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JPMorgan Chase Secretly Downgraded by Bank Regulators

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The Senate report on JPMorgan Chase's London Whale fiasco revealed that federal regulators secretly downgraded the bank's management rating last summer—a fact kept from investors and the public until last week.

The downgrade of JPMorgan's management resulted from the Office of the Comptroller of the Currency finding that the bank suffered from "lax governance and oversight in the chief investment office," as well as other "oversight deficiencies," according to the Senate report.

This news is another blow to JPMorgan, which had long enjoyed the reputation of being one of the best managed megabanks in the U.S. That reputation was already diminished by the derivatives trading losses in its London chief investment office. And then there was that report from the Federal Reserve citing weaknesses in JPMorgan's capital planning process.

(Read more: JP Morgan reaches MF Global Settlement)

The OCC issues supervisory ratings called CAMELS on banks after conducting exams. The acronym CAMEL stands for Capital adequacy, Asset quality, Management, Earnings, and Liquidity. Ratings for each category assigned on a scale of 1 to 5. In addition, a composite rating is assigned. Banks that receive a 1 or 2 rating are considered to present minimal, if any, supervisory concerns. Banks with 3 to 5 ratings exhibit moderate to extreme concerns.

The ratings are usually disclosed only to senior bank management and regulators. But the revelation about the downgrade of the management component appears on page 249 of the 300 page Senate report. It was reported Tom Braithwaite and Shahien Nasiripour of the Financial Times on the day it was released.

On Friday, Senator Carl Levin, the chair of the Senate panel that investigated the Whale trades, noted the downgrade during a public hearing.

(Read more: After Huge Blowup, Senate Report Said to Fault JP Morgan Execs)

The Senate report doesn't specify how far the management rating was downgraded, doesn't give the actual score and doesn't reveal the overall score.

A report in The Wall Street Journal on Wednesdsay says the downgrade was one-notch, from 2 to 3.

"A rating of 3 indicates management and board performance that need improvement or risk management practices that are less than satisfactory given the nature of the institution's activities. The capabilities of management or the board of directors may be insufficient for the type, size, or condition of the institution. Problems and significant risks may be inadequately identified, measured, monitored, or controlled," the OCC says on its website.

Typically, the CAMELs are never released to the public, although this secrecy has long been criticized. As far back as 1999, an economist at the San Francisco Federal Reserve pointed out that the ratings contain information that would be useful to public monitoring of bank health. Since market assessments are typically better gauges of bank health than the view of regulators, providing this information to the public would improve bank supervision.

So why are the CAMELs still secret? As the San Francisco Fed economist noted, there is a fear that banks would be less willing to provide supervisors with complete and accurate information if they feared the outcomes of the bank exams would be made public.

That's pretty outrageous. It amounts to saying that the banks cannot be trusted to cooperate with regulators and not to make the examination process a public relations exercise in the absence of secrecy.

But it's also probably accurate. Another revelation from the Senate report is that JPMorgan stopped supplying the OCC with certain data after it feared the information was leaking to the public.

Banks, of course, are probably overly fearful about having their CAMELs made public. As Jonathan Weil noted this week, the revelation of JPMorgan's downgrade hasn't exactly caused a run on the bank.

(Read more: Ex-JPMorgan Exec Blames Others for 'Whale' Loss)

In some sense, no one should be surprised by this news. It isn't really a mystery that the "capabilities of management or the board of directors may be insufficient for the type, size, or condition" of a banking goliath like JPMorgan. The real mystery is why—given all we've learned in the last six years—anyone would ever think the capabilities of any management or board could be adequate for a bank of this size.

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