Big banks will face a major test this summer.
In July, 11 banks are due to submit “living wills” to regulators to prove that they can liquidate safely in case of a failure, an event that has become a major deadline with serious implications for the banks, including higher capital levels or even, down the road, forced break-ups.
Federal Reserve Chairwoman Janet Yellen last week reaffirmed to lawmakers that she and other regulators are planning for a showdown over the plans this summer.
“We’re fully prepared to declare the living wills to be not credible,” Yellen said Tuesday.
The living wills are a little-noticed but critical feature of the 2010 Dodd-Frank financial reform law, passed by a Democratic Congress and signed by President Obama with the stated goal of preventing future financial crises and bailouts of major financial firms.
They are supposed to spell out clearly in advance how a company, in case of insolvency, would resolve its outstanding debts and close up its various lines of business without sparking a broader crisis.
But since last summer the wills have taken on a new significance, thanks largely to progressive Sen. Elizabeth Warren of Massachusetts and other lawmakers who have discussed their hopes of breaking up the big banks. Warren and others have pressured regulators to turn the living wills process into a tool to force banks to simplify their businesses themselves or to do it for them.
After the first round of living wills was submitted in 2012, regulators gave feedback the the banks in late spring 2013, identifying weaknesses and planning to give further instructions on how to make better plans in future years’ editions of the wills.
That was how the process was expected to play out, with regulators demanding constant changes to wills, and banks responding year by year the way personal wills are updated as circumstances change.
But that changed in August, just weeks after Warren, the most outspoken populist critic of Wall Street in Congress, challenged Yellen in a congressional hearing about why the regulators hadn’t rejected the living wills outright.
The Federal Reserve and the Federal Deposit Insurance Corporation in August rejected the living wills of 11 big banks, including Bank of America, Goldman Sachs and Citigroup, telling them in letters that their plans involved unrealistic assumptions about the bankruptcy process and they had failed to make the changes necessary to their legal structures to be resolved safely.
At the time, FDIC Vice Chairman Thomas Hoenig, viewed as a major critic of the size of Wall Street banks, said that the wills “demonstrate little ability to cope adequately with failure without some form of government support. The economy would almost surely go into crisis.”
Yellen’s testimony this week indicates that regulators are still taking a tough line on the round of living will submissions expected in July.
“Let me say that we are taking the living wills process very seriously,” she said in a House Financial Services Committee hearing Wednesday.
“In some of the largest firms, we have seen very meaningful steps toward reducing the number of legal entities along the lines that we have suggested. If we do not see the kind of progress that we expect, we have told these firms that we expect to find their submissions not credible,” she added.
Under Dodd-Frank, failing to create a credible living will means the regulators can impose higher minimum capital or liquidity standards on banks. After two years, if the bank fails to submit an amended plan, the regulators have the power to force divestitures, without Congress getting involved.
The living wills can run into the tens of thousands of pages, Yellen said. To have that paperwork finished before the July 1 deadline, they would have to have done whatever concrete steps are necessary by May or June. That includes spinning off ancillary businesses or decreasing the number of legal entities, a daunting task.
“I can understand that the banks feel that the timeline has been impossibly accelerated,” said Mayra Rodriguez Valladares, a financial regulatory consultant.
That acceleration, Rodriguez Valladares said, is attributable to Warren, who made the living will process “a very public event.” She added that, “if the banks keep failing it tells us the banks are too big to understand themselves.”
