Resolution Planning and Living Wills for Banks

A bank living will is a detailed resolution plan—submitted to regulators annually—that shows how the institution can be safely dismantled or restructured if it fails, without taxpayer rescue or systemic contagion. Regulators judge these plans for “credibility”: can the bank truly be resolved quickly, or is it too interconnected to fail? Plans deemed not credible trigger capital penalties and operational constraints.

The Living Will Concept

A living will is a comprehensive plan that describes how a failed bank can be put into an orderly wind-down, asset sale, or restructuring without breaching counterparty contracts, triggering mass deposit runs, or requiring public bailout. The name deliberately echoes medical end-of-life directives: just as a person pre-specifies life support choices, a bank pre-specifies how it exits.

The logic emerged from the 2008 financial crisis. Lehman Brothers’ collapse was chaotic partly because no one had prepared for its orderly dismantling. Counterparties panicked. Assets sold at fire-sale prices. The broader financial system seized up. Regulators concluded that large, interconnected institutions must plan their failure in advance.

In the United States, the Dodd-Frank Act (2010) mandated resolution plans for all banks with more than $50 billion in assets. The European Union, UK, and other jurisdictions adopted similar rules. Today, dozens of systemically important institutions file living wills annually.

What Regulators Demand

A credible living will must answer specific questions:

Can the bank be resolved quickly?

The Federal Reserve’s standard is that a bank should be resolvable in 10 business days without extraordinary government support. This means the resolution authority (FDIC in the US, or a national authority elsewhere) must be able to seize assets, notify depositors and counterparties, and transfer viable businesses to a buyer or liquidate them, all within 10 days.

What is the funding gap?

A key section describes how the bank covers the gap between cash outflows (deposit withdrawals, maturing debt, counterparty unwinding) and cash inflows (asset sales, continued operations). Banks must identify liquidity sources that remain stable even in their own failure scenario.

Which business lines are separable?

The plan breaks the bank into logical units: retail banking, investment banking, trading, wealth management. Some can be sold quickly (retail branches transfer to another bank easily). Others are harder to divest (a bespoke derivatives book may take months to unwind). Living wills must identify which units are saleable and to whom.

Who owes what to whom?

Resolution authorities must understand counterparty exposures. If the bank is a major derivatives counterparty, its failure could trigger cascading losses elsewhere. The plan must specify which contracts are derivative trades, which are contingent on the bank’s credit, and which have insolvency-triggered termination clauses.

How are maturity mismatches managed?

If a bank funds long-term loans with short-term wholesale deposits, a failure forces asset sales at unfavorable prices. The living will must explain how the resolver maintains continuity—perhaps by assuming certain liabilities or by ensuring that the most critical counterparties remain stable during the 10-day window.

Resolvability Assessments and Feedback

The Federal Reserve publishes annual determinations on whether each covered institution’s plan is credible. The scale is:

• No significant issues: The plan is realistic; the bank can be resolved without significant government support.
• Material weaknesses: The bank must address specific defects (e.g., insufficient liquidity buffers, unclear counterparty dependencies, complex legal structures).
• Deficiencies: More serious gaps. The bank must revise its plan substantially or face capital penalties and structural mandates.

Rejections typically cite:

• Structural complexity: Too many legal entities across jurisdictions, making simultaneous resolution infeasible.
• Liquidity shortfalls: Not enough liquid assets to fund the 10-day resolution window.
• Counterparty concentration: Over-reliance on a few key funding sources that could dry up if the bank fails.
• Operational risk: Systems that cannot be quickly shut down or transferred.
• Contractual obstacles: Customer contracts or counterparty agreements that impose barriers to sale or wind-down.

Consequences of Rejection

A rejected living will is not merely reputational. The Federal Reserve can impose:

1. Elevated capital requirements: The bank must hold additional capital (up to 0.5–3 percent of risk-weighted assets) if its plan is not credible. The logic: if resolution is hard, the bank must be super-safe to begin with.

2. Structural mandates: The regulator can order the bank to simplify its legal structure, divest incompatible business lines, or reduce interconnectedness with other systemically important firms.

3. Liquidity requirements: The bank may be required to hold a larger portion of assets in highly liquid form, reducing profitability but improving resolvability.

4. Foreign operations constraints: Non-US operations may be required to be self-funding and independent from the parent, so a US failure doesn’t immediately cascade globally.

5. Wind-down plans: The bank must pre-identify which business lines it is willing to sell and to whom, under stress conditions.

Living Wills vs. Contingency Plans

The distinction matters. A contingency plan is an internal bank document describing what the bank does if, say, a major counterparty fails or a trading floor goes offline. Contingency plans are scenario-specific and do not assume the bank itself is insolvent.

A living will assumes the bank is failed and insolvent. It describes how the resolver (FDIC or equivalent) unwinds the institution. This is more demanding: it requires the bank to map out paths to resolution that the bank itself may find undesirable (e.g., fire-sale of a crown-jewel trading desk to a rival).

International Coordination

In a globally active bank, resolution becomes transnational. If a UK bank fails, UK authorities must coordinate with US, EU, Asian, and other regulators. Many large banks now file resolution plans in multiple jurisdictions, creating redundancy and complexity.

Some jurisdictions demand separate legal entities in key markets, so that the resolution authority in each country can ring-fence local assets and customers. This is called operational resolvability and is particularly acute for banks with major trading operations in London, New York, and Tokyo.

Living Wills and Total Loss Absorption Capacity (TLAC)

Systemically important banks must also maintain Total Loss Absorption Capacity (TLAC)—a stock of equity and long-term debt that can absorb losses if the bank fails, without requiring a government bailout. TLAC and living wills work in tandem: the plan shows how the bank is resolved, and TLAC ensures there is enough capital to absorb losses during that resolution.

Real-World Rejections and Outcomes

The Federal Reserve has rejected or identified material weaknesses in the living wills of nearly every major US bank at least once:

• JPMorgan was criticized for structural complexity; it subsequently simplified legal entity structures.
• Bank of America faced repeated pushback on liquidity assumptions and has steadily improved its filing detail.
• Citigroup encountered structural weaknesses and was ordered to reduce the bank’s complexity.

These rejections do not lead to bank failure. Instead, they trigger capital hikes and multi-year remediation cycles. A bank with a rejected plan typically spends the next 12–24 months restructuring operations, documenting improvements, and resubmitting. The cost of rejection is real but manageable: extra capital, divested businesses, and administrative burden.

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