Big Banks Prepare Living Wills Or Emergency Liquidation Plans
U.S. Tells Big Banks to Rewrite 'Living Will' Bankruptcy Plans
Fed, FDIC Say Plans Provide 'No Credible Path' Through Bankruptcy; Raise Specter of Tougher Rules, Even Break-up
The Federal Reserve and the Federal Deposit Insurance Corp. said bankruptcy plans submitted by big banks make "unrealistic or inadequately supported" assumptions and "fail to make, or even to identify, the kinds of changes in firm structure and practices that would be necessary to enhance the prospects for" an orderly failure.
Representatives of banks declined to comment or had no immediate comment Tuesday. The Financial Services Forum, a big bank trade group, said banks are safer now than before the crisis and "the industry remains strongly committed to ensuring the financial system is less complex, safe, transparent, accountable and capable of fulfilling its role of promoting economic growth and weathering substantial stress scenarios without taxpayer dollars being at risk."
The rebuke is almost certain to fuel the debate over whether some firms remain "too big to fail"—or so big their collapse would make government support necessary to avert broad economic damage. It will likely feed the appetite of some lawmakers to push for more aggressive action to force structural changes at the biggest banks.
"Too big to fail is alive and well. The FDIC's statement that these living wills are not credible means that megabanks will live on taxpayer life support in the event of a crash," said Sen. Sherrod Brown (D., Ohio), who has proposed legislation to sharply increase capital requirements for the biggest banks, in a statement. He said regulators should use their authority to impose "much higher" capital and leverage rules "sooner rather than later."
The 2010 Dodd-Frank law required banks to submit an annual "living will" detailing their operations and exposures as well as how they could be dismantled without relying on government support in the event they reach the brink of failure.
The requirement was put in place in the wake of the 2008 financial crisis, when regulators struggled to understand the sprawling operations of teetering financial giants such as American International Group and Lehman Bros.
To avoid being hit with tougher rules—or even being required by regulators to break up the company—banks can take steps to make their bankruptcy plans more credible, regulators said Tuesday. These include "establishing a rational and less complex legal structure;" showing they can quickly produce reliable information about their exposures, and amending derivatives contracts to make them easier to bring through bankruptcy.
Regulators didn't release details about deficiencies at individual firms Tuesday. Certain banks' plans have made more progress than others, regulatory officials said on a conference call with reporters.
For months, banks have been asking regulators for specific feedback about their living wills, which they have filed each year since 2012. The banks, which have already submitted their 2014 plans, received no formal individual feedback on any of their submissions until Tuesday.
Part of the delay stemmed from internal debates at the Fed and FDIC about how to respond to firms whose resolution plans may be deficient, people familiar with those discussions have said.
On Tuesday, the FDIC was ready to deal out harsher medicine than the Fed, voting unanimously to find the 11 banks' plans "not credible." The Fed's governing board, headed by Fed Chairwoman Janet Yellen, agreed to order banks to improve their plans but stopped short of using that language. The agencies must agree to call plans "not credible" in order to trigger a legal requirement that a firm immediately resubmit a revised plan and face stiff penalties if regulators remain unconvinced of its feasibility.A Fed official said Tuesday that, while the wording of the findings was different, the agencies agreed to take strong action.
"I call them regulatory opiates," Ken Thomas, a Miami-based bank consultant and economist, said of the living wills. "They make the regulators feel good, they make Congress feel good, but what they don't realize is in the real world, things happen instantaneously, and the time to enact a living will— it doesn't exist."
"To sit there and try to come up with a plan to try to orderly unwind a major institution of this size, I don't know if it can be done," said Paul Miller, an analyst at FBR Capital Markets and former Fed examiner.
The failure of the biggest U.S. banks to convince regulators they can go bust without bringing down the financial system is likely to further strain an already tense relationship between Wall Street and Washington.
On Tuesday, the Federal Reserve and the Federal Deposit Insurance Corp. told 11 of the largest banks to address significant shortcomings in so-called living wills they submitted showing how they can be dismantled under bankruptcy and without government support.
Bank officials were surprised by the public rebuke. A senior executive at one of the banks noted his firm got a 19-page memo less than three hours before the public release by the Federal Reserve and FDIC. The executive said there was no communication with regulators beforehand.
For their part, regulators say the banks have a lot more work to do before they prove they can cope with another financial debacle.
Much of regulators' displeasure stemmed from a concern that Wall Street remains too sanguine about its ability to avoid some of the problems that contributed to the 2008 financial crisis. Regulators also said the 11 firms so far had failed to overhaul their structures or practices in ways necessary to forestall the damaging consequences of a giant financial firm's bankruptcy.
Among the areas of concern: Banks' views about how counterparties and foreign regulators would react during a crisis, and the banks' ability to produce information they would need to achieve a quick resolution. Regulators felt that banks, in some cases, took an unrealistic approach to the potential problems regulators previously had asked them to address. These assumptions, in turn, led some firms to avoid making changes that would address those risks.
In some cases, the banks' assumptions appeared to stem from a belief that regulators would address factors that helped exacerbate the last meltdown, such as how various countries would handle the assets of a failing global financial firm such as Lehman Brothers Holdings Inc.
Several banks presumed that foreign regulators won't seize subsidiaries, branches or assets in their countries if the U.S. entity runs into trouble, officials said. Regulators have been negotiating with their counterparts around the world to avoid those kinds of seizures, which are known as "ring-fencing." But until a specific agreement is in place, regulators don't want the banks to assume money will be able to freely flow back to the U.S. parent once bankruptcy begins, officials said.
"It would be foolish to assume that countries will not protect their domestic creditors and stop outflows of funds when crisis threatens," said Thomas Hoenig, the No. 2 official at the FDIC, in a statement that accompanied Tuesday's decision. "Ring fencing assets will be the norm not the exception."
Regulatory officials said it took months to reach agreement between the Fed and FDIC on the complicated blueprints, which delayed their ability to provide feedback to banks. Some of the banks' documents run for tens of thousands of pages as they list subsidiaries, exposures and how a firm could be dismantled.
In April 2013, the Fed and FDIC laid out five key challenges they wanted banks to address in their living wills, including the risk that counterparties will exercise their rights to terminate derivatives and other contracts when a firm runs into trouble, and that foreign regulators might move to seize assets or subsidiaries in their countries. Banks submitted their plans in October.
In many cases, banks presumed their counterparties will stick with them if they head toward failure, rather than exercise their rights to unwind contracts, officials said. Such assumptions in turn led banks to avoid making changes to prevent counterparties from immediately terminating standard derivatives contracts, according to some officials familiar with the plans.
Regulators believe incorporating a "stay" or pause for early-termination rights in banks' derivatives contracts is necessary to enable firms to be cleanly dismantled in a future panic. The Fed and FDIC listed the change as one of five key steps firms must take before resubmitting their plans in July 2015.
Regulators and industry representatives have been working on standardized changes to derivatives contracts that would address the issue and are expected to release it in November.
Regulators also blamed banks for what they viewed as optimistic assumptions related to derivatives and other trades that are settled through clearinghouses. Some banks presumed, for instance, that they would maintain access to clearing even amid looming collapse, and that their counterparties wouldn't require them to post more collateral, according to people familiar with the living wills. Regulators want more support for such assumptions, people familiar with the matter said.
Regulators also are concerned that banks didn't show in their plans that they have internal systems capable of providing information that would be crucial in a bankruptcy, such as whether securities they have used as collateral are still in their possession.
Banks must make significant changes by July 2015 or face escalating regulatory punishments, including possible forced divestitures. A person familiar with some of the banks' living-will plans said it is likely banks will reduce their number of legal entities, continue working on bolstering liquidity to have enough money to wind down in bankruptcy, and generally work to make the banks less complex.
This person said this is the first time at least some of the banks have received any feedback whatsoever on their 2013 plans, even though the banks already have submitted their 2014 plans. Regulatory officials said they would use the 2014 plans as a starting point for discussions about improvements the companies can make."We really think we've laid out a reasonable process here," FDIC Chairman Martin Gruenberg said in an interview. He and other officials stressed regulators now have provided firms with concrete guidance on how to improve their plans, and will work closely with them in the year ahead.
Twelve of the largest U.S. banks are trying yet again to persuade regulators they can safely navigate bankruptcy without tanking the broader financial system.
Summaries of “living wills” from firms including J.P. Morgan Chase and Co. and Goldman Sachs Group, Inc. were published Monday on the websites of the Federal Reserve and the Federal Deposit Insurance Corp. The stakes are high: If the plans don’t please regulators, firms could be forced to break up or shrink.
Among the new details: Banks have rethought how they would run a bankruptcy process, emerging significantly smaller than their current size or, in the case of Goldman Sachs and Morgan Stanley, ceasing to exist after selling themselves off in pieces.
Bankers and lawyers who worked on the plans said this year’s versions—the fourth time most of the firms have filed—should address regulators’ concerns. The wills were mandated by the Dodd-Frank regulatory overhaul to ensure that any failure wouldn’t set off the kind of catastrophe that accompanied the collapse of Lehman Bros. in 2008.
Last year, the Fed and FDIC found most plans flawed. They ordered the firms to start fixing the problems or face sanctions such as higher capital requirements or forced divestitures.
“The firms have taken meaningful, concrete steps to ensure their plans are credible and that no firm is too big to fail,” said Rob Nichols, president of the Financial Services Forum, a trade group that represents big banks.
Firms whose bankruptcy playbooks were published Monday include Bank of America Corp., Bank of New York Mellon Corp., Citigroup Inc., Goldman Sachs, J.P. Morgan, Morgan Stanley, State Street Corp., Wells Fargo and Co., and the U.S. units of Barclays PLC, UBS AG, Credit Suisse Group AG, and Deutsche Bank AG. Last year, regulators said only Wells Fargo’s plan was realistic.
The Fed and FDIC said on Monday they would begin reviewing the new plans. The agencies hope to provide feedback by the end of this year, according to people familiar with the matter. Last August they criticized banks for assuming they could sell business units and find sources of capital to remain afloat.
Almost all big U.S. banks said they would adopt a so-called “single point of entry” bankruptcy strategy, a change from many previous plans. Under the scenario, a bank’s parent company and perhaps a few subsidiaries would enter bankruptcy, while the firm’s units would be recapitalized with resources from the parent and remain open while they were sold, wound down or reorganized.
J.P. Morgan, for instance, said that under bankruptcy it would expect its national bank unit to shrink by one-third of its current size and its broker-dealer to shrink by two-thirds. The bank also said it continues to merge and eliminate legal entities.
Bank of America said in a worst-case scenario it would wind down and sell its global markets business, which focuses on sales and trading, and shrink its global banking business, which caters to corporate customers. The smaller Bank of America would focus on consumer banking and wealth management.
The bank also said it was already taking steps to make its units less interconnected, including separating its broker-dealer activities into two legal entities, one focused on retail customers and one focused on wholesale customers, such as pension and hedge funds.
Citigroup said under a wind down it expected its market businesses, operating through the broker-dealer entities, would be discontinued. The global corporate banking operations could be sold, and the U.S. retail banking operations could be spun off as their own public company. Information-technology employees would be stationed in branches or less-risky units.
Working together, the banks have completed one major item from the must-do list the Fed and FDIC issued last August, which many firms touted in their new plans: Eighteen global banks agreed to change derivatives contracts in a manner designed to prevent counterparties from terminating the contracts en masse once a bank goes into crisis, as occurred when Lehman Brothers failed in 2008.
Under orders by regulators to put more detail in the public sections of the living wills, the banks submitted longer documents this year. Citigroup’s plan this year measured 102 pages, while last year’s was 31 pages.
Private versions of the documents, by contrast, are usually thousands of pages long, leading regulatory staff to use word-search functions in their computer software as they comb the digital files.
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