While the Dodd-Frank Act and the global regulatory reform initiatives pose significant challenges for the nation's major financial institutions, the proposed rule requiring bank holding companies with consolidated assets over $50 billion and nonbank companies deemed systemically important to submit annual resolution plans is among the most challenging and has far-reaching implications.
The proposal, issued for comment by the Federal Deposit Insurance Corp. and the Federal Reserve, makes clear that this is not just another compliance exercise. Rather, the preparation of the resolution plan would require a fundamental assessment of a bank's legal entity structure, how products and services are delivered to customers and, ultimately, the overall strategy of the organization. Boards of directors and senior management will need to be actively engaged in making decisions and ultimately approve the annual resolution plan submitted to the FDIC and the Fed.
Discussions with institutions indicate that many consider the preparation of a resolution plan to be a daunting task due to the complexity of the exercise and the short time frame for submitting the initial plan. The good news is that as banks begin to go through the process, some have already identified opportunities to enhance shareholder value. At the same time, the exercise could challenge existing business models and require a fresh look at the institution's strategic plan.
Here are some areas that need immediate consideration as you draft a resolution plan.
An important component is an analysis of the bank's legal entity structure, including how subsidiaries are capitalized and funded. This analysis is likely to highlight the complexity within a specific organization and where the key interdependencies are for operational, technology, human resources, treasury and other shared services.
In addition, regulators will be focused on cross-border exposures; intercompany guarantees; back-to-back trades; exposures booked in one jurisdiction and managed in another; and anything that could pose an impediment to timely resolution. Senior management and the board of directors will need to consider the trade-offs between the value of the current structure, operations, tax implications and interdependencies against the risk that the FDIC and the Fed will require changes or impose additional capital requirements that an orderly resolution of the organization could be accomplished.
Regulatory reform has already prompted many banks to reassess their business models as compliance costs and capital requirements increase. The preparation of a resolution plan will provide further insights into the organization's opportunities — and obstacles. Banks will need to evaluate and make decisions around the value derived from businesses that involve, for example, cross-border exposure or activities that pose significant systemic risk to the financial system, since regulators may force changes such as requiring legal entities to be able to stand fully on its own from a capital, funding and management perspective, or even mandate that a business or activity be divested. This will test the strategy of the institution and will require crucial decisions around core versus noncore businesses and ultimately the value of certain activities compared with the compliance costs and regulatory requirements.
Boards of directors and senior management should not view resolution plans in isolation from other regulatory reform efforts. Rather, banks should use the resolution planning process to reassess how capital and funding is allocated to subsidiaries — especially in light of heightened requirements for both — and help put transparency on risks and possibly introduce additional risk mitigation activities. Since resolution plans are focused on legal entities, it is equally important that institutions also evaluate their governance and risk management processes — including identifying roles and responsibilities of key individuals — for subsidiaries to ensure the board of directors and senior management have a holistic view of the risk and activities of the enterprise.
The preparation of a resolution plan will be a critical yet complex process that has wide implications for the future of individual banks and the industry as a whole. While the proposed requirements seem onerous, the process can help leaders identify opportunities to realize improved operational efficiencies, reduce costs and allocate capital and funding across the enterprise more efficiently.
Banks that can act quickly and take advantage of these opportunities will be in a much better competitive and regulatory position.
