An External Assessment of JP Morgan

Executive Summary

JPMorgan Chase & Co, is a global investment and commercial bank with assets of $1.5 trillion, operations in more than 50 countries and a history of more than 200 years. The firm is a leader in investment banking, financial services for consumers, small business and commercial banking, financial transaction processing, asset management, and private equity. JPMorgan Chase & Co. is currently led by CEO Jamie Dimon and is currently the third largest banking institution in the United States. Over the years, the bank had gone through a lot of turbulent times and yet has managed to be outstanding among its competitors. However, even companies as large and well established like JPMorgan would suffer the consequences should they ignore the trends and patterns happening in the external environment that is beyond their control. Examining the some of the factors and forces of the external environment would give us a clear view of how the recent changes in trends and events are going to affect not only JPMorgan but the financial industry as a whole.

Factors Affecting the Financial Industry

According to David Fred (2007), the purpose of an external audit is to develop a finite list of the opportunities that could benefit a firm and threats that should be avoided. External factors in the general environment can be divided into five main categories that include (1) the political, governmental, and legal factors, (2) the economic factors, (3) the social, culture, demographic and environmental factors, (4) the technological factors and (5) the competitive events and trends. Though it is common to divide the external factors into five different categories, these forces are interrelated and overlapping with one another.

The first segment, involving the political, governmental and legal factors is in today’s world becoming increasingly volatile as the world faces globalization and the rapid increase in energy and food prices. Due to globalization, the major financial providers face intense competition as governments deregulate and re-regulate of the financial industry. For example, the breakdown of the Glass-Steagall Act (1933) and its replacement, the Gramm-Leach-Bliley Act (1999) according to Glenn Hubbard R. (2005), has made it possible for the merger and acquisition of investment and commercial banks in the United States.

Whether re-regulation or deregulation is an opportunity or threat is highly dependent on the effects of the changed legal framework in which the financial institution is subjected to. In the case of JPMorgan Chase, the gradual opening up of the Malaysian financial sector like how foreign banks can open more branches locally should be viewed as an opportunity to expand JPMorgan’s presence in Malaysia. On the other hand, the recent increase in the reserve requirement of bank’s operating in China is a threat, as it would reduce a bank’s profitability.

Another aspect in this area is also the imminent danger of political uncertainty due to spiking energy and food prices that have increase not only the cost of living but also the operating cost of most business firms. The results were massive riots, strikes and an uprising of popularity of opposition parties like those seen in Korea, Taiwan, and Malaysia. Political instability should be viewed, as a potential threat to financial institutions as a country’s property, equity, and currency value is highly sensitive to changes in the political environment.

The second segment, the economic factors, refers to the nature and direction of the economy in which a firm competes or may compete (Hitt, Ireland & Hokisson, 2005). According to the IMF’s World Economic Outlook April 2008, global growth will experience a slowdown (3.7%) in 2008 because of troubles in the United States like the subprime and financial crisis while emerging economies though likely to fare better would also experience adverse effects (Refer Table 3).. Global inflation on the other hand, would be a major concern as commodity prices like crude oil, tin, nickel, soybeans, corn, and wheat have reached records high in current U.S. dollar terms.

In the Malaysian context, we find that the Malaysian economy is also predicted to slow in 2008 with a Gross Domestic Product (GDP) of 5.5% (6.3% in 2007). Malaysia’s Inflation is poised to increase from previous estimates of 2.5% to 2.9% according to Citigroup Investment Research (Refer Table 4) and unemployment remains low at 3.2% (Refer Figure 9) in 2007 (Racheal Kam. et. al., 2008). On the negative side, Malaysia has highest budget deficit (Refer Table 2).as percentage of GDP within ASEAN (Fintan Ng & Suraj R., 2008) and foreign direct investments (FDIs) into Malaysia have not met pre-Asian crisis levels (Refer Table 1).

The anticipated global economic slowdown is a threat to financial institutions as it means that there will be lesser investment projects in need of finance worldwide that would result in JPMorgan being forced to compete viciously against competitors in a smaller market. Fluctuations in price levels especially in property and commodity sectors also present itself as a threat as the bank faces increased uncertainty on the value of collateral taken as insurance against defaults. However, a good deal of opportunity lies in emerging Asian countries especially in China and India that are still forecasted to maintain high economic growth according to Elaine Ang& Leong H. Y., 2008.

The third segment, the social, culture, demographic and environmental factors is concerned with the world or local population’s characteristics and the natural environment they are subjected to. In terms of population size, the world’s population is expected to increase to slightly less than 6.5 billion compared to 6.1 billion in 2000 (Hitt, Ireland & Hokisson, 2005). In terms of numbers, China and India alone would make up a third of the world’s population thereby making them the largest markets for financial services (Refer Figure 8). The largest number of illiterate population also comes from South and East Asia (Refer Figure 5).

Even though world population is projected to increase to 9.2 billion in 2050, Peter F. Drucker (2002) also noted that the next society would face a rapid growth in the older population and the rapid shrinking of the younger generation especially in developed countries like the Germany, and Japan (Refer Table 5 and Table 6). An aging population in certain countries would foster large-scale immigrations as these countries strive to maintain the quantity of their workforce. Immigration in turn would make the working environment of firms more diverse as people with different cultures and backgrounds are brought together.

The last segment, the technological factors, refers to inventions or innovations from applied science or engineering research. The accuracy of the Moore’s Law, whereby the increase in computing power comes along with a decrease in cost every year, has enabled the financial industry to serve more customers and provide a wider range of services with the same number of employees. The widespread usage of ATMs, credit cards and online banking is a good example of how the application of technology has increased the capacity and capability in the financial industry.

Yet even as technology has brought many benefits, technology can also be seen as a threat as it has brought the emergence of unprecedented events like the hacking of Citibank’s computer in 1995 and also the development of complex financial derivatives (Mishkin & Strahan, 1999) that were the core of the recent subprime mortgage crisis. Furthermore, the advancement in information technology made the financial industry more competitive as traditional barriers to entry like a branch network becomes less significant.

Among the competitive trends and events occurring in the financial industry is convergence and consolidation. As the financial landscape deregulate, financial institutions are able to proliferate services in an attempt to achieve a one-stop financial center and take full advantage of economies of scale and scope. As an example, Citibank operates security/broker firms, while security firms like Merrill Lynch operate banks. Financial institutions are also consolidating into fewer, but having a larger global presence. Banking behemoths like Citibank and Deutsche Bank operate around the globe and offer a wide range of services.

To further understand the implications that the general environment has on the industry, we use the Porters Five-Forces Model of competitive analysis. According to Michael E. Porter (2008), industry structure drives competition and profitability. The advancement in information technology has dramatically increased the bargaining power of both suppliers (depositors) and customers by increasing their price sensitivity. Depositors for example, can quickly use the internet to determine the highest interest rates in the market and deposit their money there.

Besides that, financial institutions also face more threats of new entrants as non-bank firms invade the territory previously exclusive to financial institutions. Companies like General Electric, General Motors and Wal-Mart have established their own financial arm to take advantage of their existing customer base (Rose & Hudgins, 2008). Non-bank companies like Wal-Mart could potentially put heavy pressure on prices, costs and profitability as they gain leverage of having thousands of stores that could serve as distribution channels.

In terms of threat of substitutes, financial institution find themselves facing threats from financial disintermediation as firms increasingly lean on the bond market to raise funds for their financial and working capital needs. Furthermore, companies with good credit ratings able to raise funds in the capital market at a lower interest rates and will therefore find this method more preferable than traditional bank loans.

Lastly, rivalry among exiting competitors is expected to intensify as the financial system in the world becomes more internationally integrated. Besides that, a slowdown in global economic growth is likely to happen which will make financial institutions vie for market share from a smaller pool of customers. Also taken into account should be the recent competitive trends of convergence and consolidation that would mean that bigger financial-service providers with relatively the same size would be invading each other’s territory.

Opportunities

Becoming financial holding companies (FHC). Through numerous mergers and acquisitions, JPMorgan has become a FHC that enable it to engage in a wide range of financial activities such as investment banking, asset management, private equity, insurance and reinsurance (MacDonald & Koch, 2006). Being an FHC, JPMorgan is able to proliferate its services by expanding the menu of services they offer to their customers. This is a good opportunity for JPMorgan to take advantage of economies of scale and scope to provide added value to its customers.

China Inc. China accounts for a fifth of the world’s population, yet according to the Economist (Tarun Khanna, 2007), it gobbles up more than half of the world’s cement, a third of its steel, and over a quarter of its aluminium. The country’s huge population and booming economy represents a business opportunity to those financial-service providers in position to take advantage of them. JPMorgan has already gained an advantage over competitors as it has successfully secured licenses in order to trade in China’s national currency, the yuan, on behalf of foreign businesses seeking deals inside China (Rose & Hudgins, 2008). Furthermore, China has signed an agreement with the World Trade Organization (WTO) in 2007 and foreign banks can now sell a full menu of services throughout China.

Islamic financing Islamic financing which refers to financial services provided in accordance with Islamic law of sharia (Rehman & Ali, 2008) is booming due to the abundant ‘petro-dollars’ flowing into the Middle East. Standard and Poor’s estimates that around $750 billion of assets (which is more than the GDP of Australia) is under sharia-compliant management while the World Bank reports that more than 300 institutions are providing sharia-compliant financial services. Even though other financial institutions like Citigroup (Citi Islamic) and HSBC (HSBC Amanah) have already tried to establish a beachhead, Islamic financing is still in its infancy and would provide an excellent opportunity for market expansion and penetration.

Aging population Countries like Germany and Japan (Hannah Beech, 2008) are experiencing a rapidly aging population that would represent a major change in demographics. As birthrates continue to decline in developed nations, a new market for financial services specially engineered for the elderly would become increasingly popular. For example, annuity products, long-term care insurance, and other products that can help households preserve wealth from inflation would be extremely suited for the elderly that face partial or full retirement.

The sub-prime crisis The recent subprime crisis though highly damaging to institutions like Citigroup, Merrill Lynch, and Morgan Stanley may prove to be an opportunity for JPMorgan who has been less affected compared to its competitors. The recent acquisition of Bear Sterns by JPMorgan is a good example of this as the 85 year old investment bank was acquired for only $10 per share. Bear Sterns according to executives of JPMorgan is expected to add up to $1.5 billion in earnings over time. Besides that, the acquisition of Bear Sterns comes with its prime-broking business which finances hedge funds’ trading (Economist, 22 March 2008).

Private banking The changing external environment have made the financial industry increasingly competitive as the bargaining power of both suppliers and customers, threat of substitutes, and threat of new entrants have increased. As a response to this, JPMorgan should increase the scale of its private banking business to achieve a certain extend of product differentiation. The change in the external environment is a call for financial-service providers to be more customer-centric and it is important for JPMorgan to provide more personal financing needs as a method to increase the customer’s switching costs by fostering a stronger relationship with them.

Healthcare The trend of an aging in developed countries has brought a rising awareness in health that has subsequently led to a rising demand on individual healthcare products. Many insurance and financial companies work in partnership to serve a healthy combination of a healthcare plan paired together with a savings account. This proves to be a good opportunity for JPMorgan Chase as it offers Health Saving Accounts (HSA) through partnership with many of the large health insurers such as Nationwide, AIG, and American Family Insurance (Healthy Approach: JPMorgan Chase Partners with Insurance Industry to Offer HSAs, 2008.).

Threats

Risk of entering BRIC Countries The BRIC consists of Brazil, Russia, India, and China has become increasingly dominant as these fast-growing emerging economies have the potential to become economic superpowers. The 21st century saw China and India becoming the dominant global suppliers of manufactured goods and services while Brazil and Russia dominated as suppliers of food, energy, and key raw materials (Elaine Ang. & Leong H. Y., 2008). However, the BRIC countries all suffer from a weak legal system, poor infrastructure, the lack of patent and copyright protection, and the absence of free press. What is worst is that countries like Russia have been notorious for defaulting their government bonds in 1998 while Brazil’s lack of sound fiscal policies has caused high inflation (Shapiro Alan C., 2005).

Threat of global stagflation Stagflation is the combination of the word stagnation and inflation that refers to a situation where rising price level is accompanies by falling level of aggregate output (Mishkin F.S., 2007). With fuel and food prices reaching records high in 2008, and the US economy crippled with the subprime and financial crisis, threat of the global economy entering into a period of stagflation is becoming a likely possibility. When the economy contracts, the drop in demand for goods and services will cause financial-service providers like JPMorgan to compete viciously with competitors for a smaller pool of customers.

Increasing political uncertainty As the world faces the 2008 food crisis and high fuel prices (George W. & Jonathan A., 2008), many of the governments around the world find themselves governing an increasingly hostile populace. Political uncertainty poses a threat to the international operations of JPMorgan as the legal framework and policies of countries across the globe increasingly uncertain. One good example of this is the capital controls placed by the military junta on foreign investors in Thailand. The capital controls made the value of the Thai baht drastically depreciate which resulted in massive losses for foreign investors.

The increasing significance of virtual banking and virtual money Due to the decline in prices of personal computers and their increasing availability to the mass population, virtual banks become increasing significant as a channel of distribution of financial services (Mishkin F.S., 2007). Virtual banks like everbank.com have no physical location and exist only in cyberspace would represent a threat to traditional ‘brick and mortar ‘ banks as they are able to provide customers with services at a cheaper cost and with greater convenience. Besides that, the increasing usage of e-commerce has also created virtual money that have no physical existence outside the global economy and main money markets that is created solely by currency trading (Peter F. Drucker, 2002). Virtual money is highly volatile due to floating exchange rates and is extremely price sensitive as they flow freely to institutions providing the highest interest rates.

Mispricing of risk in securitized assets and complex derivatives Every financial institution do some trading in derivatives as a routine to managing the firm’s finances, and minimize risk by bridging gaps between maturity dates (Peter F. Drucker, 2002). Even though derivatives like collateral debt obligations theoretically reduce the risk of the bank, the recent subprime crisis proves the danger in trading of these complex securities. Worst still is the fact that derivative losses by financial institution is not something new as institutions like Barings, Sumitomo, Yamaichi, and recently Bear Sterns have made colossal losses when their predictions of the external environment proves inaccurate.

Over diversification of services Although proliferation of services will enable financial institutions to diversify operations and achieve economies and scale and scope, over diversification will also adversely affect a company. This is because when a company acquires more and more subsidiary companies, the span of control of the top management will become increasingly wide and the company becomes increasingly decentralized. Management of such a large company itself would prove increasingly difficult as the top management must determine where the company’s scarce resources should be allocated to.

Financial disintermediation. Banks today are facing an increased competition from the expansion of the securities markets. With the easily available information in the securities markets as a result of the advancement in information technology, a corporation will prefer to raise funds by issuing securities at a lower cost in the bond markets rather than leaning on financial institutions (Mishkin F.S., 2007). This is especially true for large companies with high credit ratings and good standing reputation. As a result of financial disintermediation, the threat of substitutes increase and JPMorgan risk losing some of its prime customers.

Changing Natural Environment Since 2004, the frequency of natural disasters has increased dramatically with seven out of the 10 costliest storms in history striking the United States. In 2005 alone, natural disasters cost Lloyd’s syndicates and other insurers almost $60 billion which was before this a figure estimated at the very top of their worst-case scenarios (Emily F.V., 2007). The increasing number of catastrophic natural disasters would be a threat to JPMorgan due to the exposure faced by its insurance arm. According to Bernie Hart, JPMorgan Chase also needs consideration on both physical and geographical risks such as historic weather or natural disasters before they take into any investment opportunities.

Conclusion

The 21st century has brought not only breakthroughs in science and technology but also an increase in turbulence for businesses around the globe due to the velocity and magnitude of changes in the general environment. Advancement in information technology and transport technology has made the world akin to a global village and made the economies of countries in the world internationally integrated. This means that any changes in the political, legal, economic, social, demographic, environmental, or technological landscape in one country would be felt greatly by another country half the globe away. It is therefore imperative for global companies like JPMorgan & Co. to accurately forecast the upcoming future trends and events in order to strategically position the company to reap the opportunities and avoid the threats posed by the external environment. In order to achieve this, JPMorgan must match its strengths to its opportunities as well as converting potential threats into opportunities. The scarcity of resources both in human and financial form will make companies who allocate their resources effectively and efficiently triumph in this age of turbulence.

Comments
6 Responses to “An External Assessment of JP Morgan”
  1. Yi Sung says:

    Hey James, I am impressed in the clarity and flow in which this assessment of yours expresses itself. I recently researched and did due diligence on a M&A case study which required me to identify the opportunities and threats as well of this particular acquisition, and even then I found it hard to effectively identify and present the issues (because of the word limit).

    Keep on posting. I really enjoy reading your blog!

    Sung

  2. Timothy says:

    Nice Job. Pls can i get more examples of A CREDITORS OR SUPPLIIERS TO A BANK USING M. PORTER’S 5 FORCES.
    THANKS

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