Eleven of the biggest U.S. banks have no viable plan for unwinding their businesses without rattling the economy, federal regulators said Tuesday, ordering the firms to address their shortcomings by July 2015 or face tougher rules.
The sweeping rejection shows that regulators are intent on avoiding a repeat of the 2008 financial crisis, when the government stepped in to prop up ailing institutions at taxpayers’ expense. In the aftermath, the Dodd-Frank financial overhaul law forced banks to provide regulators with a blueprint for resolving their operations without harming the financial system. But regulators say the plans they have received are riddled with problems.
The Federal Reserve and the Federal Deposit Insurance Corp. called the banks’ resolution plans, or “living wills,” “unrealistic or inadequately supported.” They said the plans “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 resolution.
“Each plan being discussed today is deficient and fails to convincingly demonstrate how, in failure, any one of these firms could overcome obstacles to entering bankruptcy without precipitating a financial crisis,” Thomas M. Hoenig, vice chairman of the FDIC, said in a statement Tuesday.
Regulators reviewed the living wills of banks with more than $50 billion in assets outside of traditional banking: Bank of America, Bank of New York Mellon, Barclays, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street and UBS. All have until July 1, 2015, to submit revised plans.
The FDIC and the Fed identified several actions that banks could take to shore up their plans, including creating a “rational and less complex” legal structure to make it easier to resolve subsidiaries. Agency officials also suggested that the banks amend financial contracts to provide a stay of certain early-termination rights of investment partners that are triggered in bankruptcy.
If the firms fail to meet regulators’ expectations, they could be forced to set aside more capital — cash, investor equity and other assets — to absorb losses, face borrowing limits or restructure their operations. If the plans are not up to par after two years, regulators could make banks divest from entire lines of business.
“Regulators are taking seriously the possibility that planning for the resolution of a major banking company may, in some cases, limit the effects of a problem at a company, or the economy more broadly,” said Oliver Ireland, a partner at the law firm of Morrison & Foerster.
The resolution authority of the FDIC is widely seen as a critical component of the financial overhaul. Dodd-Frank gave the agency power to make banks exit business activities if they pose a threat to the financial system. The idea was to prevent any institution from sending shock waves through the financial system the way Lehman Brothers did when it collapsed in 2008.
Regulators, especially Hoenig at the FDIC, worry that banks are generally larger, more complicated and more interconnected than they were before the meltdown. The eight largest banks have assets equivalent to 65 percent of the gross domestic product, Hoenig said. And the average notional value of derivatives for the three largest firms exceeded $60 trillion at the end of 2013, up 30 percent from the start of the crisis.
“Subjecting these most complicated firms to bankruptcy is no simple task and will require enormous effort to accomplish,” he said. “There have been no fundamental changes in their reliance on wholesale funding markets, bank-like money-market funds, or repos [repurchase agreements], activities that have proven to be major sources of volatility.”
Industry trade groups say that the financial system is much stronger than in the years leading up to the crisis, with higher capital and liquidity requirements, revised compensation structure and the simplification of business lines at Wall Street banks.
Still, Rob Nichols, president and chief executive of the Financial Services Forum, said, “The industry not only welcomes, but also needs comprehensive and substantive feedback from the regulators on the living will process.”
Nichols, whose group represents the largest banks, said his members are “committed” to “weathering substantial stress scenarios without taxpayer dollars being at risk.”
Other big banks, including Wells Fargo, HSBC and RBS, are slated to undergo a review of their living wills in the coming months.