Banks Still Too Big to Regulate
By THE EDITORIAL BOARD
Regulating the big banks has become a race against time, with bank regulators still too slow at enforcing legal requirements under the Dodd-Frank financial reform law.
This week’s example involves “living wills” — detailed plans from the banks, required by Dodd-Frank, on how they would dismantle their operations and financial contracts in an orderly way in the event of impending failure. On Wednesday, nearly six years after the passage of Dodd-Frank and four years after the biggest banks submitted the first drafts of their living wills, the Federal Reserve and the Federal Deposit Insurance Corporation rejected the plans of Bank of America, Bank of New York Mellon, JPMorgan Chase, State Street and Wells Fargo.
Under the rules, banks whose plans have been rejected have 90 days to revise their plans, unless regulators decide to shorten or lengthen that time frame. If the revised plan is rejected, regulators can seek to shrink the size, risk and complexity of the bank by imposing stricter capital requirements and restrictions on its operations. After that, the bank has another two years to submit a credible plan. If it fails to do so, regulators can require the bank to break itself up by selling off assets and businesses.
In an act of pure indulgence, regulators have given the five banks nearly six months, until Oct. 1, to fix their plans. That is on top of a reprieve that the banks won in 2014, when the F.D.I.C., but not the Fed, rejected the wills of 11 banks, including four of the five banks that were rejected on Wednesday.
Back then, the regulators’ disagreement led to a decision to give all of the banks more time to revise their plans.
The longer it takes to develop living wills and enforce them, the bigger the risk of uncontrolled crises. But living wills are not sufficient by themselves to ensure financial system stability. They do not fully account for the ways that the failure of one bank could cause the failure of another and, in that way, become a systemwide problem.
Ditto for today’s higher capital requirements, which are an important regulatory tool for controlling risk. But the way capital is calculated does not fully account for the risks inherent in big banks’ holdings of derivatives. One of the reasons that Bank of America’s living will was found deficient is that the bank did not have a sound plan for winding down its portfolio of derivatives in a crisis. Neither Bank of America nor the other big banks are required to hold as much capital against their derivatives’ bets as is required of big international banks.
Living wills are an important piece of the regulatory puzzle, but only one piece. Constant vigilance for systemic risks and bigger capital cushions for derivative holdings are just as crucial.