Banking risks need to be managed better, says JPMorgan chief Jamie Dimon in annual letter

'Hiding in plain sight', banking risks need to be better managed

The recent crises of the Silicon Valley Bank (SVB) in the US and Credit Suisse in Europe followed by pessimism in the banking sector bring out an important point – it is as important to monitor and manage the abundant risks in the banking system as it is to satisfy regulatory criteria.

Most of the risks that led the banks to their doom were very obvious – “interest rate exposure, the fair value of held-to-maturity (HTM) portfolios and the amount of SVB’s uninsured deposits were always known – both to regulators and the marketplace,” Dimon noted.

The rapid rise of interest rates paved the way for quick deterioration of the fair value of HTM portfolios, and in the case of SVB, the lack of stickiness of uninsured deposits. The bad news was banks were holding on to safe government securities with low capital requirements which were considered highly liquid by regulators. What was even more destructive was that the stress testing done by the banks to align with the scenario devised by the Fed failed to incorporate higher interest rates.

“Any crisis that damages Americans’ trust in their banks damages all banks – a fact that was known even before this crisis,” said Dimon, underscoring the severity of the situation. However, he categorically advised against making “knee-jerk, whack-a-mole or politically motivated responses that often result in achieving the opposite of what people intended.”

Artificial intelligence, the 'extraordinary and groundbreaking technology'

Acknowledging the immense contribution of artificial intelligence (AI) in JPMorgan’s business, Dimon said, “We already have more than 300 AI use cases in production today for risk, prospecting, marketing, customer experience and fraud prevention, and AI runs throughout our payments processing and money movement systems across the globe. AI has already added significant value to our company.”

Talking about the employment opportunities that the emerging and burgeoning AI market is creating, Dimon said the bank currently employs more than 1,000 data management personnel, over 900 data scientists and 600 machine learning engineers; all forming the core of the AI development team. “We also have a 200-person, top-notch AI research group looking at the hardest problems and new frontiers in finance,” he added.

Dimon called AI, an extraordinary and groundbreaking technology, which will be critical to JPMorgan’s future success.

Also read: Even a recession might not tame inflation

Skill-gap should be narrowed to reignite the American Dream

Despite a strong labor market, Dimon noticed that the higher volume of unskilled workers is keeping America from improving income equality. “The gap between skilled and unskilled workers has been growing dramatically—so much so that unskilled labor has become less and less a ‘living wage,’” he said.

Highlighting the importance of training in relevant skills, Dimon said, ”Of all the policy errors we need to remedy in America, there are two that I believe will have a dramatic effect on growth and equality – and go a long way toward repairing the frayed American dream. The first is providing graduating students and other individuals with work skills (in fields such as advanced manufacturing, cyber, data science and technology, healthcare and so on) that will lead to better-paying jobs.”

He also suggested an expansion of existing tax credit programs to support low-wage earners.

Exhausting consumer savings a concern, but silver lining exists

Stubborn and sticky inflation was the theme most of 2022, and while the Fed has managed to tame it to some extent, the gradually cooling prices have come at the cost of increased interest rates.

“There has been a lot of market volatility over the past year, partially, in my opinion, as people over-extrapolate monthly data, which is highly distorted by inflation, supply chain adjustments, consumer substitution, basically poor assumptions about housing costs and other factors,” wrote Dimon.

This has led to diminishing consumer savings this year, with them having to spend 23 percent more than pre-pandemic times. However, Dimon identified a silver lining, saying that the remarkable home and stock price appreciation witnessed in the past decade may keep the consumers in a better situation than the Great Financial Crisis of 2008.

Apple and Walmart: Likely competitors

Highlighting the intensifying competition among tech bigwigs, Dimon said, “The pace of change and the size of the competition are extraordinary, and activity is accelerating.”

He sees Walmart’s digital technology-backed banking services as a potential competitor to Apple Card and Apple Pay, which have already made a mark in the banking and payments space. Given their size, if these companies manage to dominate the space together, the role of banks in the financial system could be largely diminished.

“Large tech companies, already 100 percent digital, have hundreds of millions of customers, as well as enormous resources, in data and proprietary systems—all of which give them an extraordinary competitive advantage,” Dimon said.