Inadequate 'Living Wills', Banks to Correct Flaws by 2015

Banks have failed to convince the Federal Deposit Insurance Corp. (FDIC) and the Federal Reserve regarding their respective ‘Living Wills', a measure to prove that they could be easily be wound down in case of collapse. Both the regulatory agencies deemed the living wills of the banks inadequate, after reviewing their plans submitted in 2013.

Under provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the banks (with total consolidated assets of $50 billion or more) are required to outline the ways to liquidate by breaking up and selling off assets if they are on the verge of collapse.

The U.S. banks that had submitted their living wills are Bank of America Corporation BAC, The Bank of New York Mellon Corporation BK, Citigroup Inc. C, The Goldman Sachs Group, Inc. GS, JPMorgan Chase & Co. JPM, Morgan Stanley MS and State Street Corporation STT. Apart from these, the U.S. units of Barclays PLC BCS, Credit Suisse Group AG CS, Deutsche Bank AG DB and UBS AG UBS had also submitted their resolution plans.

Shortcomings

Though the FDIC and the Fed noted some degree of improvement from the living wills previously submitted in 2012, still several shortcomings needed to be addressed. There were flaws in plans of particular banks along with many common errors. All the 11 banks have been individually notified.

According to the regulators, the shortcomings stemmed from the fact that the living wills were based on certain unrealistic and inadequate assumptions. These included the behavior of clients, investors, counterparties and customers, among others during the crisis. Further, the banks failed to identify structural changes that will aid their wind-down.

Notably, several actions to make the living wills more purposeful were suggested by the FDIC and the Fed. These include simplifying the businesses and amending financial derivative contracts so as to offer stay of early termination rights of investors, which get triggered in bankruptcy.

The banks have been given a deadline of Jul 1, 2015 to submit their modified living wills. In case they fail to do the same, the regulators will be compelled to order the banks to divest units for downsizing the business structure.  

Purpose of ‘Living Wills'

The main idea behind the submission of living wills is to avoid re-run of the 2008 financial crisis, the period when Lehman Brothers Inc. went down. The living wills will reduce the risks of further bailouts, if these banks sink in the event of another financial crisis.

A systemic resolution, maximizing the sale value of a failed bank and minimizing creditor losses, would help in efficient handling of bank failures. Moreover, the FDIC will have the power to liquidate a bank if its collapse knocks down the country's financial stability.

Moreover, unlike a one-time affair, the living wills are required to be submitted on a yearly basis.

Will the Purpose of ‘Living Wills' be Served?

Since almost all banks are dependent on each others' businesses, a single breakdown among them would cause ripples all over the financial market. As a result, there will be limited number of healthy financial institutions to buy assets from the weaker ones. So, the outcome will not change to a great extent.

However, living wills will hopefully prevent big banks from messing around with risky activities that jeopardize general economic health. Most importantly, the advance precautions would ultimately translate into lesser involvement of taxpayers' money for bailing out troubled financial institutions.

Moreover, the banks have been simplifying their operations through divestiture or closure of non-core/unprofitable businesses. We believe that these efforts, along with several other measures being undertaken by the financial regulators will aid in averting a financial crisis (similar to 2008) to some extent.