JP Morgan Chase 2005 Annual Report Download - page 63

JPMorgan Chase & Co. /2005 Annual Report 61
Liquidity risk management
Liquidity risk arises from the general funding needs of the Firm’s activities and
in the management of its assets and liabilities. JPMorgan Chase’s liquidity
management framework is intended to maximize liquidity access and minimize
funding costs. Through active liquidity management, the Firm seeks to preserve
stable, reliable and cost-effective sources of funding.This enables the Firm to
replace maturing obligations when due and fund assets at appropriate matu-
rities and rates. To accomplish this task, management uses a variety of liquidity
risk measures that take into consideration market conditions, prevailing interest
rates, liquidity needs and the desired maturity profile of liabilities.
Governance
The Asset & Liability Committee (“ALCO”) reviews the Firm’s overall liquidity
policy and oversees the contingency funding plan. The ALCO also provides
oversight of the Firm’s exposure to SPEs, with particular focus on the potential
liquidity support requirements that the Firm may have to those SPEs.
Treasury is responsible for formulating the Firm’s liquidity strategy and targets,
understanding the Firm’s on- and off-balance sheet liquidity obligations,
providing policy guidance, overseeing policy adherence, and maintaining
contingency planning and stress testing. In addition, it identifies and measures
internal and external liquidity warning signals to permit early detection of
liquidity issues.
An extension of the Firm’s ongoing liquidity management is its contingency
funding plan. The goals of the plan are to ensure maintenance of appropriate
liquidity during normal and stress periods, measure and project funding
requirements during periods of stress, and manage access to funding sources.
The plan considers temporary and long-term stress scenarios where access
to unsecured funding is severely limited or nonexistent. The plan forecasts
potential funding needs, taking into account both on- and off-balance sheet
exposures, separately evaluating access to funds by the parent holding company
and JPMorgan Chase Bank.
The Firm’s liquidity risk framework also incorporates tools to monitor three
primary measures of liquidity:
• Holding company short-term position: Measures the parent holding
company’s ability to repay all obligations with a maturity of less than one
year at a time when the ability of the Firm’s subsidiaries to pay dividends to
the parent company is constrained. Holding company short-term position is
managed to a positive position over time.
• Cash capital surplus: Measures the Firm’s ability to fund assets on a fully
collateralized basis, assuming access to unsecured funding is lost. This
measurement is intended to ensure that the illiquid portion of the balance
sheet can be funded by equity, long-term debt, trust preferred securities
and deposits the Firm believes to be core.
• Basic surplus: Measures the Bank’s ability to sustain a 90-day stress event
that is specific to the Firm where no new funding can be raised to meet
obligations as they come due.
Each liquidity position is managed to provide sufficient surplus.
Risk monitoring and reporting
Treasury is responsible for measuring, monitoring, reporting and managing
the liquidity profile of the Firm through both normal and stress periods.
Treasury analyzes the diversity and maturity structure of the Firm’s sources of
funding; and assesses downgrade impact scenarios, contingent funding
needs, and overall collateral availability and pledging status. A downgrade
analysis considers the impact of both parent and bank level downgrades (one-
and two-notch) and calculates the loss of funding and increase in annual
funding costs for both scenarios. A trigger-risk funding analysis considers the
impact of a bank level downgrade through A-1/P-1 as well as the increased
contingent funding requirements that would be triggered. These liquidity
analytics rely on management’s judgment about JPMorgan Chase’s ability to
liquidate assets or use them as collateral for borrowings and take into account
credit risk management’s historical data on the funding of loan commitments
(e.g., commercial paper back-up facilities), liquidity commitments to SPEs,
commitments with rating triggers and collateral posting requirements. For a
further discussion of SPEs and other off–balance sheet arrangements, see
Off–balance sheet arrangements and contractual cash obligations on pages
58–59, as well as Note 1, Note 13, Note 14 and Note 27 on pages 91,
108–111, 111–113, and 124–125, respectively, of this Annual Report.
Funding
Sources of funds
Consistent with its liquidity management policy, the Firm has raised funds at
the parent holding company sufficient to cover its obligations and those of
its nonbank subsidiaries that mature over the next 12 months. Long-term
funding needs for the parent holding company over the next several quarters
are expected to be consistent with prior periods.
As of December 31, 2005, the Firm’s liquidity position remained strong based
upon its liquidity metrics. JPMorgan Chase’s long-dated funding, including
core deposits, exceeds illiquid assets, and the Firm believes its obligations
can be met even if access to funding is impaired.
The diversity of the Firm’s funding sources enhances financial flexibility and
limits dependence on any one source, thereby minimizing the cost of funds.
The deposits held by the RFS, CB and TSS lines of business are a stable and
consistent source of funding for JPMorgan Chase Bank. As of December 31,
2005, total deposits for the Firm were $555 billion, which represented
67% of the Firm’s funding liabilities. A significant portion of the Firm’s retail
deposits are “core” deposits, which are less sensitive to interest rate changes
and therefore are considered more stable than market-based deposits. Core
The Audit Committee is responsible for oversight of guidelines and policies
that govern the process by which risk assessment and management is under-
taken. In addition, the Audit Committee reviews with management the system
of internal controls and financial reporting that is relied upon to provide reason-
able assurance of compliance with the Firm’s operational risk management
processes. Both committees are responsible for oversight of reputation risk.
The Chief Risk Officer and other management report on the risks of the Firm
to the Board of Directors, particularly through the Board’s Risk Policy
Committee and Audit Committee. The major risk types identified by the Firm are
discussed in the following sections.