Banks Face Higher Stakes as They Prep New Living Wills

WASHINGTON — Federal regulators have upped the ante for the latest round of "living wills" that the 12 most complex banks must submit by Wednesday.

The agencies delivered a stinging rejection of the plans last year, declaring them deeply flawed and warning that their next effort must both fix flaws and do a better job of conveying to the public how these firms might be unwound safely in the event of a crisis.

"The stakes are higher this time around," said Robert Burns, a director with Deloitte Advisory and a former deputy director for complex financial institutions at the Federal Deposit Insurance Corp. "A lot more is being expected. It is not just about submitting a plan, but about showing the firms are making themselves much more resolvable."

It will likely take months before regulators finish reviewing the voluminous plans that run into the tens of thousands of pages, but one key gauge of the quality of the plans will be the portion released to the public.

When banks submitted their living wills last summer, their second try after getting a mulligan on the initial submissions, their public summaries were derided by analysts and observers as having little value.

"The ones that I read last year were very high level and very generic and you didn't learn a lot reading them," said Paul Kupiec, a resident scholar at the American Enterprise Institute and former associate director at the FDIC.

But regulators have been communicating frequently with the banks to ensure they develop usable plans. They have strongly signaled that observers should expect more from the public summaries, which will likely be released the week after the July 1 deadline.

In a statement that followed the living will submissions last year, the Federal Reserve Board and FDIC said that the agencies are "committed to finding an appropriate balance between transparency and confidentiality of proprietary and supervisory information in the resolution plans" and that they would be working with the firms to "explore ways to enhance public transparency of future plan submissions."

Observers said regulators are particularly focused on the "public" aspect of the plan.

"In principle having such a document would be quite valuable if it could make credible that the regulators were going to follow these plans and not bail out the debt," said Chester Spatt, a professor at the Carnegie Mellon Tepper School of Business. "The purpose of the living will process is to provide a mechanism so that the market perceives in the event of a crisis that policy makers are going to be willing to let large institutions fail."

Exactly what institutions will do to make the public portions of the plan more readable is unclear.

Karen Shaw Petrou, managing partner of Federal Financial Analytics, said banks could provide more information in the public summaries by drawing a "link between other publicly announced actions and the resolution planning process."

A key failing of previous submissions was that institutions used overly optimistic assumptions, according to regulators.

"I fully expect to see discussions" about steps the firms have taken to streamline some of their operations, Burns said. He also expects to see "a more detailed discussion of the firm's actual resolution strategies."

If the summaries are more comprehensible, that could persuade investors and a skeptical public that regulators will not seek to bailout the big banks again if another crisis hits. If the market perception of "too big to fail" fades, it would also reduce any potential funding advantage from such a belief.

Lawmakers, too, are keenly interested in the opacity of the living will process, viewing it as a key test for banks and their regulators.

"What has been released to the public is 35 pages long…I think the plans that have been released by these companies have not been something that the public can look at and say that 'yeah I see that they have a plan to get through this," Sen. Elizabeth Warren, D-Mass., said last year.

Regulators have responded by reminding banks that they have been granted significant power through the Dodd-Frank Act to ensure that the plans are credible.

FDIC Chair Martin Gruenberg keyed in on the living will process in a May speech, saying it is the FDIC's mandate to "use the living will process to bring about real-time changes in the structure and operations of firms to facilitate orderly resolution under bankruptcy."

"Ultimately, if a firm fails to submit a plan that demonstrates its resolvability in bankruptcy, the agencies may jointly impose requirements or restrictions on the firm or its subsidiaries, including more stringent capital, leverage, or liquidity requirements," Gruenberg said.

Still, as banks balance transparency and confidentiality it may still be difficult to glean much information about how resolvable a bank is, observers said.

"It would be tough to draw the ultimate conclusion from the public disclosure. Maybe if a public disclosure is really inadequate, that may raise questions as to what the rest of the plan would look like, but it wouldn't necessarily answer that question," Burns said.

Some observers said they also have doubts about the efficacy of the living will process. They noted that regulators' feedback last year was in response to the first round of plans submitted in 2013. Banks did not receive that criticism until after they submitted their 2014 plans, which regulators have not publicly evaluated.

"The fact that it takes so long maybe illustrates that this approach may not be as workable as the advocates of it have tried to suggest," Spatt said.

The bigger problem with the resolution planning process is not necessarily what the banks do, but the "fragmentary nature of what the agencies could do particularly in an event of a cross-border failure," Petrou said.

"There are many things the banks cannot simplify. The banks are being held responsible for planning for a process that is not yet clear enough for anyone to reasonably be able to plan for."

But observers said the importance of the effort cannot be overstated.

"The most important objective of these public disclosures is to create public credibility for the resolution process," Robert DeYoung a professor at the University of Kansas School of Business and former FDIC official said. "Without this credibility, financial markets will likely react poorly to large bank insolvencies and policymakers will face pressure to rescue those banks."

The twelve banks submitting their living wills on July 1 will be Bank of America, Bank of New York Mellon, Barclays, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street Corp., UBS and Wells Fargo.