Although the Federal Deposit Insurance Corp. views the seizure of a failing behemoth as "the option of last resort," an effective resolution system developed by the agency will combat competitive distortions in the market, the agency's acting chief said Thursday.
Acting FDIC Chairman Martin Gruenberg told large-bank representatives that regulators should favor an "integrated" process, using supervision to force institutions to repair problems early and avoid failure, while still prepping in case a resolution is necessary.
But he added that just having a workable resolution system in place will help fix inequities favoring the big firms, and that there is "a very strong public interest" in the FDIC succeeding.
"Without this capability, these institutions — which by definition pose a risk to the financial system — create an expectation of public support to avert failure," Gruenberg said in prepared remarks to a meeting of The Clearing House, which represents the 20 largest commercial banks. "That distorts the financial marketplace, giving these institutions a competitive advantage that allows them to take on even greater risk and creating an unlevel playing field for other financial institutions that are not perceived as benefiting from potential support."
The FDIC has long had the power to resolve failed banks, but following the turmoil of the 2008 financial crisis, Congress in the Dodd-Frank Act extended that power for systemically important giants — including holding companies and investment firms — which the government believes could wreck the economy if put into bankruptcy.
"Developing a credible capacity to place a systemically important financial institution into an orderly resolution process is essential to subjecting these companies to meaningful market discipline," Gruenberg said.
Much of the agency's work to implement the system is complete, he said. The FDIC finalized a rule in July outlining mechanical details of the wind-down facility, including the priority list for creditor claims stemming from a large-firm receivership. Two rules finished in September — including one done jointly with the Federal Reserve Board — lay out requirements for the company-drafted "living wills", that are meant to show regulators how a firm could be unwound.
The living-will requirements "will ensure comprehensive and coordinated resolution planning for both the insured depository and its holding company and affiliates in the event that an orderly liquidation is required," he said.
Additionally, Gruenberg said the agency's new Office of Complex Financial Institutions has been working since passage of Dodd-Frank to complete the FDIC's own internal resolution plans, which "apply many of the same powers that the FDIC has long used to manage failed-bank receiverships to a failing systemically important financial institution."
But he stressed that resolution planners and supervisors need to work in tandem, with the ideal objective being that troubled firms never get in the position where the government has to seize them.
"It is important to recognize up front that resolution is always the option of last resort," Gruenberg said. "The purpose of the supervisory process is to make sure that institutions manage their risks so that the risk of failure is minimized. The goal is to have a supervisory process that can recognize problems early and encourage management to address problems in a proactive way."
"What is needed," he added, "is an integrated process of supervision and resolution planning for systemically important financial institutions that will provide for early supervisory intervention to avoid resolution, but that will be prepared to carry out an orderly resolution if needed."
