JP Morgan CEO (JPM) Jamie Dimon is causing yet another ruckus this week after questioning the vaunted Tier 1 ratios reported by his competitors Goldman Sachs (GS), Merrill Lynch (MER), Morgan Stanley (MS), and Lehman (LEH).
Dimon’s criticism is that while commercial banks calculate their ratios under Basel I guidelines and under the watch of the Federal Reserve, I-banks calculate their ratios under the more subjective Basel II and under the watch of the SEC. The disparity makes for an apples-to-oranges comparison says Dimon. Dimon also criticises how bankers can massage assumptions about the riskiness of asset classes to produce whatever result they want.
With the Tier 1 ratio, the potential for problems lies in judgments underpinning the measure. It looks simple: the ratio compares one variation of shareholders’ equity to a risk-adjusted measure of assets. The higher the Tier 1 ratio, the safer the bank. But deciding on the proper risk weighting for assets leaves the process open to subjective judgments…
it is easy to understand Mr. Dimon’s displeasure. J.P. Morgan, seen as one of the strongest banks, posted a Tier 1 ratio for the second quarter of 9.1%. Lehman, whose stock has been pummelled as some investors question its ability to survive, would have a Tier 1 ratio of about 13% following a recent capital increase, and posted a 10.7% ratio for its fiscal second quarter that ended in May…
The Basel II framework will make bank and broker finances even more of a black box. That is because Basel II relies on management judgment, models and ratings to determine the risk-weighting for various assets.
Indeed, Sheila Bair, head of the Federal Deposit Insurance Corp., said last year that Basel II risked “letting banks set their own capital requirements.”
Mark-to-market accounting has problems, but explicitly allowing subjectivity into the valuation process invites abuse. Banks won’t cop to losse until they absolutely have to, especially when doing so threatens their capital ratios, potentially forcing them to raise more capital.
Chart and photo: WSJ