Bank of England's Sharp on why JP Morgan London Whale shows banks must provide transparency

As reported by Bloomberg, the Bank of England's Richard Sharp observed that information on exposure details is so "distorted" as it is passed through different levels of management at a bank that it is virtually impossible for management or regulators to stay on top of the risks banks are taking.

Richard Sharp, a member of the Bank of England’s Financial Policy Committee, said the so-called London Whale losses at JPMorgan Chase & Co. (JPM) illustrate the financial-stability risks posed by firms “too big to manage.” 

JPMorgan’s report on the losses is “very chilling” in revealing how information “can get distorted” as it passes through management layers, Sharp said in a parliamentary testimony today in London. Money laundering in places such as Mexico at HSBC Holdings Plc and rogue trading at UBS AG are among other examples, he said. 

“Risks aren’t understood where they need to be understood within the organization,” Sharp said. “That obviously begs a question how even the regulator can be on top of that if even the organization itself can’t be on top of that risk?”...

“I worry that the auditors are ill-equipped,” Sharp said. “The JPMorgan experience indicates that even the executives were ill-equipped to see what was in a multi-trillion dollar portfolio.” 

This observation is why banks must be required to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.  

With this level of disclosure, the information on the risks that banks are taking is not distorted.  Instead, it it readily available for all market participants, including rival trading firms, banking competitors and regulators, to assess.

By harnessing the analytical power of the market and the experts within it, ultra transparency fosters a much better understanding of each bank's risk.

An understanding that results in the linkage of a bank's cost of funds to the amount of risk it is taking.  This linkage is important as it is the mechanism by which the market exerts discipline on each bank to restrain its risk taking.