NEW YORK--(BUSINESS WIRE)--The recent regulatory reviews of large U.S. banks' "living wills" illustrate liquidity remains a key challenge in resolution planning, according to Fitch Ratings.
On April 13, 2016, the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve Board (the Fed) jointly announced the results of their review of the largest eight bank holding companies' resolution plans. Seven of the eight banks had either "deficiencies" or "shortcomings" associated with their liquidity planning when executing their resolution strategy. Deficiencies are regarded as more significant than shortcomings and must be addressed in the banks' resubmission on Oct. 1, 2016. If a bank has not taken sufficient actions to address deficiencies in its October 2016 filing, the authorities have the power to impose more stringent capital or liquidity requirements.
U.S. banks are required to submit resolution plans demonstrating their ability to be resolved in an orderly manner through a bankruptcy filing (Dodd Frank Title I) as opposed to an orderly liquidation under Dodd Frank Title II. Resolution under Title II allows the FDIC to wind down a failed systemic bank using "Orderly Liquidation Authority" (OLA) powers. Use of OLA powers allows the authorities to provide liquidity support to facilitate resolution; but this is envisaged as an exception to "normal" bankruptcy and needs to be authorized by the Treasury secretary as well as the FDIC and the Fed. Resolution under Title I bankruptcy is challenging for banks, as the amount of liquidity needed by a failing G-SIB is likely material, especially if liquidity held in overseas entities is not available due to ring-fencing.
Bank of America BAC, Bank of New York Mellon BK, JP Morgan Chase (JPM), State Street (STT) and Wells Fargo (WFC) have failed to submit credible 2015 living wills in the eyes of regulators. Consequently, these banks must resubmit their plans on Oct. 1, 2016. In the resubmission, the regulators expect the banks to either remedy the noted deficiencies or to have made material progress and show how the deficiencies will be remedied by the July 2017 submission.
In contrast, Goldman Sachs (GS), Morgan Stanley (MS) and Citigroup (C) are not subject to an October 2016 re-submission (but need to address shortcomings in their July 2017 assessments). All three firms lacked the more serious deficiencies noted for the five banks. The Fed disagreed with the FDIC in finding GS's plan to be "credible," whereas the FDIC disagreed with the Fed in finding MS's plan to be credible. However both regulators agreed Citi's plan was credible.
All of the banks, with the exception of WFC, had either deficiencies or shortcomings associated with their liquidity planning. The resolution framework requires banks to estimate their liquidity needs and ensure high-quality liquid assets are available to meet stand-alone entity and parent holding company funding needs pre-resolution. Then, after the parent's bankruptcy filing, firms need to estimate and ensure there is sufficient liquidity to enable surviving entities to operate post-filing. The review outcomes mainly point to challenges banks had estimating liquidity needs for all of their material entities or may face in moving liquidity between subsidiaries, particularly foreign subsidiaries and branches, during resolution.
The regulators also highlighted concerns about firms' ability to provide critical services - such as custody, trust and clearing functions - both to the market and to group entities throughout a resolution proceeding. BAC, JPM, MS, GS and Citi's plans for winding down or hedging their sizable derivatives portfolios were found to be insufficient.
U.S. banks continue to make progress toward improving resolvability, but Fitch believes that the authorities will continue to find a Title I resolution challenging for the U.S. G-SIBs, and therefore, OLA remains a likely scenario in the event of a U.S. G-SIB resolution.
Fitch does not view the lack of acceptance by regulators of the respective resolution plans to be reflective of these institutions' current and ongoing financial health.
For all firms subject to the resolution planning process, Fitch's ratings incorporate the expectation that objectives set out by the regulators in this process will be achieved in a timely fashion. While it is not Fitch's expectation, should a bank become subject to regulatory action due to ongoing deficiencies in their resolution plan, Fitch could take negative rating actions.
Additional information is available on www.fitchratings.com.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.