RICHMOND, Virginia (Reuters) - Globally active U.S. banks may need to overhaul their operating structures to draw up realistic resolution plans, or ‘living wills’, a senior Federal Reserve official said on Tuesday, but that is the price for ending ‘too big to fail’.
“Credible living wills may require significant changes for financial firms. They could lead to more capital, less complex relationships among affiliates and perhaps even to smaller firms,” said Richmond Fed Bank President Jeffrey Lacker. “‘Too big to fail’ is unsustainable.”
Dodd-Frank financial market reforms, in an effort to prevent the repeat of the chaos after investment bank Lehman Brothers failed in September 2008, demands that big banks draft a plan for their own orderly resolution, dubbed a ‘living will’.
An initial round of living wills were submitted to U.S. regulators last year by the biggest banks in the United States.
Lacker said these plans were a good first step that provide valuable insights into the challenges that remain, and spelled out what he saw as the next steps.
“One approach to this problem is to require globally active firms to form distinct legal subsidiaries, with separate capital and liquidity holdings, to conduct material overseas operations, so that they can be resolved separately in the event of distress,” he said.
This might give rise to additional costs, he acknowledged, but that price was the “trade off” for an institution that was too complex to wind down without causing wide market turmoil, especially if it had cross-border operations.
“If subsidiarization is what it takes to make a resolution plan credible, then the magnitude of the resulting burden to private firms should be viewed as a measure of the subsidization attributable to their ‘too big to fail’ status,” he said.
Some critics have urged President Barack Obama to go further and demand a break-up of the biggest banks, while lawmakers and regulators still have much work to do to fully write up the legislation outlined by Dodd-Frank.
Lacker said it might well be right to constrain the size and scope of big banks.
But he argued it was hard to know where to impose those limits and said figuring out a credible living will was the best way.
“Such maps would provide an objective basis for judgments about how the structure or activities of such firms need to be altered in order to give policymakers the confidence to choose unassisted bankruptcy in the event of distress,” he said.
Reporting By Alister Bull; Editing by Neil Stempleman