What Citigroup’s ‘Living Will’ Win Means for Big Banks

Five big banks’ living wills were deemed to be not credible by regulators; that Citi passed is significant

By John Carney

Citigroup was the only one of the big U.S. banks to submit a ‘living will’ plan regulators didn’t find not credible.

Citigroup was the only one of the big U.S. banks to submit a ‘living will’ plan regulators didn’t find not credible. Photo: Agence France-Presse/Getty Images
 
 
Citigroup C 5.61 % earned bragging rights on Wall Street this week by being the only big U.S. bank whose so-called living will wasn’t found to be not credible by either the Federal Reserve or the Federal Deposit Insurance Corp.
 
The fact that Citi succeeded where its rivals, including J.P. Morgan Chase JPM 4.23 % , stumbled will no doubt be a cause for mirth on Wall Street. After all, just two years ago, Citi’s stress-test submissions were found wanting by the Fed. Ironically, in the eyes of many on Wall Street, if regulators wanted to make an example of one bank, Citi was the most likely candidate—just not in a positive way.
 
Instead, Citi stands tall. By accepting Citi’s plan, the Fed and the FDIC have shown that it is possible for a bank often considered too big to fail to earn a passing grade. Which is to say, Citi has convinced regulators that it could credibly be resolved in an orderly manner through bankruptcy rather than bailout.
 
This is good news for the five banks whose resolution plans were deemed “not credible” by both the Fed and the FDIC. It suggests there is a path forward for them. The crucial point for investors: Regulators aren’t rejecting banks simply because of their size.
 
The snag is that might be tougher than investors anticipate. While regulators rejected the resolution plans of the banks, it is clear that the objections go beyond just paperwork.
 
The plans of at least some of the banks that failed lack credibility because, as currently structured, they can’t be resolved through bankruptcy. Regulators aren’t just asking for better plans. They are demanding better—more resolvable—banks.

That is a big difference. And it is an especially important one given that the living-will process gives regulators extraordinary powers that ranging from requiring a firm to hold more capital to the ability to effective force a breakup. Regulators won’t be rash to embrace the nuclear option, but banks and investors shouldn’t forget that it exists.

More immediately, the resolution process is viewed by regulators as a tool to require changes in real time to the basic structures and operations of the biggest banks. Which means it is likely a mistake to think banks that failed this time just need to spend more money putting together more persuasive or comprehensive plans.

Keep in mind that even Citi didn’t exactly pass with flying colors. Regulators cited shortcomings in governance, assumptions about the bank’s ability to hedge portfolio risk and estimating liquidity needs during resolution. They officially put Citi on notice that failure to address these shortcomings could land them in the penalty box next time around.

In other words, regulators intend to tighten the screws over time—just as they have with the stress tests. Each year, getting regulatory approval will likely become incrementally more difficult. Passing now isn’t a guarantee of passing forever.

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