Why watering down resolution plans is a bad idea
Critics of living wills – the plans banks prepare to help the authorities in case of failure – are in the ascendant. Trump’s comptroller of the currency, Jonathan Gould, would like to see the FDIC’s bank-level plans abolished. He is seen as having played a significant role in a recent proposal to halve the requirements for banks. In the EU, where the Single Resolution Board writes the plans with data from the region’s banks, the Commission is pushing for less regular data reporting in the name of competitiveness.
Resolution plans are an obvious target for the coterie of lobbyists, politicians and regulators working to dismantle the post-2008 regulatory apparatus. They are long, complex, and require dedicated teams of specialists to prepare. Most of all, critics point to the 2023 bank failures in the US and Switzerland as evidence they are unusable: no failed bank was resolved according to its resolution plan that year.
But this verdict is misguided. It’s undeniable that the plans were not strictly adhered to in 2023. But they remain useful in a number of ways. In the case of Credit Suisse, a sale to UBS was facilitated by AT1 bondholders being written down. Though the Swiss authorities presented a number of guarantees to smooth the transaction, ultimately investors took the brunt of the bank’s losses, and no state-funded capital injection was needed. In the US regional banking crisis that same year, SVB’s previous resolution plan is said to have been useful to the authorities, particularly in keeping track of the bank’s international operations.
More broadly, while resolution plans can never be step-by-step guides to an orderly failure, they provide crucial information which allows resolution authorities to act fast to prevent contagion. What banks have built in the past decade, and continue to build every time they sit down and draft resolution plans, are the structures that make failures manageable.
The development of resolution planning over the past 10 years marked two great advances over the previous status quo. One, it limited the unpredictability of bank failures and their aftershocks by setting out clear paths forward in different scenarios. Two, it ensured protocols are in place for regulators to receive the necessary information to act fast.
In the frantic weekend leading up to Lehman’s shock bankruptcy, regulators lacked both a clear range of options and the means to act on them. A solution that would have prevented catastrophe was not unattainable. A plan to split the investment bank into two new entities almost came to fruition. But once that option fell apart in the face of UK government opposition, the bankers and their regulators simply ran out of time. The markets opened, Lehman declared bankruptcy, the global economy was sent into a tailspin.
From then on, there was no playbook: regulators rushed to create emergency liquidity facilities to restart frozen money markets and injected hundreds of billions in state-funded capital.
Ad-hoc solutions can work in situations with few moving parts, like the failure of a small bank. But in large, complex organisations, quick action is made possible by existing structures. Successful bank risk management is built on the same principle: unforeseen losses become manageable when banks are set up to keep executives on top of risks, for example through a risk and asset-liability committee structure which includes senior leadership.
The 2023 failures were by no means plain sailing for resolution authorities. They led to exceptional interventions and significant litigation in both the US and Switzerland. But they also showed the progress made since 2008. Regulators can rely on resolution plans to quickly get a view of a large banking group’s activities. For banks subject to them, clean holding companies and stays on derivatives provide legal certainty, while bail-in bonds provide an extra cushion to protect depositors and avoid equity injections. Taken together, these tools provide authorities with the guardrails that were so sorely lacking in 2008.
It may be true that the current US model puts too much onus on the banks to plan for their failure. Moving towards a model closer to Europe’s, where the resolution authority takes on most of the work of scenario planning, may be preferable. But reforms should preserve, and in some cases (such as US regional banks) expand, the structures that make it possible to limit the impact of bank failures. We’ve come a long way since 2008. Now is not the time to take a step back.
Editing by Alex Krohn
