Decoding Bank Resolutions and ‘Living Wills’
When banks and their supervisors provide glimpses of transparency, it often leaves the public wondering what to do with the given information. Take, for example, the Federal Reserve’s recent publication of excerpts from the resolution plans or “living wills” of several banks it supervises. While these documents are necessary, they can also be quite frustrating due to the lack of detailed information provided.
The Purpose and Complexity of Living Wills
Each bank submits a detailed plan to its supervisors, outlining its strategy for an orderly wind-up in the event of a catastrophic loss. The goal of these plans is to describe how the process could be managed without a bailout, market disruption, losses to the deposit insurance fund, or interruption of critical functions. However, these are commercially sensitive matters, and thus, most of the intriguing details are omitted.
Commonalities and Differences
Despite the lack of specific details, all resolution plans share a common structure. They employ a “single point of entry” strategy whereby the top-level holding company transfers all its capital and liquidity to the crucial operating subsidiaries before declaring bankruptcy. The differences between plans are primarily based on the number of subsidiaries and the amount of capital they may require.
Analyzing the Systemic Importance of Banks
A rough measure of the systemic importance and complexity of large U.S. banks can be assessed by counting the pages of their respective filings. Trading positions that could be subject to a margin call necessitate more planning than retail lending and deposit business. Thus, the size of the bank isn’t the only factor determining its systemic importance.
Qualitative Analysis Possibilities
Qualitative analysis may be possible by considering the process through which these documents are produced. Each resolution plan represents the management team’s attempt to confront the worst-case scenario – the demise of their bank. Considering such a grim possibility is psychologically challenging, as witnessed by the Federal Reserve’s decade-long efforts to get banks to take the exercise seriously.
Evaluating the Approach to Worst-Case Scenarios
A potential measure of how well banks handle the scenario planning can be how swiftly they acknowledge the possibility of a catastrophe in their documents. Some banks are noticeably reluctant, taking a significant portion of their document to address the issue. Wells Fargo, for instance, gets nearly half way through before mentioning any potential negative outcomes.
Directness Versus Euphemism
When comparing the way banks address the worst-case scenario, some are more straightforward than others. Goldman Sachs sets the standard for directness, while others like Morgan Stanley and Bank of America resort to euphemisms and passive voice. This difference in approach might seem minor, but it reflects the management team’s willingness to confront harsh realities directly.
Conclusion
The effectiveness of these resolution plans will largely depend on their execution, which in turn hinges on the bank’s senior management’s ability to confront a harsh reality. Considering this, one might question whether it’s more reassuring to have a team that softens the blow with diagrams and euphemisms or one like Goldman Sachs that readily admits the proximity of potential disaster. Experience, expertise, authoritativeness, and trustworthiness (E-E-A-T) are critical factors in this context, which underscores the importance of frankness in disaster planning.
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