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Regulators, Banks Move to New Stage on Living Wills

For the first time ever, the Federal Reserve Board (Fed) and the Federal Deposit Insurance Corporation (FDIC) exercised an authority created by the Dodd-Frank Act to deem the resolution plans, or “living wills,” of five of the eight largest systemically important U.S.-based banks “not credible.” This week’s decision moves regulators into a new stage in the post-crisis effort to ensure that some of the country’s biggest banks are no longer too big to fail, a stage that could result in substantial structural changes being forced on these banks by regulators.

What “Not Credible” Means, What Happens Next

A living will is intended to provide a blueprint for how a financial institution would be wound down in a rapid and orderly manner during a crisis. Dodd-Frank requires living wills from banks with $50 billion or more in assets and from certain systemically important nonbank financial firms.

The “not credible” determination means that the Fed and the FDIC believe these living wills would not facilitate orderly resolution were these banks to fail. The Fed and the FDIC gave the five banks whose plans were deemed “not credible” until October 1 to make them acceptable to those agencies. If the banks fail to do so by that date, the regulators have the authority to impose prudential requirements more stringent than the ones already in place for other large banks. This may include requiring additional capital beyond that already imposed by Dodd-Frank and Basel III through provisions like the liquidity coverage ratio, the countercyclical capital buffer, and the SIFI surcharge. The agencies could also limit the growth of a bank by, for example, prohibiting mergers and acquisitions or restricting the types of assets the bank could purchase and trade.

If the agencies do impose additional prudential requirements on a bank, doing so would trigger a second timer that gives the institutions two years to make their plans acceptable to the agencies or face possible forced divestiture of assets or operations by the regulators. In other words, after the two years, the regulators have the authority to break up a bank whose living will they had continued to deem “not credible.”

The process to come will give the first, real-life look at how the two agencies will or will not use the new authority granted to them under Dodd-Frank. We will be watching to see whether the banks that were given “not credible” grades are able to bring their resolution plans up to the regulators’ standards by October 1 and, if not, what action the agencies decide to take in response, and when they take it.

The Too-Big-to-Fail Debate

BPC has previously argued that Dodd-Frank made significant progress in addressing the too-big-to-fail problem. The orderly liquidation authority and resolution planning process created in Dodd-Frank, the FDIC’s single point of entry resolution strategy, new loss-absorbing debt requirements, and higher capital and other prudential standards are among the provisions implemented since the financial crisis that make it much easier for large financial institutions to fail without threatening the stability of the financial system.

There remains disagreement, however, about whether too-big-to-fail has been adequately addressed. Living wills have been part of the ongoing debate about whether large banks should be forced by regulators to break up as an additional necessary step. Beyond being a 2016 campaign issue, the question of breakups has been raised by a number of policymakers, including the new president of the Federal Reserve Bank of Minneapolis, Neel Kashkari, who held the first in a series of public meetings on the subject earlier this month. In remarks earlier this year at Brookings, Kashkari agreed that Dodd-Frank gives regulators the power to break up large banks, but argued that it is unlikely that Congress intended that authority to be used for a general policy of breakups.

What We Found Interesting

One of the banks that earned a failing grade, Wells Fargo, had a living will that was found to be “not credible” by both regulators despite neither regulator having deemed its 2014 resolution plan “not credible.” Among the three large banks that did not earn failing grades from both agencies but were under review, the resolution plans of two were deemed “not credible” by one of the two agencies but not the other. This essentially means that these two banks are not on the clock to get their resolution plans up to speed by October 1 despite significant concerns from one of the two agencies. The final of the eight U.S.-based banks, Citigroup, was the only one that submitted a living will that neither agency found “not credible.”

The decision by the Fed and the FDIC only covers eight of the largest U.S. banks. The living wills of several foreign-based banks are also being reviewed by the two agencies. However, we expect a separate decision on their living wills later this year due to a rule promulgated by the Fed that requires each foreign bank to establish an “intermediate holding company” to house its U.S. operations. Each such holding company would allow regulators to supervise it independently of the parent bank’s global operations. The deadline for compliance with the intermediate holding company rule is July 1, 2016, so it is not surprising that the agencies may be considering the foreign banks separately from the largest U.S.-based banks.

Until this week’s decision, few knew whether the Fed and the FDIC would deem the living wills of any of the eight largest U.S-based banks “not credible.” The two agencies took a major step by deeming over half of the plans not credible. The process for developing resolution plans has been iterative between the banks and regulators, and each of the feedback letters given to the eight bank yesterday mark significant improvement on previous resolution plans. The time between now and October 1 will be devoted to addressing the remaining shortcomings.

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