JPMorgan loss leads to Fed inquiry into bank deposits

US regulators are investigating how Wall Street banks invest their excess deposits in the wake of JP Morgan's $2 billion (£1.3 billion) trading loss.

The New York Federal Reserve, the arm of the central bank that regulates Wall Street banks, is said to be examining the issue because JP Morgan's losses stemmed from its chief investment office, which invests the deposits the bank has yet to lend out.

As well as damaging JP Morgan's reputation for risk management, the losses are posing questions for regulators who have pledged to make America's financial system safer and sounder since the crisis. America's biggest banks, including JP Morgan, have built up an excess of deposits as loan growth has remained sluggish in recent years.

The total size of deposits at banks insured by US regulators has jumped 25% to $10.2 trillion over the past four years.

The crisis that has hit JP Morgan's chairman and chief executive Jamie Dimon showed little sign of easing on Friday amid reports that losses on the trades could reach $5 billion. The bank warned last week that total losses could rise by $3 billion.

JP Morgan, which had built a reputation as Wall Street's best managed bank, saw its shares fall 1.3% yesterday - they are down more than 10% since the $2 billion loss was first disclosed to investors on May 10.

It has also emerged that JP Morgan did not have a treasurer in place between last October and March, a period when some of the troubled trades carried out by the $350 billion chief investment office were made. A treasurer typically reports to a bank's finance director and helps manage its overall risk. Joseph Bonocore, the treasurer who left the bank in October, was replaced in March by Sandie O'Connor.

JP Morgan's blunder also spilled further into the race for The White House yesterday. Mitt Romney, the Republican who is favourite to take on president Barack Obama in November's election, said that the losses were part of the "American way" and were a natural product of the risks that any bank takes.

"I would not rush to pass new legislation or new regulations," said Romney, who has blamed excessive regulation since the crisis for slowing down the recovery in the world's biggest economy.

However, Wall Street's critics in Washington argue that the losses racked up in six weeks by JP Morgan show that banks should not be granted any loopholes as regulators continue their work on turning some of the ambitions contained in the Dodd-Frank Act into actual rules. Banks have been lobbying to be allowed to conduct "portfolio hedging", in which they put on trades to offset their risk across a series of investments rather than just one.

Carl Levin, a Democratic Senator who has been pushing for tougher regulation, said that following the $2bn losses "we've seen exactly what 'portfolio hedging' might mean".

Dimon has insisted that the trades were hedges that backfired, but that account is likely to be challenged by politicians when he appears before Congress next month.