As required by the Dodd-Frank Act, the largest U.S. banks have submitted resolution plans (aka living wills) to the federal government describing their strategy for rapid and orderly resolution in the event of bankruptcy. The banks now await “credibility letters” from the government, which will signal what regulators consider to be an acceptable resolution strategy. A minimalist approach is not likely to be adequate. In 2013, institutions in the second wave of resolution plan submissions, including the growing mid-tier, can benefit from lessons being learned now by larger banks.
The purpose of the resolution plans is to help prevent a replay of the turmoil that followed the 2008 financial crisis by ensuring that distressed institutions have a strategy for rapid and orderly resolution in the event of bankruptcy.
Each plan, commonly referred to as a living will, is intended to provide transparency regarding organizational structure, critical operations and interdependencies within the organization. That’s no simple task given the complexity of maintaining the day-to-day operations of a large financial institution. An institution can comprise a web of different legal entities, business units and international operations, creating many potential barriers to implementing an effective resolution plan. And the consequences of noncompliance could be severe— strong regulatory scrutiny or a possible breakup of an institution if a resolution plan is not acceptable to regulators.
An orderly resolution strategy must be built on a credible, actionable plan that specifies which entities are preserved, which are unwound, and, most importantly, how the institution plans to go about the process. Fulfilling this mandate requires developing a legal entity framework that supports a viable business model, doesn’t complicate resolution, and protects the firm’s best experts, technology, data centers and real estate in an entity that can remain through bankruptcy.
Some institutions view compliance with the resolution requirements as largely a documentation task. However, this approach has potentially serious shortcomings, in particular failing to adequately describe how the resolution process will be conducted. Forward-thinking banks recognize that an orderly resolution strategy must be built on a credible, actionable plan that specifies which entities are preserved, which are unwound, and, most importantly, how the institution plans to go about the process. And they are using the regulatory mandate as an opportunity to rationalize and streamline their organizations.