrics to monitor and manage
liquidity. One set of analyses used by the Firm relates to the timing
of liquidity sources versus liquidity uses (e.g., funding gap analysis
and parent holding company funding, which is discussed below). A
second set of analyses focuses on ratios of funding and liquid
collateral (e.g., measurements of the Firm’s reliance on short-term
unsecured funding as a percentage of total liabilities, as well as
analyses of the relationship of short-term unsecured funding to
highly-liquid assets, the deposits-to-loans ratio and other balance
sheet measures).
The Firm performs regular liquidity stress tests as part of its liquidity
monitoring. The purpose of the liquidity stress tests is intended to
ensure sufficient liquidity for the Firm under both idiosyncratic and
systemic market stress conditions. These scenarios evaluate the Firm’s
liquidity position across a full year horizon by analyzing the net fund-
ing gaps resulting from contractual and contingent cash and collateral
outflows versus by the Firm’s ability to generate additional liquidity by
pledging or selling excess collateral and issuing unsecured debt. The
scenarios are produced for the parent holding company and major
bank subsidiaries as well as the Firm’s major U.S. broker-dealer
subsidiaries.
The idiosyncratic stress scenario employed by the Firm is a JPMor-
gan Chase-specific event that evaluates the Firm’s net funding gap
after a short-term ratings downgrade from the current level of A-
1+/P-1 to A-2/P-2. The systemic market stress scenario evaluates
the Firm’s net funding gap during a period of severe market stress
similar to market conditions in 2008 and assumes the Firm is not
uniquely stressed versus its peers. The Firm’s liquidity position is
strong under the Firm-defined stress scenarios outlined above.
Parent holding company
Liquidity monitoring on the parent holding company takes into
consideration regulatory restrictions that limit the extent to which
bank subsidiaries may extend credit to the parent holding company
and other nonbank subsidiaries. Excess cash generated by parent
holding company issuance activity is placed with both bank and
nonbank subsidiaries in the form of deposits and advances to
satisfy a portion of subsidiary funding requirements. The remainder
of the excess cash is used to purchase liquid collateral through
reverse repurchase agreements. As discussed below, the Firm’s
liquidity management activities are also intended to ensure that its
subsidiaries have the ability to generate replacement funding in the
event the parent holding company requires repayment of the
aforementioned deposits and advances.