The U.S. banking regulators, namely the Federal Reserve and the Federal Deposit Insurance Corp (FDIC) have found faults in the ‘Living Wills’ of the U.S. units of The Royal Bank of Scotland Group plc (RBS - Snapshot Report), HSBC Holdings plc (HSBC) and BNP Paribas SA (BNPQY). Both regulatory agencies deemed the living wills of these banks inadequate, after reviewing their plans submitted in 2014.

Under the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the banks (with total consolidated assets of $50 billion or more) are required to outline the ways to liquidate by breaking up and selling off assets, if they are on the verge of collapse, without harming the overall financial system.

Though the FDIC and the Fed noted some degree of improvement from the living wills previously submitted in 2013, many shortcomings still remained to be addressed. The concerned banks have been notified individually.

According to the regulators, the shortcomings stemmed from certain unrealistic and inadequate assumptions upon which the living wills were based. These included the behavior of clients, investors, counter parties and customers, among others, during the financial crisis. Further, the banks had not properly analyzed the interconnections between the financial institutions.

Nevertheless, the Fed and the FDIC suggested several moves to make the living wills more purposeful. These include simplifying the businesses and amending financial derivative contracts so as to offer stay of early termination rights of investors, which get triggered during bankruptcy.

These three banks have been granted a deadline of Dec 31, 2015 for submitting their modified living wills. In case they fail to do the same, the regulators will be compelled to order the banks to divest units for downsizing the business structure. 

The regulators had taken a similar step when they had found flaws in the living wills of 11 other banks in Aug 2014. Those banks were Bank of America Corporation (BAC - Analyst Report), The Bank of New York Mellon Corporation (BK - Analyst Report), Citigroup Inc. (C - Analyst Report), The Goldman Sachs Group, Inc. (GS - Analyst Report), JPMorgan Chase & Co. (JPM - Analyst Report), Morgan Stanley (MS - Analyst Report) and State Street Corporation (STT - Analyst Report).

Apart from these, the U.S. units of Barclays PLC (BCS - Analyst Report), Credit Suisse Group AG (CS - Snapshot Report), Deutsche Bank AG (DB - Analyst Report) and UBS AG (UBS) had faults in their resolution plans (read more: Inadequate 'Living Wills', Banks to Correct Flaws by 2015).

Now, whether the resolution plans of these banks are adequate to serve the purpose is  a question that looms large. Hypothetically, it is easy to say that living wills should be made in such a way that it would not cause any adverse impact on the overall financial system. However, in practice, we believe it is difficult to mitigate the harm as banks depend considerably on each other’s businesses.

Nonetheless, since the banks will submit their living wills, it would become easy for the regulators to wind them up in case of failures. Also, the banks are simplifying operations and doing away with non-core businesses through divestiture, closure or spin-offs. We opine that such efforts, along with several other measures undertaken by the regulators, will help avert a future financial crisis to some extent.