JP Morgan Chase 2015 Annual Report Download - page 148

Management’s discussion and analysis
138 JPMorgan Chase & Co./2015 Annual Report
Internal Capital Adequacy Assessment Process (“ICAAP”)
processes. In addition, the results are incorporated into the
quarterly assessment of the Firm’s Risk Appetite Framework
and are also presented to the DRPC.
Nonstatistical risk measures
Nonstatistical risk measures include sensitivities to
variables used to value positions, such as credit spread
sensitivities, interest rate basis point values and market
values. These measures provide granular information on the
Firm’s market risk exposure. They are aggregated by line of
business and by risk type, and are also used for monitoring
internal market risk limits.
Loss advisories and profit and loss drawdowns
Loss advisories and profit and loss drawdowns are tools
used to highlight trading losses above certain levels of risk
tolerance. Profit and loss drawdowns are defined as the
decline in net profit and loss since the year-to-date peak
revenue level.
Earnings-at-risk
The VaR and stress-test measures described above illustrate
the economic sensitivity of the Firm’s Consolidated balance
sheets to changes in market variables. The effect of interest
rate exposure on the Firm’s reported net income is also
important as interest rate risk represents one of the Firm’s
significant market risks. Interest rate risk arises not only
from trading activities but also from the Firm’s traditional
banking activities, which include extension of loans and
credit facilities, taking deposits and issuing debt. The Firm
evaluates its structural interest rate risk exposure through
earnings-at-risk, which measures the extent to which
changes in interest rates will affect the Firm’s net interest
income and interest rate-sensitive fees. Earnings-at-risk
excludes the impact of CIB’s markets-based activities and
MSRs, as these sensitivities are captured under VaR.
The CIO, Treasury and Corporate (“CTC”) Risk Committee
establishes the Firm’s structural interest rate risk policies
and market risk limits, which are subject to approval by the
DRPC. The CIO, working in partnership with the lines of
business, calculates the Firm’s structural interest rate risk
profile and reviews it with senior management including the
CTC Risk Committee and the Firm’s ALCO. In addition,
oversight of structural interest rate risk is managed through
a dedicated risk function reporting to the CTC CRO. This risk
function is responsible for providing independent oversight
and governance around assumptions and establishing and
monitoring limits for structural interest rate risk. The Firm
manages structural interest rate risk generally through its
investment securities portfolio and interest rate derivatives.
Structural interest rate risk can occur due to a variety of
factors, including:
• Differences in the timing among the maturity or
repricing of assets, liabilities and off-balance sheet
instruments
• Differences in the amounts of assets, liabilities and off-
balance sheet instruments that are repricing at the same
time
• Differences in the amounts by which short-term and
long-term market interest rates change (for example,
changes in the slope of the yield curve)
• The impact of changes in the maturity of various assets,
liabilities or off-balance sheet instruments as interest
rates change
The Firm manages interest rate exposure related to its
assets and liabilities on a consolidated, firmwide basis.
Business units transfer their interest rate risk to Treasury
and CIO through a transfer-pricing system, which takes into
account the elements of interest rate exposure that can be
risk-managed in financial markets. These elements include
asset and liability balances and contractual rates of interest,
contractual principal payment schedules, expected
prepayment experience, interest rate reset dates and
maturities, rate indices used for repricing, and any interest
rate ceilings or floors for adjustable rate products. All
transfer-pricing assumptions are dynamically reviewed.
The Firm generates a net interest income baseline, and then
conducts simulations of changes for interest rate-sensitive
assets and liabilities denominated in U.S. dollar and other
currencies (“non-U.S. dollar” currencies). Earnings-at-risk
scenarios estimate the potential change in this net interest
income baseline, excluding CIB’s markets-based activities
and MSRs, over the following 12 months, utilizing multiple
assumptions. These scenarios may consider the impact on
exposures as a result of changes in interest rates from
baseline rates, as well as pricing sensitivities of deposits,
optionality and changes in product mix. The scenarios
include forecasted balance sheet changes, as well as
modeled prepayment and reinvestment behavior, but do not
include assumptions about actions which could be taken by
the Firm in response to any such instantaneous rate
changes. For example, 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. The Firm’s earnings-at-risk scenarios
are periodically evaluated and enhanced in response to
changes in the composition of the Firm’s balance sheet,
changes in market conditions, improvements in the Firm’s
simulation and other factors.