Resolution plan: Meaning, Criticisms & Real-World Uses

What Is a Resolution Plan?

A resolution plan is a comprehensive strategy developed by large and complex financial institutions outlining how they would be safely and efficiently wound down in the event of severe financial distress or failure. Falling under the broader category of financial regulation, these plans aim to prevent a failing firm from causing widespread disruption to the financial system, thereby protecting financial stability and minimizing costs to taxpayers. A robust resolution plan details how a failing institution's core businesses and operations can be maintained or transferred, ensuring essential services continue and limiting contagion.

History and Origin

The concept of a resolution plan gained prominence following the 2008 financial crisis, which exposed significant weaknesses in the existing frameworks for handling the failure of large, interconnected financial firms. Prior to the crisis, the perceived need for government bailouts to prevent systemic collapse highlighted the "too big to fail" problem. In response, policymakers around the world sought new mechanisms to facilitate the orderly liquidation of such institutions without resorting to public funds.

In the United States, the Dodd-Frank Act of 2010 mandated that large banks and other systemically important financial institutions (SIFIs) submit annual resolution plans, often referred to as "living wills." The Act created the Financial Stability Oversight Council (FSOC) and introduced the Orderly Liquidation Authority (OLA) to provide a framework for resolving non-bank financial companies that pose a significant threat to financial stability.⁸ Internationally, the Financial Stability Board (FSB) developed the "Key Attributes of Effective Resolution Regimes for Financial Institutions," setting global standards for resolution planning and cross-border cooperation.⁷

Key Takeaways

A resolution plan is a blueprint for the orderly wind-down of a large financial institution in distress, designed to prevent systemic disruption.
Mandated largely by the Dodd-Frank Act in the U.S. and endorsed by international bodies like the Financial Stability Board, these plans emerged post-2008 financial crisis.
They aim to minimize taxpayer exposure and maintain essential financial services during a firm's failure.
Key components include identifying critical functions, assessing capital and liquidity needs, and mapping interconnections.
Regular submission and review of resolution plans help authorities assess a firm's resolvability and ensure preparedness.

Interpreting the Resolution Plan

A resolution plan is not a static document but rather a dynamic framework subject to regular review and refinement by both the submitting institution and regulatory bodies like the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve Board. Its interpretation hinges on assessing the firm's preparedness to undergo an orderly resolution without triggering a wider systemic risk. Regulators evaluate the plan's credibility by examining its proposed strategy for providing timely access to insured deposits, maximizing asset value, minimizing losses for creditors, and addressing potential adverse effects on U.S. economic conditions or financial stability.⁶

The plan's effectiveness is often gauged by its ability to identify and ensure the continuity of critical functions, such as payment systems, clearing, and settlement services, that are essential to the broader economy. It also demonstrates how sufficient capital requirements and liquidity could be deployed to facilitate the resolution process.

Hypothetical Example

Consider "Global Bank Corp," a hypothetical systemically important financial institution. Global Bank Corp is required to submit a resolution plan to its regulators. In this plan, they would detail how, if they were to fail, their diverse operations across consumer banking, investment banking, and asset management would be managed.

The resolution plan would identify:

Core business lines: Which parts of Global Bank Corp are essential for the economy (e.g., managing customer deposits, processing payments for businesses)?
Interconnections: How do different legal entities within Global Bank Corp rely on each other for services like IT, human resources, or funding?
Resolution Strategy: What specific actions would be taken? For example, spinning off the retail banking arm into a "bridge bank" while the investment banking division goes through a managed wind-down.
Financial Resources: How much contingent capital and liquidity is available and where it's positioned to absorb losses and fund the resolution process?

The plan aims to show regulators that Global Bank Corp can be dismantled without resorting to a government bailout, ensuring its depositors are protected and critical market functions continue.

Practical Applications

Resolution plans are a cornerstone of modern risk management in the financial sector, primarily applied to large, globally active banks and other financial entities deemed systemically important. They serve several practical purposes:

Regulatory Compliance: Financial institutions with assets exceeding certain thresholds are legally required to submit these plans to regulators, such as the FDIC and the Federal Reserve in the U.S. The FDIC regularly amends and updates its resolution planning requirements for larger banks.⁵
Enhancing Resolvability: The process of creating a resolution plan forces firms to understand their own complex structures, interdependencies, and potential impediments to an orderly wind-down. This self-assessment can lead to operational changes that make a firm easier to resolve in a crisis.
Informing Supervisory Actions: Regulators use these plans to assess a firm's preparedness for failure. If significant shortcomings are identified, regulators can require the firm to take corrective actions or impose higher capital requirements or other prudential measures.
Facilitating Cross-Border Cooperation: For multinational financial institutions with extensive cross-border operations, resolution plans necessitate coordination between home and host country regulators. The Financial Stability Board's Key Attributes provide a framework for this cooperation.⁴

Limitations and Criticisms

Despite their importance, resolution plans face several limitations and criticisms. One significant challenge lies in the sheer complexity of large financial institutions, making it difficult to fully anticipate and plan for every potential failure scenario. The theoretical nature of these plans means they have not been fully tested in a real-world, large-scale financial crisis, particularly for highly interconnected global firms.³

Critics also point to the difficulty in operationalizing certain aspects of the plans, especially concerning rapid data availability, valuation of complex assets during a crisis, and seamless continuity of shared services across different legal entities and jurisdictions. Furthermore, the effectiveness of tools like "bail-in" (where creditors absorb losses) within a resolution plan depends on market participants' understanding and acceptance of the risks, as well as the availability of sufficient bail-inable debt. Ensuring coordination and legal enforceability across different national legal systems for global firms also remains a challenge.

Resolution Plan vs. Living Will

The terms "resolution plan" and "living will" are often used interchangeably, particularly in the context of U.S. financial regulation. A resolution plan is the formal document submitted by a financial institution to regulators detailing how it would be resolved in a crisis. The term living will is the informal, yet widely adopted, name given to these resolution plans. It metaphorically describes the institution's "wishes" for its own orderly demise, much like a personal living will outlines an individual's medical treatment preferences. Both terms refer to the same strategic document designed to ensure a firm's orderly wind-down without systemic disruption or taxpayer bailout.

FAQs

What is the primary goal of a resolution plan?

The primary goal of a resolution plan is to ensure that a large financial institution can fail without causing a significant disruption to the broader financial system or requiring a government bailout. It aims to facilitate an orderly liquidation.

Which financial institutions are required to have resolution plans?

In the United States, typically large bank holding companies and other systemically important financial institutions (SIFIs) with assets above certain thresholds (e.g., $50 billion or more for banks, with enhanced requirements for those over $100 billion) are required to submit resolution plans.²

How often are resolution plans updated?

The frequency of resolution plan submissions varies based on the size and systemic importance of the institution. Globally systemically important banks (G-SIBs) often submit plans every two years, while other large institutions might submit them every three years, with interim updates as required.¹

What happens if a firm's resolution plan is deemed not credible?

If regulators determine a firm's resolution plan is not credible, they can take supervisory actions. These might include requiring the firm to revise the plan, implement specific changes to its structure or operations to improve resolvability, or even impose more stringent capital requirements or other restrictions.

How do resolution plans relate to stress testing?

Resolution plans and stress testing are complementary tools in financial regulation. While stress testing assesses a firm's ability to withstand adverse economic or financial scenarios, a resolution plan outlines how the firm would be wound down if those stress scenarios, or other unforeseen events, lead to its failure. Stress testing can inform the assumptions and scenarios used in developing the resolution plan.