Will reg relief plan bring back failure-related risks?

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WASHINGTON — There is broad agreement that several years after the crisis regulators should ease the rigor of resolution planning requirements. But critics say the Federal Reserve Board plan to reduce the frequency and severity of "living wills" goes too far.

The proposal that the Fed drafted jointly with the Federal Deposit Insurance Corp. would tailor the requirements based mostly on institution size. U.S. banking companies with assets of between $100 billion to $250 billion would be exempted from submitting a resolution plan entirely, while larger firms could submit plans less often.

The changes would reflect some relief already in practice and implement certain measures from the regulatory reform law passed last year. But several observers argued the agencies went way beyond those measures and the proposal needlessly waters down requirements designed to make failed banks easier to resolve in a crisis.

“When things are rosy, you don’t always walk away from the things that made them rosy,” said Ron Klein, a partner at Holland & Knight and a former Democratic House lawmaker from Florida who sat on the House Financial Services Committee during the drafting of the 2010 Dodd-Frank Act. “This is the time to make sure you keep in place the things that are working well."

Under Dodd-Frank, banks with over $50 billion of assets were required to plan out their hypothetical bankruptcy. The aim was to avoid a repeat of the messy failures that had sent systemic shock waves to other banks during the crisis.

Supporters pointed to two benefits of living wills. The plans would assist the FDIC in building a new system, also created by the 2010 law, to manage certain resolutions where the government viewed traditional bankruptcy as too risky for financial system. Secondly, living wills would force banks to simplify their structure so that a bankruptcy would be less threatening.

But completing the plans and awaiting feedback on them from the Fed and FDIC has proven to be an arduous process, and many policymakers have concluded that they can achieve the same benefits but still provide the industry with relief.

The Fed has seen “substantial gains in both the resiliency and resolvability of large banking organizations and the broader financial system,” said Randal Quarles, the Fed board's vice chairman of supervision, at a board meeting earlier this month. "Congress recognized this progress when it passed the Economic Growth, Regulatory Relief, and Consumer Protection Act last year. Consistent with the law, the proposal seeks to tailor the both the frequency and content of resolution plans according to the business model and risk profile of firms."

Yet the proposal went further than that law, which exempted firms with less than $100 billion of assets from the requirements.

The eight U.S.-based global systemically important banks, or G-SIBs, would still have to file plans every two years — making formal what has been the agencies' recent practice following what had initially been an annual filing schedule. Yet the companies would have to submit "complete" plans only every four years. The alternating plans would be "targeted," containing just core capital and liquidity elements and any material changes since the previous round.

Banks with assets between $250 billion and $700 billion would only have to file every three years, with a complete plan due every six years. Meanwhile, foreign firms that have more than $250 billion of global assets but that sit in the Fed's least risky supervisory category due to limited U.S activity would submit "reduced content" plans every three years.

Some worry the changes could result in firms being less mindful of how their failure would affect the economy, which could exacerbate the impact of failures in a crisis.

Dennis Kelleher, the president and CEO of Better Markets, said if banks had been filing resolution plans in 2006, they might have been better equipped to address risks before the housing crash and ensuing recession.

“In the financial institutions, their activities and these financial markets are moving at the speed of light and … can change very substantially, including the risks in those activities, institutions and markets,” he said. “What this is going to do is structurally put regulators behind those institutions, activities and markets by years.”

Fed Gov. Lael Brainard voted against the board's proposal, saying in a statement that while she supported some reduction in the frequency of plan submissions, the new regulation would "weaken the important safeguards put in place to address vulnerabilities that proved extremely damaging in the crisis."

Yet some former regulators say it is prudent to allow firms that present less of a systemic risk than the global megabanks to file complete plans less often.

"The risk of having a messy, government-resolved failure really focuses in my view on a much larger institution, so the ones that are actually still covered by the resolution planning I think will be the ones that you'd be most concerned about there,” said Mike Krimminger, a partner at Cleary Gottlieb who was the FDIC's general counsel when the original living wills rule was drafted in 2011.

After banks and regulators have completed several rounds of submitting and grading plans, there now may be a better understanding about which aspects of the plans are most important.

“There's a lot that goes into preparing and reviewing these plans, where I imagine there is a cost benefit of what's coming out of the full-blown exercises,” said Katheryn Van der Celen, a director at Promontory Financial Group. “There's now been enough learning to see what has been most meaningful and impactful, and I think that's what's being reflected here."

The Fed and FDIC also retained the discretion in their proposal to require full resolution plans from banks if market conditions or substantial changes warranted, said Krimminger.

“I think not to require plans at all for institutions that are, say, edging towards $250 [billion] or something like that could create some problems in a crisis, but it depends on the nature of the crisis, how it plays out, where the real stresses are,” he said.

Still, critics of the industry said easing the requirements increases the chance that the government would have to step in at a failing megabank rather than risk the consequences of a traditional bankruptcy.

“You could be stuck without enough capital or liquidity to take care of significant trouble at your bank without government assistance,” said Marcus Stanley, the policy director at Americans for Financial Reform.

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