Big banks don’t want to write living wills
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Big banks don’t want to write living wills

Regulators find resolution plans ‘non-credible’; threat of break up hangs in the air.

The US Federal Reserve and the Federal Deposit Insurance Corporation offered damning judgments last month on the living wills written by 11 of the world’s largest banks to outline a strategy for rapid and orderly resolution in the event of distress.

 I am sometimes told that regulators have not provided sufficient guidance to firms preparing plans. I disagree

Thomas Hoenig

Producing credible living wills is a key requirement of policymakers in their efforts to prevent taxpayer subsidy of too-big-to-fail banks from encouraging excessive risk-taking. The intent is to subject banks to the same market discipline as industrial corporations by making conventional bankruptcy proceedings, with an orderly disposal of assets, a realistic prospect.

The US regulators told Bank of America, Bank of New York Mellon, Barclays, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan, Morgan Stanley, State Street and UBS, that the latest drafts of their resolution plans were based on unrealistic and inadequately supported assumptions about the likely behaviour of customers, counterparties, investors, central clearing facilities, and regulators, and condemned the banks’ collective “failure to make, or even to identify, the kinds of changes in firm structure and practices that would be necessary to enhance the prospects for orderly resolution”.

Thomas Hoenig, vice chairman of the FDIC was in no mood to take prisoners, anticipating and rejecting banks’ subsequent off-the-record counter briefings about lack of specific detail in regulators’ requirements. “I am sometimes told that regulators have not provided sufficient guidance to firms preparing plans. I disagree and would note that besides regulators, the bankruptcy law itself provides guidance. I also would note that many of the firms being required to provide living wills are the same firms that employ teams of experts that prepare acquisition and restructuring plans for clients, corporations, and financial companies across the globe. There is every reason to expect a credible plan from these firms.”


Hoenig’s credibility in leveling these charges is probably enhanced by the self-criticism implied in his analysis of where six years of enhanced regulatory oversight has left the industry. “These firms are generally larger, more complicated, and more interconnected than they were prior to the crisis of 2008. They continue to combine commercial banking, investment banking, and broker-dealer activities. The average notional value of derivatives for the three largest US banking firms at year-end 2013 exceeded $60 trillion, a 30% increase over their level at the start of the crisis.”

He adds: “There have been no fundamental changes in their reliance on wholesale funding markets, bank-like money market funds, or repos, activities that have proven to be major sources of volatility.”

It’s not hard to see why banks have dragged their feet on living wills. Large banks have generally enjoyed an implicit promise of sovereign support that lets them fund at low-cost, engage in maturity transformation to lend to the real economy and profit on the margin. This not-so-secret sauce has continued to spice up their profits, even after post crisis financial regulation sought to free taxpayers from the contingent liability to support failing banks. In its Global Financial Stability report published in April, the IMF found that even in 2012, the implicit subsidy given to global systemically important banks was up to $70 billion in the US, and up to $300 billion in the euro area.

No bank in its right mind will rush to give that away.

But there is something even more profound in the antagonism between regulators and banks hinted at in the vehemence of Hoenig’s criticisms. Banks’ unwillingness to simplify their overly-complex portfolios of legal companies, to disentangle the cross subsidies and dependencies between different divisions and to separate profit centers into stand-alone businesses capable of triage in an emergency and separation between those that can be sold-off, closed down, or otherwise saved stems from an existential anxiety.

Break-up call

Bank chief executives must fear that if they do produce the living wills regulators demand, then the consequences might confront them long before any firm-specific or industry-wide crisis requiring resolution. The next step might well be for investors to press for banking conglomerates to break themselves up. It would also be much easier for regulators to re-impose a Glass-Steagall style separation of riskier and more volatile investment banking activity from utility-style deposit taking, payments services and lending if banks would only neatly repackage those business lines into separate legal entities under new holding companies. Of course, they could do it anyway.

I am somewhat surprised by how few senior bankers seem to understand regulators’ determination to reshape the industry

Euromoney speaks to a recently departed senior figure at one of the leading bank regulatory bodies who explains: “The banking industry is still subject to fundamental change and I am somewhat surprised by how few senior bankers seem to understand regulators’ determination to reshape the industry and alter its business model. Regulators are very focused on how, in the build up to the crisis, while banking books grew by an order of magnitude at least correlated to GDP growth, banks’ market exposures grew by a multiple of economic growth. Regulators will continue to press. You see it in FICC where more and more activity will take place on regulated exchange-like venues. And more and more trading and even lending activity will take place outside the banking industry.”

The Fed and the FDIC have given the 11 banks until next July to improve their resolvability. The punishments if they are then declared in non-compliance with Dodd-Frank might include suspension of dividends and share repurchases and enhanced capital requirements. Hoenig notes: “While these most complicated firms may have added some capital as a funding source, they have only marginally strengthened their balance sheet to facilitate their resolvability, should it be necessary.” He points out: “They remain excessively leveraged with ratios of nearly 22 to 1 on average. The remainder of the industry averages closer to 12 to 1.”

But the threat of enforced break up also now hangs in the air.

Frederick Cannon and Matthew Dinneen, analysts at Keefe, Bruyette & Woods, note: “The FDIC’s use of the term ‘not credible’ is important, as part of Dodd-Frank, a finding of “not credible” can allow for the agencies to require divestitures.” They add: “The FDIC’s use of the term “not credible” for all of the banks this year makes us believe that one or more individual banks may be at risk in 2015 for enforcement action.”

Most at risk

In view of Hoenig’s concerns about complexity, size of derivatives outstanding and dependence on short-term wholesale funding, the KBW analysts find that among US banks, the most at risk are likely to include Citi, JPMorgan and Goldman Sachs, while among the foreign banks are Barclays, Credit Suisse and Deutsche. They conclude: “We believe that one of the results of the Living Wills review will be to accelerate the divestitures of subsidiaries.”

Big banking conglomerates have so far mainly simplified by selling small foreign operations, such as Barclays did last month in offloading its retail and corporate banking, wealth and investment management businesses in Spain to CaixaBank and its retail banking business in UAE to Abu Dhabi Islamic Bank. Meanwhile speculation abounded that Citi will sell its consumer banking business in Japan. KBW points out that Citi has made 44 divestitures since 2009.

Piero Novelli, chairman of global M&A at UBS, tells Euromoney that beyond disposals of small, non-core assets, banks are unlikely to engage in more profound M&A before 2016 and 2017. “It might surprise you to hear, but when it comes to M&A bank executives are by nature quite conservative and very aware of deal risks. Larger deals are also highly political. FIG often rises to prominence only late in the M&A cycle, which is only now beginning to pick up.”

But regulators may press for something faster and more profound.

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