The FDIC's resolution plan for failed megabanks is an empty promise

Alliance - stock.adobe.com

In April the Federal Deposit Insurance Corporation published a detailed plan for resolving failures of systemically important bank holding companies under Title II of the Dodd-Frank Act. The FDIC's plan seeks to achieve one of the primary goals of the Dodd-Frank Act by protecting taxpayers from the costs of rescuing "too big to fail" megabanks. Although the FDIC developed its Title II plan over the past decade, that plan remains unused.

The FDIC's plan adopts a "single point of entry" resolution strategy. Under that approach, only the parent holding company of a failed megabank is placed in a Title II receivership. Losses from the receivership are imposed on the holding company's shareholders and owners of the holding company's long-term debt. The FDIC provides the necessary funding to maintain the continued operations of the holding company's bank and nonbank subsidiaries.

The FDIC's plan has two very significant flaws. First, imposing losses on the parent holding company's shareholders and debt holders will not provide the resources needed to keep a failed megabank's subsidiaries open and operating. Wiping out the claims of debt-holders will increase the holding company's equity from an accounting standpoint, but it will not provide any new funds to pay the operating costs and other obligations of the holding company's subsidiaries.

Second, the FDIC's sole source of funding for a Title II receivership is the Orderly Liquidation Fund, or OLF, which the Treasury administers. When Congress passed the Dodd-Frank Act, the big-bank lobby defeated proposals that would have required megabanks to pay risk-based premiums to prefund the OLF. As a result, the OLF has a zero balance. The FDIC must therefore borrow from the Treasury to pay the costs of a Title II receivership that cannot be covered by wiping out the holding company's shareholders and debt-holders.

The FDIC has very strong incentives to avoid borrowing from the Treasury to finance the resolution of a failed megabank. Borrowing from the Treasury would raise political red flags by increasing the federal government's debt burden and signaling that taxpayers might have to pay additional taxes if the FDIC cannot repay the Treasury.

Such concerns apparently played a major role when Silicon Valley Bank collapsed in March 2023. SVB's failure provided the FDIC, Federal Reserve and Treasury with a perfect opportunity to show that Title II provided an effective methodology for resolving SVB. However, federal regulators chose not to use Title II, probably because they wanted to avoid borrowing from the Treasury during the political fight over raising the federal debt ceiling in early 2023.

Regulation and compliance

The CFPB is turning to Dodd-Frank’s unfinished business

The Consumer Financial Protection Bureau’s unified agenda was quietly released this week, and it shows that rules on consumer access to financial records and small-business data collection are top priorities. 

By Kate Berry

June 24

Instead, the FDIC (with the Fed's and Treasury's concurrence) issued a systemic risk determination and placed SVB in a bank receivership under the Federal Deposit Insurance Act. A separate Chapter 11 bankruptcy proceeding was required for SVB's parent holding company, SVB Financial Group, or SVBFG. The Chapter 11 proceeding was controlled by SVBFG's creditors instead of the FDIC. A Title II receivership would have avoided Chapter 11 and given the FDIC complete command over SVBFG and its nonbank subsidiaries.

By forgoing a Title II receivership, the FDIC lost the opportunity to gain substantial proceeds from selling SVBFG's valuable securities and venture capital subsidiaries. The FDIC also exposed itself to SVBFG's $1.9 billion deposit claim, which the holding company could not have asserted under Title II.

Thus, the decision to forgo a Title II receivership for SVB imposed significant additional losses on the FDIC and its Deposit Insurance Fund. The FDIC estimates that the DIF will suffer a $19.2 billion loss from protecting SVB's uninsured depositors. To cover that loss, the FDIC imposed a special assessment on FDIC-insured banks with more than $5 billion of uninsured deposits.

If the FDIC had established a Title II receivership for SVB, large bank holding companies with $50 billion or more of assets would have been obligated to reimburse all of the FDIC's losses. Instead, as indicated above, the FDIC imposed a portion of those losses on smaller banks. Additionally, the FDIC depleted the DIF in the midst of a serious banking crisis, thereby creating potential risks for insured depositors as well as taxpayers standing behind the federal government's full faith and credit guarantee for FDIC-insured deposits. 

The FDIC's decision to protect SVB's uninsured depositors was part of a larger series of bailouts during the spring of 2023. Those bailouts included the FDIC's rescue of uninsured depositors at Signature Bank and First Republic Bank, as well as the Fed's very generous loans to other vulnerable banks under the Bank Term Funding Program.  

The FDIC could not use Title II to resolve the failures of Signature and First Republic. Those banks did not have parent holding companies, and Title II does not apply to FDIC-insured banks. Congress should promptly close that dangerous gap by amending Title II to cover all systemically important banks and bank holding companies.

By forgoing a Title II receivership for SVB, federal regulators created substantial doubts whether Title II will ever be used to resolve the failure of a systemically important bank holding company. The same kind of deep skepticism arose after Swiss authorities arranged a government-assisted takeover of Credit Suisse by UBS. Swiss authorities decided not to perform an internal restructuring of Credit Suisse (including a write-off of Credit Suisse's bail-in bonds) because they feared that wiping out Credit Suisse's bondholders could trigger a panic in global financial markets.

The publicly supported rescues of SVB and Credit Suisse confirmed that regulators have not solved the "too big to fail" problem. The pledges of "no more bailouts" in the Dodd-Frank Act and similar laws adopted by other countries remain empty promises, despite the elaborate resolution planning efforts of the FDIC and other global regulators. The FDIC and the Fed reinforced concerns about the resolvability of megabanks when they identified shortcomings in the most recent resolution plans submitted by four of the five largest U.S. banks.

Megabanks continue to exploit implicit subsidies resulting from widely shared expectations of future bailouts. Given the lack of credible strategies for resolving failures of megabanks without publicly funded rescues, we must recognize that megabanks pose grave threats to financial stability and social welfare. Requiring big banks to increase their equity capital significantly would be an important first step in addressing those threats.