Last month, the FDIC Board of Directors voted to propose a rule that would reduce the risk of bailouts and financial crises stemming from large bank failures.1 The agencies proposed requiring owners of these banks to have more skin in the game to bear losses incurred by their own risk-taking. The rule reflects some critical lessons from the 2008 financial crisis that crushed the global economy.
But even with more skin in the game, banks can still fail – and they can fail very quickly. And even when the failing bank isn’t a Wall Street giant, the risk of contagion and crisis is real, as we saw with the failures of Silicon Valley Bank, Signature Bank, and First Republic Bank.
Today, the FDIC Board of Directors is voting on proposed rules that would help protect the public in the event of a massive bank failure, reducing the need for emergency measures, rapid megamergers, and big losses to the Deposit Insurance Fund.
First, the FDIC is proposing to significantly increase the rigor and credibility of the wind-down plans submitted by large banks.2 The enhancements would be especially relevant for domestic systemically important banks (DSIBs).3
Rather than simply assuming that an even bigger bank will be available to acquire it in the event of a failure, under the proposed rule, DSIBs would provide more detailed information on their lines of business, branch footprints, valuation methods, and other details that would enable the FDIC to break up a bank in, and sell it in, pieces to multiple buyers. The proposed rule also contemplates that a failed DSIB could be restructured and recapitalized, including through an initial public offering. Rather than just produce reams of paper, banks would have to demonstrate they have the capabilities necessary to execute their plans.
Second, in conjunction with the Federal Reserve Board of Governors and the Office of the Comptroller of the Currency, we are proposing to require DSIBs to fund their operations with a minimum level of long-term debt. Since big payments on this debt are not due rapidly, long-term debt does not create additional liquidity pressure on a bank facing financial stress. The debt would be available to absorb losses in the event of failure, which would help the FDIC execute the strategies outlined in the DSIB plans for breakup, winddown, or restructuring. Banks would be able to raise this debt in the capital markets or even issue it as a substitute for other types of executive compensation.
Finally, the FDIC and Federal Reserve Board of Governors are proposing guidance that strengthens the resolution plans, or “living wills,” submitted by certain DSIBs and large foreign banks operating in the U.S.4 Unlike the bank-focused wind-down plans that help the FDIC when it takes over a bank as receiver, these broader plans cover the entire conglomerate, and seek to ensure the company and its nonbank operations can fail under Chapter 11 of the U.S. Bankruptcy Code in an orderly fashion. The proposed guidance also addresses certain lessons learned from the recent stress at Credit Suisse that resulted in an emergency government-facilitated megamerger with UBS.5
Collectively, the proposed rules would give the FDIC more options and greater flexibility as the receiver of a failed DSIB. The current approach to deal with a large failing bank is to quickly sell it to an even larger bank. The universe of potential whole bank buyers is small and there is inherent risk in rapidly bidding on a failed bank without months of due diligence, so this strategy can still lead to steep losses to the FDIC’s Deposit Insurance Fund and further industry concentration creep.
But perhaps more importantly, there will be times when a buyer will not be immediately available. Rather than invoke emergency measures, the long-term debt requirement and the submission of wind-down plans will give the FDIC more time and more options. The FDIC can maximize value and minimize negative spillover effects if it can auction off individual business lines, regional branch networks, or otherwise restructure the bank.
Private insurers and creditors use similar strategies to protect their interests. The FDIC should do the same.
While I appreciate that the FDIC’s proposal is the subject of negotiation across banking agencies, the long-term debt proposal does have a few places that do not appear to be grounded in empirical and market realities. During the comment period, the agencies must review whether certain aspects of the proposal need to be adjusted before it is finalized.
First, the proposed long-term debt requirement is only for banks with $100 billion or more in assets. This threshold is somewhat weird. In fact, we have real-world examples where banks under $100 billion, particularly those with high levels of “uninsured” deposits, posed meaningful threats of contagion and had limited resolution options upon failure. In one notable example, the failure of IndyMac in 2008 exacerbated stress in the banking system and led to a $12.4 billion loss to the Deposit Insurance Fund, after there was no immediate buyer available. IndyMac had just $32 billion in assets. Other institutions experiencing failure or stress this year should make us question whether $100 billion is the correct threshold.
Before finalizing, we should determine whether institutions below $100 billion, such as those with high levels of “uninsured” deposits or those that have grown very rapidly, should also be subjected to a similar requirement.6
Second, the proposed rule establishes a long three-year transition period for banks that cross the $100 billion threshold in the future, rather than a prompt effective date. A lot can happen in three years. For example, Silicon Valley Bank crossed the $100 billion threshold in June 2021, and would not have been required to come into full compliance until June 2024.
I appreciate the need for there to be time for banks to plan for and execute new requirements after a rule is put into place, but as the Federal Reserve Board’s Silicon Valley Bank post-mortem highlighted, we need to rethink transition periods for banks that cross regulatory thresholds in the future after the rule has been in place for a while.7
Every serious regulator is concerned about our country’s ability to withstand the failure of large bank, without rushing to a bailout. Today’s package would improve the range of options available to the FDIC when handling a DSIB failure.
The proposed requirement for an insured depository institution to issue minimum amounts of long-term debt is not a Dodd-Frank Act Section 165 “enhanced prudential standard,” and is therefore not tied to the Economic Growth, Regulatory Relief, and Consumer Protection Act’s $100 billion asset threshold.
- Statement of CFPB Director Rohit Chopra, Member, FDIC Board of Directors, Regarding the Proposal to Strengthen the Resilience of America’s Largest Banks, July 27, 2023, https://www.consumerfinance.gov/about-us/newsroom/statement-of-cfpb-director-rohit-chopra-member-fdic-board-of-directors-proposal-strengthen-resilience-americas-largest-banks/.
- The IDI resolution plans, codified at 12 C.F.R. Part 360.10, generally cover the insured depository subsidiary, and contemplate a resolution under the Federal Deposit Insurance Act. These plans are distinct from, but complementary to, the Dodd-Frank Act Title I resolution plans that cover the entire conglomerate and contemplate resolution under Chapter 11 of the U.S. Bankruptcy Code.
- The primary resolution strategy envisioned by global systemically important banks in Title I resolution plans is referred to as “single point of entry” and does not involve an FDI Act resolution of their insured depository subsidiaries.
- Domestic systemically important banks with between $100 billion - $250 billion in assets are not currently subjected to the Dodd-Frank Act Title I resolution plan requirement.
- For example, the governance expectations in the proposed guidance reflect agency staff observations that measurement systems and criteria used by Credit Suisse to evaluate the condition of the U.S. operations and the global operations were inconsistent, which could have complicated the judgments necessary to successfully execute a resolution.
- The proposed requirement for an insured depository institution to issue minimum amounts of long-term debt is not a Dodd-Frank Act Section 165 “enhanced prudential standard,” and is therefore not tied to the Economic Growth, Regulatory Relief, and Consumer Protection Act’s $100 billion asset threshold.
- Board of Governors of the Federal Reserve System, Review of the Federal Reserve’s Supervision and Regulation of Silicon Valley Bank (2023), .