A strong capital position is essential to the Firm’s business strategy and competitive position. The Firm’s capital strategy focuses on long-term stability, which enables the Firm to build and invest in market-leading businesses, even in a highly stressed environment. Prior to making any decisions on future business activities, senior management considers the implications on the Firm’s capital. In addition to considering the Firm’s earnings outlook, senior
management evaluates all sources and uses of capital with a view to preserving the Firm’s capital strength. Maintaining a strong balance sheet to manage through economic volatility is considered a strategic imperative by the Firm’s Board of Directors, CEO and Operating Committee. The Firm’s balance sheet philosophy focuses on risk-adjusted returns, strong capital and reserves, and robust liquidity.
The Firm’s capital management objectives are to hold capital sufficient to:
• Cover all material risks underlying the Firm’s business activities;
• Maintain “well-capitalized” status under regulatory requirements;
• Maintain debt ratings that enable the Firm to optimize its funding mix and liquidity sources while minimizing costs;
• Retain flexibility to take advantage of future investment opportunities;
• Maintain sufficient capital in order to continue to build and invest in its businesses through the cycle and in stressed environments; and
• Distribute excess capital to shareholders while balancing other stated objectives.
These objectives are achieved through ongoing monitoring of the Firm’s capital position, regular stress testing, and a capital governance framework. Capital management is intended to be flexible in order to react to a range of potential events. JPMorgan Chase has firmwide and LOB processes for ongoing monitoring and active management of its capital position.
Capital strategy and governance
The Firm’s CEO and Operating Committee establish principles and guidelines for capital planning, capital issuance, usage and distributions; and, establish capital targets and minimums for the level and composition of capital in both business-as-usual and highly-stressed environments.
The Firm’s capital targets and minimums are calibrated to the U.S. Basel III requirements. The Firm’s target Tier 1 common ratio under the Basel III Advanced approach, on a fully phased-in basis, is 10%+. This long-term Tier 1 common ratio target level will enable the Firm to retain market access, continue the Firm’s strategy to invest in and grow its businesses; and, maintain flexibility to distribute excess capital. The Firm intends to manage its capital so that it achieves the required capital levels and composition
during the transition from Basel I to Basel III, in line with, or ahead of, the required timetable.
The Firm’s senior management recognizes the importance of a capital management function that supports strategic decision-making. The Firm has established the Capital Governance Committee and the Regulatory Capital
Management Office (“RCMO”) as key components in support of this objective. The Capital Governance Committee is responsible for reviewing the Firm’s Capital Management Policy and the principles underlying capital issuance and distribution alternatives. The Committee is also responsible for governing the capital adequacy assessment process, including overall design, assumptions and risk streams, and ensuring that capital stress test programs are designed to adequately capture the idiosyncratic risks across the Firm’s businesses. The RCMO is responsible for reviewing,
approving and monitoring the implementation of the Firm’s capital policies and strategies, as well as its capital
adequacy assessment process. The Board of Director’s Risk Policy Committee assesses the Firm’s capital adequacy process and its components. This review encompasses determining the effectiveness of the capital adequacy process, the appropriateness of the risk tolerance levels, and the strength of the control infrastructure. For additional discussion on the Board’s Risk Policy Committee, see Risk Management on pages 113–173 of this Annual Report.
Internal Capital Adequacy Assessment Process
Semiannually, the Firm completes the Internal Capital Adequacy Assessment Process (“ICAAP”), which provides management with a view of the impact of severe and unexpected events on earnings, balance sheet positions, reserves and capital. The Firm’s ICAAP integrates stress testing protocols with capital planning.
The process assesses the potential impact of alternative economic and business scenarios on the Firm’s earnings and capital. Economic scenarios, and the parameters underlying those scenarios, are defined centrally and applied uniformly across the businesses. These scenarios are articulated in terms of macroeconomic factors, which are key drivers of business results; global market shocks, which generate short-term but severe trading losses; and idiosyncratic operational risk events. The scenarios are intended to capture and stress key vulnerabilities and idiosyncratic risks facing the Firm. However, when defining a broad range of scenarios, realized events can always be worse. Accordingly, management considers additional stresses outside these scenarios, as necessary. ICAAP results are reviewed by management and the Board of Directors.
Comprehensive Capital Analysis and Review (“CCAR”) The Federal Reserve requires large bank holding
companies, including the Firm, to submit a capital plan on an annual basis. The Federal Reserve uses the CCAR and Dodd-Frank Act Wall Street Reform and Consumer
Protection Act (the “Dodd-Frank Act”) stress test processes
JPMorgan Chase & Co./2013 Annual Report 161
to ensure that large bank holding companies have sufficient capital during periods of economic and financial stress, and have robust, forward-looking capital assessment and planning processes in place that address each bank holding company’s unique risks to enable them to have the ability to absorb losses under certain stress scenarios. Through the CCAR, the Federal Reserve evaluates each bank holding company’s capital adequacy and internal capital adequacy assessment processes, as well as its plans to make capital distributions, such as dividend payments or stock
repurchases.
The Firm’s CCAR process is integrated into and employs the same methodologies utilized in the Firm’s ICAAP process.
On January 7, 2013, the Firm submitted its capital plan to the Federal Reserve under the Federal Reserve’s 2013 CCAR process. On March 14, 2013, the Federal Reserve informed the Firm that it did not object to the Firm’s 2013 capital plan, but asked the Firm to submit an additional capital plan.
On September 18, 2013, the Firm submitted the additional capital plan which addressed the weaknesses the Federal Reserve had identified in the Firm’s original 2013 submission. On December 2, 2013, the Federal Reserve informed the Firm it did not object to the Firm’s 2013 capital plan, as resubmitted.
On January 6, 2014, the Firm submitted its 2014 capital plan to the Federal Reserve under the Federal Reserve’s 2014 CCAR process. The Firm expects to receive the Federal Reserve’s final response to its plan no later than March 14, 2014.
For additional information on the Firm’s capital actions, see Capital actions on pages 166–167, and Notes 22 and 23 on pages 309 and 310, respectively, of this Annual Report.
Capital Disciplines
The Firm uses three primary capital disciplines:
• Regulatory capital
• Economic capital
• Line of business equity
Regulatory capital
The Federal Reserve establishes capital requirements, including well-capitalized standards, for the consolidated financial holding company. The Office of the Comptroller of the Currency (“OCC”) establishes similar capital
requirements and standards for the Firm’s national banks, including JPMorgan Chase Bank, N.A. and
Chase Bank USA, N.A.
In connection with the U.S. Government’s Supervisory Capital Assessment Program in 2009 (“SCAP”), U.S.
banking regulators developed an additional measure of capital, Tier 1 common, which is defined as Tier 1 capital less elements of Tier 1 capital not in the form of common equity, such as perpetual preferred stock, noncontrolling interests in subsidiaries and trust preferred securities. In 2013, the Federal Reserve employed a minimum 5% Tier 1 common ratio standard for CCAR purposes, in addition to other minimum capital requirements, to assess a bank holding company’s capital adequacy. For the 2014 CCAR process, the Federal Reserve has introduced a requirement to include, in addition to the Basel I Tier 1 common
standards, a Basel III Tier 1 common test with a minimum of 4% for 2014 projections and 4.5% for 2015 projections.
Basel I and Basel 2.5
The minimum U.S. risk-based capital requirements in effect on December 31, 2013, follow the Capital Accord (“Basel I”) of the Basel Committee. In June 2012, U.S. federal banking agencies published the final rule that specifies revised market risk regulatory capital requirements (“Basel 2.5”). While the Firm is still subject to the capital
requirements of Basel I, Basel 2.5 rules also became effective for the Firm on January 1, 2013. The Basel 2.5 final rule revised the scope of positions subject to the market risk capital requirements and introduced new market risk measures, which resulted in additional capital requirements for covered positions as defined. The implementation of Basel 2.5 in the first quarter of 2013 resulted in an increase of approximately $150 billion in RWA compared with the Basel I rules at March 31, 2013.
The implementation of these rules also resulted in
decreases of the Firm’s Tier 1 capital, Total capital and Tier 1 common capital ratios by 140 basis points, 160 basis points and 120 basis points, respectively, at March 31, 2013.
Management’s discussion and analysis
162 JPMorgan Chase & Co./2013 Annual Report
A reconciliation of total stockholders’ equity to Tier 1 common, Tier 1 capital and Total qualifying capital is presented in the table below.
Risk-based capital components and assets
December 31, (in millions) 2013 2012
Total stockholders’ equity $ 211,178 $ 204,069
Less: Preferred stock 11,158 9,058
Common stockholders’ equity 200,020 195,011 Effect of certain items in accumulated
other comprehensive income/(loss)
excluded from Tier 1 common (1,337) (4,198)
Less: Goodwill(a) 45,320 45,663
Other intangible assets(a) 2,012 2,311
Fair value DVA on structured notes and derivative liabilities related to
the Firm’s credit quality 1,300 1,577
Investments in certain subsidiaries
and other 1,164 920
Tier 1 common 148,887 140,342
Preferred stock 11,158 9,058
Qualifying hybrid securities and
noncontrolling interests(b) 5,618 10,608
Other — (6)
Total Tier 1 capital 165,663 160,002
Long-term debt and other instruments
qualifying as Tier 2 16,695 18,061
Qualifying allowance for credit losses 16,969 15,995
Other (41) (22)
Total Tier 2 capital 33,623 34,034
Total qualifying capital $ 199,286 $ 194,036
Credit risk RWA $ 1,223,147 $ 1,156,102
Market risk RWA 164,716 114,276
Total RWA $ 1,387,863 $ 1,270,378
Total adjusted average assets $ 2,343,713 $ 2,243,242 (a) Goodwill and other intangible assets are net of any associated
deferred tax liabilities.
(b) Primarily includes trust preferred securities of certain business trusts. Under the Basel III interim final rule published by U.S. federal banking agencies in October 2013, trust preferred securities will be phased out from inclusion as Tier 1 capital, but included as Tier 2 capital, beginning in 2014 through the end of 2015 and phased out from inclusion as Tier 2 capital beginning in 2016 through the end of 2021.
Capital rollforward
The following table presents the changes in Basel I Tier 1 common, Tier 1 capital and Tier 2 capital for the year ended December 31, 2013.
Year ended December 31, (in millions) 2013
Tier 1 common at December 31, 2012 $ 140,342 Net income applicable to common equity 17,118
Dividends declared on common stock (5,585)
Net issuance of treasury stock (2,845)
Changes in capital surplus (776)
Effect of certain items in accumulated other comprehensive
income/(loss) excluded from Tier 1 common (40) Qualifying noncontrolling minority interests in consolidated
subsidiaries (47)
DVA on structured notes and derivative liabilities 277 Goodwill and other nonqualifying intangibles (net of
deferred tax liabilities) 642
Other (199)
Increase in Tier 1 common 8,545
Tier 1 common at December 31, 2013 $ 148,887 Tier 1 capital at December 31, 2012 $ 160,002
Change in Tier 1 common 8,545
Net issuance of noncumulative perpetual preferred stock 2,100 Redemption of qualifying trust preferred securities (4,942)
Other (42)
Increase in Tier 1 capital 5,661
Tier 1 capital at December 31, 2013 $ 165,663 Tier 2 capital at December 31, 2012 $ 34,034 Change in long-term debt and other instruments qualifying
as Tier 2 (1,366)
Change in allowance for credit losses 974
Other (19)
Decrease in Tier 2 capital (411)
Tier 2 capital at December 31, 2013 $ 33,623 Total capital at December 31, 2013 $ 199,286
JPMorgan Chase & Co./2013 Annual Report 163
RWA Rollforward
The following table presents the changes in the credit risk and market risk components of RWA under Basel I including Basel 2.5 for the year ended December 31, 2013. The rollforward categories are estimates, based on the predominant driver of the change.
Year ended December 31, 2013 (in billions)
Credit risk RWA
Market
risk RWA Total RWA RWA at December 31, 2012 $ 1,156 $ 114 $ 1,270
Rule changes(a) 39 134
Model & data changes(b) 24 1
Portfolio runoff(c) (11) (45)
Movement in portfolio levels(d) 15 (39)
Increase in RWA 67 51 118
RWA at December 31, 2013 $ 1,223 $ 165 $ 1,388 (a) Rule changes refer to movements in RWA as a result of changes in
regulations, in particular, Basel 2.5, which resulted in certain positions previously captured under market risk under Basel I being included as noncovered positions under credit risk RWA.
(b) Model & data changes refer to movements in RWA as a result of revised methodologies and/or treatment per regulatory guidance (exclusive of rule changes).
(c) Portfolio runoff for credit risk RWA reflects lower loan balances in Mortgage Banking and for market risk RWA reflects reduced risk from position rolloffs, including changes in the synthetic credit portfolio.
(d) Movement in portfolio levels for credit risk RWA refers to changes in book size, composition, quality, as well as market movements; and for market risk RWA, refers to changes in position and market movements.
The following table presents the risk-based capital ratios for JPMorgan Chase at December 31, 2013 and 2012, under Basel I (and, for December 31, 2013, inclusive of Basel 2.5)
Risk-based capital ratios
December 31, 2013 2012
Capital ratios
Tier 1 capital 11.9% 12.6%
Total capital 14.4 15.3
Tier 1 leverage 7.1 7.1
Tier 1 common(a) 10.7 11.0
(a) The Tier 1 common ratio is Tier 1 common capital divided by RWA.
At December 31, 2013 and 2012, JPMorgan Chase maintained Basel I Tier 1 and Total capital ratios in excess of the well-capitalized standards established by the Federal Reserve. In addition, at December 31, 2013 and 2012, the Firm’s Basel I Tier 1 common ratio was significantly above the 2013 5% CCAR standard.
Additional information regarding the Firm’s capital ratios and the federal regulatory capital standards to which the Firm is subject is presented in Note 28 on pages 316–318 of this Annual Report and the Supervision and Regulation section of the 2013 10-K. For further information on the Firm’s Basel 2.5 measures and additional market risk disclosures, see the Firm’s consolidated Basel 2.5 Market Risk Pillar 3 Reports which are available on the Firm’s website (http://investor.shareholder.com/jpmorganchase/
basel.cfm) within 60 days after December 31, 2013.
Basel II & Basel III
U.S. banking regulators published a final Basel II rule in December 2007, which was intended to be more risk sensitive than Basel I and eventually replace Basel I for large and internationally active U.S. banks, including the Firm. The Firm has been reporting Basel II capital ratios in parallel to the banking agencies since 2008. In October 2013, U.S. federal banking agencies published an interim final rule implementing further revisions to the Capital Accord in the U.S.; such further revisions are commonly referred to as “Basel III.” Basel III is comprised of a Standardized Approach and an Advanced Approach. For large and internationally active banks, including the Firm, both the Basel III Standardized and Advanced Approaches became effective commencing January 1, 2014.
For 2014, the Basel III Standardized Approach requires the Firm to calculate its capital ratios using the Basel III definition of capital divided by the Basel I definition of RWA, inclusive of Basel 2.5 for market risk. Commencing January 1, 2015 the Basel III Standardized Approach requires the Firm to calculate the ratios using the Basel III definition of capital divided by the Basel III Standardized RWA, inclusive of Basel 2.5 for market risk.
Prior to full implementation of the Basel III Advanced Approach, the Firm is required to complete a qualification period (“parallel run”) of at least four consecutive quarters (inclusive of quarters in which the Firm reported in parallel under Basel II) during which it needs to demonstrate that it meets the requirements of the rule to the satisfaction of its U.S. banking regulators. Pursuant to the requirements of the Dodd-Frank Act, the Firm, upon exiting the Basel III Advanced Approach parallel run, will be required to calculate regulatory capital ratios under both the
Standardized and Advanced Approaches. The Firm’s capital adequacy will be evaluated against the approach that results in the lower ratio.
Basel III revises Basel I and II by, among other things, narrowing the definition of capital, and increasing capital requirements for specific exposures. Basel III introduces a new Tier 1 common ratio requirement which has a phase-in period from 2015 to 2019. By January 1, 2019, the minimum Tier 1 common ratio requirement is 7%,
comprised of a minimum ratio of 4.5% plus a 2.5% capital conservation buffer.
Global systemically important banks (“GSIBs”) will also be required to maintain Tier 1 common requirements above the 7% minimum, in amounts ranging from an additional 1% to an additional 2.5%. In November 2013, the Financial Stability Board (“FSB”) indicated that it would require the Firm, as well as one other bank, to hold the additional 2.5% of Tier 1 common; the requirement will be phased in beginning in 2016. The Basel Committee also stated that certain GSIBs could be required to hold as much as an additional 3.5% of Tier 1 common above the 7%
minimum if they were to take actions that further increase their systemic importance. Currently, no GSIB (including the
Management’s discussion and analysis
164 JPMorgan Chase & Co./2013 Annual Report
Firm) is required to hold more than the additional 2.5% of Tier 1 common.
In addition, Basel III establishes a 6.5% Tier I common equity standard for the definition of “well capitalized”
under the Prompt Corrective Action (“PCA”) requirements of the FDIC Improvement Act (“FDICIA”). The Tier I common equity standard is effective from the first quarter of 2015.
The following chart presents the Basel III minimum risk-based capital ratios during the transitional periods and on a fully phased-in basis. The chart also includes management’s target for the Firm’s Tier 1 common ratio. It is the Firm’s current expectation that its Basel III Tier 1 common ratio will exceed the regulatory minimums, both during the transition period and upon full implementation in 2019 and thereafter.
The Firm estimates that its Tier 1 common ratio under the Basel III Advanced Approach on a fully phased-in basis would be 9.5% as of December 31, 2013, achieving management’s previously stated objectives. The Tier 1 common ratio as calculated under the Basel III Standardized Approach is estimated at 9.4% as of December 31, 2013.
The Tier 1 common ratio under both Basel I and Basel III are non-GAAP financial measures. However, such measures are used by bank regulators, investors and analysts to assess the Firm’s capital position and to compare the Firm’s capital to that of other financial services companies.
The following table presents a comparison of the Firm’s Tier 1 common under Basel I rules to its estimated Tier 1 common under the Advanced Approach of the Basel III rules, along with the Firm’s estimated risk-weighted assets.
Key differences in the calculation of RWA between Basel I and Basel III Advanced Approach include: (1) Basel III credit risk RWA is based on risk-sensitive approaches which largely rely on the use of internal credit models and parameters, whereas Basel I RWA is based on fixed supervisory risk-weightings which vary only by counterparty type and asset class; and (2) Basel III includes RWA for operational risk, whereas Basel I does not. Operational risk capital takes into consideration operational losses in the quarter following the period in which those losses were realized, and the calculation generally incorporates such losses irrespective of whether the issues or business activity giving rise to the losses have been remediated or reduced. The Firm’s
operational risk capital model continues to be refined in conjunction with the Firm’s Basel III Advanced Approach parallel run. As a result of model enhancements in 2013, as well as taking into consideration the legal expenses incurred by the Firm in 2013, the Firm’s operational risk capital increased substantially in 2013 over 2012.
Tier 1 common under Basel III includes additional adjustments and deductions not included in Basel I Tier 1 common, such as the inclusion of accumulated other comprehensive income (“AOCI”) related to AFS securities and defined benefit pension and other postretirement employee benefit (“OPEB”) plans.
December 31, 2013 (in millions, except ratios)
Tier 1 common under Basel I rules $ 148,887 Adjustments related to AOCI for AFS securities and
defined benefit pension and OPEB plans 1,474
Add back of Basel I deductions(a) 1,780
Deduction for deferred tax asset related to net
operating loss and foreign tax credit carryforwards (741)
All other adjustments (198)
Estimated Tier 1 common under Basel III rules $ 151,202 Estimated risk-weighted assets under Basel III
Advanced Approach(b) $ 1,590,873
Estimated Tier 1 common ratio under Basel III
Advanced Approach(c) 9.5%
(a) Certain exposures, which are deducted from capital under Basel I, are risked-weighted under Basel III.
JPMorgan Chase & Co./2013 Annual Report 165 (b) RWA under Basel III Advanced Approach is on a fully phased-in basis.
Effective January 1, 2013, market risk RWA requirements under Basel 2.5 became largely consistent across Basel I and Basel III.
(c) The Tier 1 common ratio under Basel III rules is Tier 1 common divided by RWA under Basel III Advanced Approach.
Additionally, the Firm estimates that its Tier 1 capital ratio under the Basel III Advanced Approach on a fully phased-in basis would be 10.2% as of December 31, 2013. The Tier 1 capital ratio as calculated under the Basel III Standardized Approach on a fully phased-in basis is estimated at 10.1%
as of December 31, 2013.
Management’s current objective is for the Firm to reach an estimated Basel III Tier I common ratio of 10%+ and a Basel III Tier 1 capital ratio of 11.0%, both by the end of 2014.
Tier 1 common capital and the Tier 1 common and Tier 1 capital ratios under Basel III are all non-GAAP financial measures. However, such measures are used by bank regulators, investors and analysts to assess the Firm’s capital position and to compare the Firm’s capital to that of other financial services companies.
The Basel III interim final rule also includes a requirement for advanced approach banking organizations, including the Firm, to calculate a supplementary leverage ratio (“SLR”).
The SLR, a non-GAAP financial measure, is defined as Tier 1 capital under Basel III divided by the Firm’s total leverage exposure. Total leverage exposure is calculated by taking the Firm’s total average on-balance sheet assets, less amounts permitted to be deducted for Tier 1 capital, and adding certain off-balance sheet exposures, such as undrawn commitments and derivatives future exposure.
Following approval of the Basel III interim final rule, the U.S.
banking agencies issued proposed rulemaking relating to the SLR that would require U.S. bank holding companies, including JPMorgan Chase, to have a minimum SLR of at least 5% and insured depository institutions (“IDI”), including JPMorgan Chase Bank, N.A. and
Chase Bank USA, N.A., to have a minimum SLR of at least 6%. The Firm and its IDI subsidiaries are not required to meet the minimum SLR until January 1, 2018. The Firm estimates, based on its current understanding of the U.S.
rules, that if the rules were in effect at December 31, 2013, the Firm’s SLR would have been approximately 4.7% and JPMorgan Chase Bank, N.A.’s SLR would have been approximately 4.7%. Management’s current objective is to achieve an SLR of 5.5% for the Firm and an SLR of 6% for JPMorgan Chase Bank, N.A, each in advance of the SLR effective date.
On January 12, 2014, the Basel Committee issued a revised framework for the calculation of the denominator of the SLR. The estimated impact of these revisions would have been to reduce each of the Firm’s SLR and J.P. Morgan Chase Bank, N.A.’s SLR by 10 basis points as of December 31, 2013.
The Firm’s estimates of its Tier 1 common ratio under Basel III and of the Firm’s and JPMorgan Chase Bank, N.A.’s SLR reflect its current understanding of the U.S. Basel III rules
based on the current published rules and on the application of such rules to its businesses as currently conducted. The actual impact on the Firm’s capital and SLR ratios at the effective date of the rules may differ from the Firm’s current estimates depending on changes the Firm may make to its businesses in the future, further implementation guidance from the regulators, and regulatory approval of certain of the Firm’s internal risk models (or, alternatively, regulatory disapproval of the Firm’s internal risk models that have previously been conditionally approved).
Economic risk capital
Economic risk capital is another of the disciplines the Firm uses to assess the capital required to support its
businesses. Economic risk capital is a measure of the capital needed to cover JPMorgan Chase’s business activities in the event of unexpected losses. The Firm measures economic risk capital using internal risk-assessment methodologies and models based primarily on four risk factors: credit, market, operational and private equity risk and considers factors, assumptions and inputs that differ from those required to be used for regulatory capital requirements.
Accordingly economic risk capital provides a
complementary measure to regulatory capital. As economic risk capital is a separate component of the capital
framework for Advanced Approach banking organizations under Basel III, the Firm is currently in the process of enhancing its economic risk capital framework to address the Basel III interim final rule.
Line of business equity
The Firm’s framework for allocating capital to its business segments is based on the following objectives:
• Integrate firmwide and line of business capital management activities;
• Measure performance consistently across all lines of business; and
• Provide comparability with peer firms for each of the lines of business
Equity for a line of business represents the amount the Firm believes the business would require if it were operating independently, considering capital levels for similarly rated peers, regulatory capital requirements (as estimated under Basel III) and economic risk measures. Capital is also allocated to each line of business for, among other things, goodwill and other intangibles associated with acquisitions effected by the line of business. ROE is measured and internal targets for expected returns are established as key measures of a business segment’s performance.