JP Morgan Chase 2012 Annual Report Download - page 159

JPMorgan Chase & Co./2012 Annual Report 169
exposure through the stress testing of earnings-at-risk,
which measures the extent to which changes in interest
rates will affect the Firm’s core net interest income (see
page 77 of this Annual Report for further discussion of core
net interest income) and interest rate-sensitive fees
(“nontrading interest rate-sensitive revenue”). Earnings-at-
risk excludes the impact of trading activities and MSRs, as
these sensitivities are captured under VaR.
The Firm conducts simulations of changes in nontrading
interest rate-sensitive revenue under a variety of interest
rate scenarios. Earnings-at-risk tests measure the potential
change in this revenue, and the corresponding impact to the
Firm’s pretax net interest income, over the following 12
months. These tests highlight exposures to various interest
rate-sensitive factors, such as the rates themselves (e.g.,
the prime lending rate), pricing strategies on deposits,
optionality and changes in product mix. The tests include
forecasted balance sheet changes, such as asset sales and
securitizations, as well as prepayment and reinvestment
behavior. Mortgage prepayment assumptions are based on
current interest rates compared with underlying contractual
rates, the time since origination, and other factors which
are updated periodically based on historical experience and
forward market expectations. The amount and pricing
assumptions of deposits that have no stated maturity are
based on historical performance, the competitive
environment, customer behavior, and product mix.
Immediate changes in interest rates present a limited view
of risk, and so a number of alternative scenarios are also
reviewed. These scenarios include the implied forward
curve, nonparallel rate shifts and severe interest rate
shocks on selected key rates. These scenarios are intended
to provide a comprehensive view of JPMorgan Chase’s
earnings-at-risk over a wide range of outcomes.
JPMorgan Chase’s 12-month pretax net interest income
sensitivity profiles.
Immediate change in rates
December 31,
(in millions) +200bp +100bp -100bp -200bp
2012 $ 3,886 $ 2,145 NM (a) NM (a)
2011 4,046 2,326 NM (a) NM (a)
(a) Downward 100- and 200-basis-point parallel shocks result in a federal
funds target rate of zero and negative three- and six-month treasury
rates. The earnings-at-risk results of such a low-probability scenario
are not meaningful.
The change in earnings-at-risk from December 31, 2011,
resulted from investment portfolio repositioning, partially
offset by higher expected deposit balances. The Firm’s risk
to rising rates was largely the result of widening deposit
margins, which are currently compressed due to very low
short-term interest rates, and ALM investment portfolio
positioning.
Additionally, another interest rate scenario used by the Firm
— involving a steeper yield curve with long-term rates rising
by 100 basis points and short-term rates staying at current
levels — results in a 12-month pretax net interest income
benefit of $778 million. The increase in net interest income
under this scenario is due to reinvestment of maturing
assets at the higher long-term rates, with funding costs
remaining unchanged.
Risk monitoring and control
Limits
Market risk is controlled primarily through a series of limits
set in the context of the market environment and business
strategy. In setting limits, the Firm takes into consideration
factors such as market volatility, product liquidity and
accommodation of client business and management
experience. The Firm maintains different levels of limits.
Corporate level limits include VaR and stress limits.
Similarly, line of business limits include VaR and stress
limits and may be supplemented by loss advisories,
nonstatistical measurements and profit and loss
drawdowns. Limits may also be allocated within the lines of
business, as well at the portfolio level.
Limits are established by Market Risk in agreement with the
lines of business. Limits are reviewed regularly by Market
Risk and updated as appropriate, with any changes
approved by lines of business management and Market
Risk. Senior management, including the Firm’s Chief
Executive Officer and Chief Risk Officer, are responsible for
reviewing and approving certain of these risk limits on an
ongoing basis. All limits that have not been reviewed within
specified time periods by Market Risk are escalated to
senior management. The lines of business are responsible
for adhering to established limits against which exposures
are monitored and reported.
Limit breaches are required to be reported in a timely
manner by Risk Management to limit approvers, Market
Risk and senior management. Market Risk consults with
Firm senior management and lines of business senior
management to determine the appropriate course of action
required to return to compliance, which may include a
reduction in risk in order to remedy the excess. Any Firm or
line of business-level limits that are in excess for three
business days or longer, or that are over limit by more than
30%, are escalated to senior management and the
Firmwide Risk Committee.