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By Dave Clarke and Alexandra Alper
WASHINGTON (Reuters) - U.S. bank regulators will review whether JPMorgan Chase & Co
OCC chief Thomas Curry said his agency will evaluate the compensation of the Chief Investment Office responsible for the trading loss, and will assess JPMorgan's determination on clawbacks as part of that evaluation.
In written testimony prepared for a Senate Banking Committee hearing on Wednesday and obtained by Reuters, Curry also said JPMorgan's trading loss will affect its earnings but does not present a solvency issue and does not threaten the broader financial system.
JPMorgan announced the losses last month, rattling Wall Street and Washington and raising questions about whether banks are still taking too many risks following the 2007-2009 financial crisis.
Among the areas being examined is whether the bank provided the OCC with enough information about the trades and whether the JPMorgan board of director's risk committee is "appropriately informed and engaged," Curry said.
JPMorgan used a kind of derivative known as credit default swaps to make bets on whether companies would become more or less creditworthy.
The positions were originally designed to be disaster insurance against the corporate credit market tanking in response to global economic stress, but over time the trades morphed into a bet on credit markets improving.
Outside experts have estimated the loss could go as high as $5 billion. When JPMorgan disclosed the loss had reached $2 billion, CEO Jamie Dimon said it could grow to $3 billion "or more."
Dimon mentioned the possibility of clawing back pay from executives responsible for the trades at an annual shareholder meeting last month.
"We will do the right thing. That may well include claw-backs," he told reporters after the annual meeting.
Ina Drew, the former head of the Chief Investment Office, was one of the highest paid executives at the bank before she resigned after the losses were announced. Drew was paid more than $15 million in each of the last two years, according to company reports to shareholders.
REGULATORS ON HOT SEAT
Wednesday's hearing will provide lawmakers with their first chance to quiz the regulators responsible for monitoring JPMorgan, the largest U.S. bank by assets, since the losses were announced.
Regulators have come under scrutiny for not raising red flags earlier about the massive hedging strategy that went awry, despite having more than 100 examiners embedded at JPMorgan.
The OCC regulates JPMorgan's banking activities, while the Federal Reserve Bank of New York is the primary regulator of JPMorgan's holding company.
Curry is due to testify alongside Fed Governor Daniel Tarullo, Federal Deposit Insurance Corp acting Chairman Martin Gruenberg, Deputy Treasury Secretary Neal Wolin, and Consumer Financial Protection Bureau Director Richard Cordray.
Dimon is scheduled to appear before the committee next week.
In his prepared testimony, Curry said the value of the JPMorgan position "deteriorated rapidly" at the end of April and during the first days of May, after OCC examiners began to evaluate the trades and strategy at the bank.
In late 2011 and early 2012, JPMorgan revised its strategy to reduce the amount of protection it had against credit losses in a stressed global economy, Curry said.
But the instruments the bank chose to make the move were different from those that had been used originally and the change introduced new risks, he said. The new threats included higher liquidity risk, which means the bank might not be able to easily change the positions.
Curry said that since that time, the OCC has been meeting daily with JPMorgan managers to re-evaluate the bank's risk management and what actions JPMorgan should take to reduce the risk of the positions at issue.
Tarullo, in his prepared testimony, said the Fed is also paying close attention to the steps the bank is taking to "de-risk" the portfolio.
OCC examiners have not found activity at other large banks similar to the scale or complexity of JPMorgan's trading activity, Curry said.
Lawmakers are expected to press regulators on how the trading debacle will impact the final version of the so-called Volcker rule, which is expected to be released in the coming months.
The Volcker rule prohibits banks that enjoy government backstops like deposit insurance or access to Fed loans from trading with their own funds for profit.
The trading crackdown, which was included in the 2010 Dodd-Frank financial oversight law, does provide an exemption for trades made to hedge risk.
Supporters of the restrictions are pressuring regulators to tighten the exemption, arguing the JPMorgan losses are evidence that a draft rule released in October would provide too much leeway.
Curry said the OCC has not drawn any conclusions about whether the JPMorgan trades would have fallen under the Volcker rule.
(Reporting by Dave Clarke and Alexandra Alper in Washington and David Henry in New York; Editing by Gary Hill and Tim Dobbyn)