Rejection of banks’ living wills unlikely to carry near-term enforcement action

From  SNL
By Zach Fox
August 7, 2014


Following the rejection of the second submission of living wills for 11 large, complex banks, regulatory consultants are looking to July 2015, when the banks have to re-submit their plans. The fundamental question: What would regulators do if banks failed to address the living wills yet again?

Media reports varied widely. A MarketWatch report quoted a senior Federal Reserve official as saying the regulators have the power to “take whatever supervisory action we thought appropriate,” including divestiture. However, a piece in The Wall Street Journal paraphrased a Federal Reserve official as saying the agency would only force divestitures if a bank’s submissions failed to pass muster for multiple years.

Contacted by SNL, a Federal Reserve spokesman said he could not comment on the Journal’s phrasing and that the Fed was not providing any guidance on potential actions should the 11 banks’ 2015 submissions fail.

However, an FDIC spokesman was willing to offer additional detail, which suggested that no enforcement action was possible in the near-term, that any regulatory action related to living wills would be at least a year away and that any chance of a forced divestiture was at least three years away.

The spokesman said the agencies need to issue a notice of deficiency prior to taking any sort of enforcement action. Such a notice requires a determination that the living wills were “not credible” from both the FDIC and the Federal Reserve, whereas only the FDIC made such a determination in the Aug. 5 rejection.

Per FDIC guidance, after a notice of deficiency is issued, the company receiving the notice has 90 days to submit a revised resolution plan, but the company can request an extension if it provides sufficient justification. Then, if the re-submitted plan does not adequately address the initial deficiencies, the FDIC and Fed can subject any company or subsidiary “to more stringent capital, leverage, or liquidity requirements, or restrictions on growth, activities, or operations.”

But even then the regulators cannot force divestiture. Only if the company fails to address its resolution plan within a two-year window after the enforcement action can the FDIC and the Fed direct the company to divest assets. Therefore, for now, the banks have an opportunity to address the regulators’ concerns and re-submit a plan.

“I don’t know how many times that game of ping pong goes on, but I think that’s kind of the nature of the exercise,” said Oliver Ireland, a partner with Morrison Foerster who specializes in bank regulatory issues.

At the same time, the sheer size of the banking organizations played a role in the FDIC’s “not credible” determination. FDIC Vice Chairman Thomas Hoenig issued a forceful statement ripping the resolution plans. In doing so, he made note that the banks have only become larger and more interconnected after the 2008 panic. He highlighted that the assets of the eight largest U.S. banking companies total 65% of gross domestic product and that the average notional value of derivatives for the three largest U.S. banks increased 30% since the start of the crisis to $60 trillion at 2013 year-end.

Indeed, SNL data shows asset growth has been significant for the seven U.S. banks among the 11 organizations included in the so-called “first wave” of resolution plans.

Combined, the seven U.S. companies reported total assets of $8.970 trillion in the 2014 second quarter, up 12.54% from $7.971 trillion as of the 2007 fourth quarter. However, that rate of asset growth has been slower than improvements in the national gross domestic product, so as a portion of GDP, the asset size of the seven U.S. banks constituted 53.40% of GDP in the second quarter, down from 55.05% at the end of 2007. Hoenig’s figure of 65% represented the eight largest banking organizations, which would include Wells Fargo & Co., a massive company that was not part of the first wave of resolution plans and therefore not included in SNL’s figures.

Yet, even some advocates of banking reform are not pushing for divestiture. They point to other regulatory efforts, such as the Volcker Rule, capital adequacy requirements and the liquidity coverage ratio, as already forcing banks to simplify and shrink.

Mayra Rodriguez Valladares, managing principal of MRV Associates, a financial regulatory consulting and training company, said the living wills force banks to look in the mirror and face issues of excessive complexity, particularly in cross-border claims.

“Most of the time, you’re so enormous supposedly because you’re getting a tax relief, you’re getting some type of capital relief out of it, it really is helping you increase your profits. But if it isn’t achieving any of that, then why do you have all this? Why are you so big and unwieldy?” Rodriguez Valladares told SNL.

She said one of the primary takeaways from the Aug. 5 rejection was that banks might need to rethink the amount they have paid outside legal consultants who pitched the banks on their expertise in resolving cross-border jurisdictional issues.

“I think this is a real black eye for all these global legal firms that have been racking up millions of dollars in fees. … If I were the CEO of a bank, I’d be pretty pissed off right now,” she said.

With a different take, Cornelius Hurley, director of the Boston University Center for Finance, Law and Policy, said he thought banks might have wanted to fail the living wills test in order to ensure the market would continue to offer a too-big-to-fail subsidy. That sentiment was shared in an Aug. 6 blog post by Better Markets, a nonprofit focused on financial reform.

“I think the root of the problem is that it’s not in the interest of these 11 institutions to submit a good plan. If they had, on the shelf, the best plan that would prove to the Fed and the public that they can be resolved in an orderly way, they would not submit it because they benefit from the opacity,” Hurley told SNL.

As long as their resolvability remains shrouded in mystery, Hurley said, markets will continue to consider them safer due to an implied government backstop. Whether huge banks enjoy such a market discount was the subject of a controversial Government Accountability Office report, which some industry participants used to claim that the too-big-to-fail problem had greatly diminished. However, there appeared to be consensus among senators at a hearing on the report that too big to fail continues to exist.

In his statement on the rejection of living wills, the FDIC’s Hoenig said the resolution plans were not an ultimate solution that could ensure large, complex banks can be resolved in bankruptcy and without government support. He pointed to effective examination and supervisory oversight, along with strong management and prudent capital management.

“You’re never going to have too-big-to-fail in a box,” Morrison Foerster’s Ireland told SNL. “In my view, if you’re in a full-blown financial panic, are you going to be comfortable liquidating a bank under one of these living will processes and think you’re not going to aggravate the panic?”…


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