On a cold March morning, a long line of people meandered around a bank building. They had waited all night, hoping to withdraw their savings when the bank opened the next morning. Many were retirees living off meager monthly pensions sufficient to buy bread and milk but not luxuries such as meat and fruit. Around 10 p.m. the night before, my 68-year-old father patiently stepped up to the end of the line, wearing an old but presentable three-piece suit. He belonged to a pre-World War II generation that believed one ought to dress up to visit a reputable institution such as a bank.
On that drizzly morning, as daylight was struggling to penetrate city smog and gray clouds, it turned out that his three-piece suit was not necessary. By the time he reached the teller window—a solid 12 hours after he had joined the line and a mere hour after the bank had opened its doors—there was no money left to distribute to depositors. The bank was going under, and in the run on deposits, my father was not quick enough. His life savings were wiped out.
The next day, he went to a street corner where he recalled seeing day laborers as he had made his daily trips to get bread and milk. This time, he was wearing patched-up pants, a sweater that my mother had knitted from leftover wool, and old shoes that he had polished that morning. Once again, he stepped in line, hoping to earn 10 Deutsche Marks for eight hours of physical labor.
The year was 1993, and my father was in Belgrade, former Yugoslavia, as the country was falling apart.
When I assumed the chairmanship of the Federal Deposit Insurance Corporation (FDIC) in June of last year, I did so with a firm belief that we ought to do whatever it takes to ensure that no 68-year-old would ever wait in a bank line and walk away empty-handed. Eight months later, I believe I know how we can get there…together.
During its 85 years of experience as a resolution authority for banks and insured depository institutions, the FDIC has resolved more than 2,700 institutions with assets of more than $1 trillion and almost $800 billion in deposits. It has weathered two banking crises in the past four decades: one in the 1980s and early 1990s and another during the recent Great Recession.
Each failure and crisis has presented us with opportunities to assess and adapt our resolution strategies and procedures. We have developed new tools, ranging from bridge banks to loss-sharing arrangements, while also adapting to new congressional requirements, such as the mandate that we resolve banks at the least cost to the Deposit Insurance Fund.
Over the course of thousands of resolutions throughout the FDIC’s history, no depositor has ever lost a penny of insured deposits. We are proud of our record of successfully handling smaller bank failures, but we recognize the differences and unique challenges associated with resolving larger institutions, particularly the most complex global financial institutions. Our efforts to strengthen and streamline the process of resolving a large institution are constant and ongoing.
The goals of resolution
The fundamental goal of resolution should be the same for institutions large or small: to enable failure in the least disruptive manner. That may sound too negative, but providing a vehicle for failure is critical.
Markets work best when risk-takers are held accountable for both their gains and losses. When institutions benefit from the upside of their gains, but taxpayers bear the burden of their losses, the result is market failure and moral hazard. In such circumstances, institutions—and their shareholders and counterparties—benefit not from their business decisions but from political decisions. Resolution should work to break this cycle and to make sure that market discipline is real and imposed.
Institutions that are big must be able to fail just like small institutions: without taxpayer bailouts and without undermining the market’s ability to function. This is no easy task because a large institution’s failure can have a tremendous impact on the market and third parties.
This is the core challenge surrounding failure—a challenge that the FDIC and resolution authorities around the world must address.
Resolution in the United States
The greatest untested resolution challenge comes from the largest, most complex institutions. Because our goal for these institutions is that they are able to fail, our first priority is preparing to facilitate orderly resolution of these firms in bankruptcy. In the United States, the largest bank holding companies and certain foreign banking organizations with US operations (FBOs) are required by law to submit resolution plans outlining how they can fail, in an orderly way, under the U.S. Bankruptcy Code. These plans, known as living wills, describe the firm’s strategy for rapid and orderly resolution in the event of material financial distress or failure of the company, and include both public and confidential sections.
While we need to do advanced planning, after several cycles of reviewing these comprehensive plans and providing feedback, we recognize that we can do so in a more targeted and efficient manner. Because it is good government to regularly revisit regulations to ensure they are appropriate for the present, the FDIC and the Federal Reserve Board of Governors have been reviewing the resolution planning regulations for all covered companies.
US global systemically important bank resolution planning
Through the resolution plan process, US global systemically important banking organizations (G-SIBs) have made strides and implemented significant structural and operational improvements that have enhanced their resolvability in bankruptcy.
They have developed a single-point-of-entry (SPOE) resolution strategy that, if successful, would enable the functioning of critical operations at key subsidiaries, while the parent enters what is akin to a prepackaged bankruptcy proceeding. These firms have established clean holding companies and issued long-term debt so that market participants—not taxpayers—bear the risk of loss, and they have identified mechanisms for measuring, maintaining and making available timely liquidity to fund operations during this period. They have taken steps to modify their contracts with service providers and counterparties, and they have worked to simplify their structures and funding lines to facilitate their strategies.
There have been some indications that markets have reacted positively to these developments. Some studies suggest that we have seen improved debt pricing for the largest banks. While we should be cautious in drawing conclusions based on such data, they are nonetheless encouraging.
Still, although progress has been made, SPOE in bankruptcy remains untested, the challenges to successful execution of a SPOE strategy are notable, and there is still work to do. The FDIC and the Federal Reserve have identified several key areas in need of further clarity, and firms should continue work developing, testing and operationalizing their systems and capabilities to make sure that their resolution strategies will work if and when they are needed.
Foreign banking organization resolution planning
Similarly, certain FBOs also submit resolution plans. The FDIC and the Federal Reserve review the plans and engage with the FBOs on their resolution planning requirements. This includes meeting with the four largest FBOs and issuing detailed and publicly available feedback letters. As host authorities, we recognize the importance of continued home-host cooperation and the preferred outcome for these FBOs: successful home-country resolution.
Since the Great Recession, the four FBOs have improved their resolvability by significantly reducing the size and risk profiles of their US operations and increasing their capital and liquidity levels. At the same time, the resolvability of firms will change as both the firms and markets continue to evolve. The FDIC and the Federal Reserve expect all firms subject to resolution planning requirements to remain vigilant in assessing their resolvability.
Insured depository institution resolution planning
Separate from the resolution planning requirement described above, which applies at the holding-company level, the FDIC has a separate resolution plan rule for insured depository institutions (IDIs), the so-called “IDI rule”. This requirement generally applies to IDIs with at least $50 billion in assets.
There are a few noteworthy differences between the holding-company and IDI requirements. Instead of focusing on the entire banking organization and envisioning a resolution under the U.S. Bankruptcy Code, the IDI rule focuses only on the IDI subsidiary and envisions a resolution using the FDIC’s traditional resolution tools under the Federal Deposit Insurance Act. Instead of focusing on financial stability and systemic risk, the IDI plan is focused on the FDIC’s ability to resolve a particular firm, protect taxpayers, minimize potential losses to the Deposit Insurance Fund and ensure that insured depositors have access to their cash in an orderly fashion and as quickly as possible.
The FDIC recognizes the costs and burdens involved in developing these plans, and we are exploring a more targeted and efficient approach, including significant changes to the IDI rule. We plan to propose revisiting the current $50 billion threshold for application of the rule and ensuring that requirements are appropriately tailored to reflect differences in size, complexity, risk and other relevant factors.
Given the cross-border implications of resolving a G-SIB, we have to be cognizant of our role as host authority as well. Many US firms operate overseas, some foreign firms operate in the United States, and regulators need to make sure we are not working at cross-purposes. The FDIC has strong working relationships with our foreign counterparts. For many years, the FDIC, the Bank of England, the European Commission, the Single Resolution Board and the Swiss Financial Market Supervisory Authority (FINMA)—to name a few—have worked closely on cooperation and resolution planning.
We host annual crisis-management group meetings that bring together home and host authorities to discuss resolution planning for each US G-SIB, and we participate in similar meetings for foreign G-SIBs operating in the United States. We regularly coordinate with foreign jurisdictions through multilateral venues, and we have built a solid foundation for cooperation and planning with other resolution authorities around the world.
Much of the current bilateral and multilateral work focuses on cross-border planning for operational readiness, such as the positioning of cross-border resources, approaches to the wind-down of cross-border derivatives portfolios and facilitating continued access to financial-market infrastructures. This reflects a progression from policymaking to implementation as work on resolution planning matures. I expect this approach will gain momentum as we continue to build the cooperative relationships that underpin our operational readiness.
We have a very good foundation for building a better understanding and process, but there is still important work to do.
It has been more than a decade since the onset of the financial crisis. The FDIC has devoted considerable time and resources to studying the crisis, including its causes and its consequences. There were regulatory gaps leading up to the crisis—perhaps none more important than the inadequate planning for the potential failure of the largest banks and their affiliates.
At this point, a number of the post-crisis regulatory changes have been in effect for several years. While it is essential that we learn from prior crises, it is crucial that our regulatory framework be sufficiently agile to address a future crisis. We must, therefore, closely examine how these new regulatory requirements are working and whether modifications are appropriate in order to ensure that agility in both the institutions’ preparedness and regulators’ response.
Orderly resolution is a goal that resonates personally and profoundly with me. My now 93-year-old father lives with me in the United States. He is a constant reminder of why resolution planning is so important. It does not mean that we are rooting for resolution; it means we are building a process to ensure that orderly failure is possible, that market discipline exists, that taxpayers are protected and that insured depositors have confidence they will receive their cash quickly and orderly under any circumstances.
Under my leadership, the FDIC will forge ahead to ensure the stability of our financial system while continuing to engage with our foreign counterparts. After all, we are in this together.
“Crisis and Response: An FDIC History, 2008–2013,” available at https://www.fdic.gov/bank/historical/crisis/crisis-complete.pdf