U.S. regulators have told 11 of their biggest banks that their plans for unwinding their operations in case of a bankruptcy are inadequate and they must rewrite them.
The Federal Reserve and the Federal Deposit Insurance Corp. have demanded banks create "living wills" to prevent the sort of financial disaster that struck in 2008 in which bank failures ruptured the financial system and led to a massive government bailout.
Banks with more than $50 billion in assets submitted their "living wills" in 2013, but this month were sent letters by the regulators criticizing their plans as "not credible."
"Despite the thousands of pages of material these firms submitted, the plans provide no credible or clear path through bankruptcy that doesn’t require unrealistic assumptions and direct or indirect public support," Thomas M. Hoenig, the vice chairman of the FDIC, said in a statement.
Bank of America, JPMorgan Chase, Goldman Sachs, Citigroup and Morgan Stanley are among the group of banks being told to rewrite their plans by 2015.
The "living wills" are intended to give bankers and regulators a clearer understanding of a bank’s operations and its assets and liabilities. The banks also must state how they would distribute large losses among stakeholders and wind down their operations in an orderly manner.
If the banks do not make changes that satisfy the regulators, they could be required to sell units to shrink and simplify their corporate structures, officials said.
Federal Reserve Chair Janet Yellen has said that the largest U.S. banks also need to hold additional capital to withstand periods of financial stress.
In 2010, Congress passed the Dodd-Frank Act which aims to set up a more stable financial regulatory system and prevent a repeat of the 2008 debacle. The tighter monitoring of bank health and request for "living wills" is part of that legislation.
The regulators said that the shortcomings in the plans varied, but one area of concern was derivatives, one of the financial instruments that played a role in 2008 bank failures. The agencies want banks to have a plan to handle extreme derivatives losses.
Another common failure was unrealistic assumptions about what clients would do if the bank seemed to be failing and inability to identify steps that would make it easier to wind themselves down, the regulators said.
The banks may be unsettled by the rebuke from regulators, but the "living will" process is in its first round and will need to be refined over the next two years, bankers said.