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Bank Living Wills: Five Years Later, Still in Probate

On Wednesday, 11 large globally active bank holding companies (BHCs) are required to submit revised “living wills”—a plan for its own demise while it is still operational—to the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve Board (Fed) for review.1 These updated living wills describe how such banks would be resolved in the case of their failure using the existing U.S. Bankruptcy code and standard bank resolution authorities; they cannot assume the use of the newly created Orderly Liquidation Authority contained in Dodd-Frank’s Title II. If the plans aren’t up to the standards the FDIC and the Fed are expecting, it may start a countdown for more serious actions. Dodd-Frank grants regulators the power to deal harshly with firms whose wills are deemed “not credible,” but it remains to be seen whether the regulators will go down this route. Specifically, the two agencies can impose extra prudential requirements and possibly even forced divestitures.

Here’s what we’ll be watching for:

1. Will any of the 2015 living wills still be found insufficient by the FDIC or the Fed?
2. If so, will the two agencies jointly deem any of the living wills “not credible?”
3. If they do deem any plans not credible, how long will the agencies give the companies to address outstanding issues before imposing more stringent prudential standards?
4. Will the agencies give any indication of what the more stringent standards might be?

Living Wills: Background

Dodd-Frank requires all banks with consolidated assets greater than $50 billion (often called “bank SIFIs”) to submit living wills. The legislation also requires all nonbank SIFI’s to file living wills. The purpose is to make resolution of these firms easier, by requiring that each company provide a plan for its own demise while it is still operational. This is one of the tools in Dodd-Frank designed to end the “Too-Big-to-Fail” (TBTF) problem.

The FDIC and Fed review each plan to determine whether it is “credible.” If the agencies determine the plan is not credible, Dodd-Frank requires the two agencies provide the firm with a notice of deficiencies and a due date for revisions. If the firm fails to resubmit a plan deemed “credible” within that timeframe, Dodd-Frank provides tools the agencies may use to force compliance.

Resolution plans are relevant because they seek to preempt any possibility that an institution will become “too-big-to-fail.” The Fed’s implementing regulation for living wills, Regulation QQ, reflects this emphasis by requiring SIFIs to report their corporate structure and the degree to which they are interconnected with other SIFIs. The hope is that having a plan in place will allow the government to rapidly resolve a large complex financial institution without endangering the broader financial system, thereby negating the need for taxpayer-funded bailouts. Another benefit of the plans is to provide regulators with information to allow them to anticipate future financial shocks. In addition, the firms themselves can react to their own plans by strengthening their structures and operations to better protect against potential risk.

Where Are We Now?

As we reported in May, the FDIC and the Fed found that the 2013 plans submitted by these 11 companies were not where they needed to be. The FDIC stated that the plans were “not credible and do not facilitate an orderly resolution under the U.S. Bankruptcy Code.” The Fed stopped short of saying the plans were “not credible,” instead using the non-legal term “insufficient,” and said that the 11 BHCs “must take immediate action to improve their resolvability and reflect those improvements in their 2015 plans.” The statement implied that if the deficiencies were not cured in the 2015 plans, both regulators may move to label the plans “not credible.”

Doing so would trigger two timers. First, the Fed and the FDIC would set a time limit for the BHCs to make the plans credible under the threat of “more stringent capital, leverage, or liquidity requirements, or restrictions on the growth, activities, or operations of the company” until a credible plan is submitted. Dodd-Frank sets a second and more severe timer at two years, after which the Fed and the FDIC would have the authority to force divestiture of assets or break up the banks. BPC’s prior work examined the complexities of how to break up large complex financial institutions (hint: it is a lot harder than you think).

There is no guarantee the FDIC and the Fed will designate anyone’s living will as being “not credible” or even if there is such a designation, that the regulators would use these tools to mandate compliance. But if any 2015 plans are deemed not credible, the living will process will likely move into a new stage that brings these actions closer. We’ll be watching to see if the agencies can beat the 14 months it took to review the 2013 plans, and whether they will publish their review of these new submissions by the end of 2015.

1 The 11 BHCs were Bank of America, Bank of New York Mellon, Barclays, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street Corp., and UBS.

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