How a Chemical Reaction Helped Mold Today's Chase: Retired Leader Walter Shipley Recalls How a Corporate Turn toward Risk Management Began with a Trip to Harvard, and Ponders Why Risk Discipline Failed for Many Recently

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In the challenging days of 2008, JPMorgan Chase & Co. has been on the federal government's short list of places to call when a situation needs rescuing. In March, Chase announced the Fed-assisted acquisition of Bear Stearns, and in September, working with FDIC, Chase announced the acquisition of much of what had been Washington Mutual. In October, the company agreed to accept a federal capital infusion, along with other top banks, to help get the industry recovery some momentum.

Today JPMorgan Chase is a respected $2 trillion-plus organization at the other end of a government hotline. But Walter V. Shipley, who retired as chairman of the company in 1999 when it was still The Chase Manhattan Corp., remembers a day in the early 1990s when he suddenly realized that something was lacking at the top of what he modestly calls "what was then a pretty good size money center bank, at $140 billion, though tiny by today's standards." At the time he was CEO of Chemical Bank, which later merged with Chase.

Board in need of risk tools

"I came to the realization that my board didn't really understand the kinds of risks that we were taking, even things as simple as short or long funding of the loan portfolio," says Shipley.

Chemical, which had recently joined with Manufacturers Hanover, had foreseen a period of rising rates. Management instituted a program of liability management to squeeze some extra profits before the hike hit the company's asset funding effort. "Short-funding" needs to be managed, and understood at the top, said Shipley. In addition, the bank had entered some unusual (for that day, for a bank) businesses, including foreign-exchange trading and fixed-income instrument trading. While "these are simple basic types of instruments relative to the very complex stuff that is being managed today," said Shipley, "back then they were exotic."

So Shipley said he took the chairman of the bank's Audit Committee, another director, and himself up to Harvard Business School, "for a three-day seminar on understanding risk in a large, complex, financial services company."

The selection of concepts and solutions offered was simple today, though profound at the time.

"My gosh," said Shipley with mock astonishment "we got into things like hedging."

Building a risk management framework

Shipley had let a powerful demon out of its bottle. By telling the board, effectively, that it didn't appreciate the risks the bank was taking, he was telling directors they needed to remedy said deficiency.

"So we created a risk management committee at the board level," Shipley recalled. He believes Chemical was the first major bank to do so.

The board's approach, and the bank's, continued to evolve. Shipley said the board had a meeting with the president of the New York Federal Reserve Bank after its annual examination. There had been some criticisms. But then the Fed Bank president added, "One thing this board should feel very good about is that this company has an excellent risk-management process, among the best of the major banks."

Shipley says current JPMorgan Chase leader Jamie Dimon is himself "an excellent risk manager."

However, he said, "I like to think that the company that is JPMorgan today inherited a pretty sophisticated risk management culture."

Risk management by saying "No"

Today, risk management is practiced--or, at least, paid lip service to--among all players. And the science has expanded beyond financial risk management to include other categories, including reputation risk. …