Resolution planning

Resolution planning is a crucial aspect of [financial regulation] designed to ensure the orderly wind-down or restructuring of a large, complex financial institution in the event of its severe distress or failure. It aims to prevent such a failure from causing significant disruption to the broader financial system and the economy. Essentially, it's a "living will" for major financial firms, outlining how they could be resolved without resorting to taxpayer-funded [bailout] operations, which were a common occurrence during past financial crises.⁵⁰, ⁵¹, ⁵²

History and Origin

The concept of resolution planning gained significant traction following the 2008 global [financial crisis]. The crisis exposed the profound dangers posed by "too big to fail" financial institutions—firms so large and interconnected that their collapse threatened to destabilize the entire global economy. T⁴⁸, ⁴⁹he failure of investment bank Lehman Brothers in September 2008, and the subsequent government interventions to prevent the collapse of other major firms like AIG, highlighted the urgent need for a structured approach to managing the failure of systemically important institutions.

⁴⁷In response, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law in the United States in 2010. A key provision of this act, specifically Title I and Title II, mandated that large bank holding companies and certain non-bank financial companies submit annual resolution plans to the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC). T⁴⁴, ⁴⁵, ⁴⁶hese plans, often referred to as "living wills," demonstrate how a firm could be resolved under bankruptcy in a manner that substantially mitigates the risk of serious adverse effects on U.S. [financial stability]. T⁴³he FDIC also gained the Orderly Liquidation Authority (OLA) under Title II, providing a backstop for winding down large, complex financial companies if bankruptcy is not feasible or sufficient to protect financial stability.

⁴¹, ⁴²## Key Takeaways

• Resolution planning mandates that large financial institutions create "living wills" detailing how they can be unwound without taxpayer assistance.
  *³⁸, ³⁹, ⁴⁰ It is a core component of post-2008 financial reforms aimed at preventing future "too big to fail" scenarios and reducing [systemic risk].
  *³⁶, ³⁷ Plans must address how an institution's critical functions and services would be maintained during a resolution.
  *³⁴, ³⁵ Regulatory bodies like the Federal Reserve and FDIC review these plans to ensure they are credible and capable of rapid and orderly execution under distress.
  *³², ³³ Effective resolution planning aims to ensure the continuity of essential financial services, minimize contagion, and protect depositors and the broader economy.

³⁰, ³¹## Interpreting Resolution Planning

Resolution planning requires financial institutions to think critically about their structure, operations, and interdependencies. It compels firms to identify core business lines, map financial and operational [interconnectedness], and develop strategies for separating or selling off parts of the business if necessary during a crisis. T²⁸, ²⁹he plans typically address how the firm would maintain [liquidity] and sufficient [capital requirements] to absorb losses during a resolution. Regulators assess these plans for their credibility and feasibility, often requiring firms to revise submissions that are deemed unrealistic or lacking in detail. The goal is to ensure that even the largest and most complex institutions can fail without triggering a wider financial collapse, thereby fostering greater [financial stability] and public confidence in the financial system.

²⁵, ²⁶, ²⁷## Hypothetical Example

Consider a hypothetical globally significant bank, "GlobalConnect Bank," with diverse operations including retail banking, investment banking, and a large portfolio of complex [derivatives]. Its resolution plan, submitted to regulators, would detail how GlobalConnect Bank could undergo an orderly wind-down if it faced severe financial distress.

First, the plan would identify GlobalConnect's critical functions, such as its payment systems and deposit-taking operations, ensuring these would continue uninterrupted. It would outline how the bank could ring-fence or sell off non-essential business lines, such as its derivatives trading desk, to preserve value. The plan would also specify strategies for maintaining sufficient [liquidity] to meet obligations and honor customer withdrawals, potentially through the pre-positioning of assets or access to emergency funding. Furthermore, it would detail how customer accounts, particularly those covered by [deposit insurance], would be protected and transitioned smoothly. The successful implementation of such a plan would allow GlobalConnect Bank to be resolved without causing a panic among its customers or triggering a cascading failure across the financial markets.

Practical Applications

Resolution planning is fundamentally applied in the regulatory oversight of large, [systemically risk] financial institutions. Regulators use these "living wills" to assess the resolvability of major banks and financial companies, pushing them to simplify complex structures and pre-plan for potential failure. T²⁴his involves comprehensive [stress testing] scenarios to ensure that firms can withstand severe economic shocks and still execute their resolution strategies.

²², ²³The Federal Reserve and FDIC regularly issue guidance and review resolution plans submitted by covered firms, providing feedback and requiring revisions to enhance their credibility. F¹⁹, ²⁰, ²¹or example, the Federal Reserve and FDIC recently issued final joint guidance in August 2024 to assist certain large banks in developing their resolution plans, outlining expectations for capital, liquidity, and operational capabilities needed during resolution. T¹⁷, ¹⁸his ongoing process aims to reduce the likelihood of future [bailout]s by ensuring that institutions can manage their own failures.

¹⁶## Limitations and Criticisms

Despite its importance, resolution planning faces several limitations and criticisms. A primary concern is the sheer complexity of unwinding a globally interconnected financial institution, especially those with extensive [derivatives] portfolios. Critics argue that even with detailed plans, the real-world execution during a crisis might be far more challenging than anticipated, potentially still leading to market disruption or the need for government intervention.

¹⁵Some also suggest that the "too big to fail" problem persists, as the largest banks have grown even larger since the 2008 crisis, raising questions about whether any resolution plan could truly prevent a [bailout] if a major institution faced collapse. A¹⁴n IMF working paper notes that while resolution regimes have been strengthened, challenges remain in areas such as ensuring adequate loss-absorbing capacity and providing sufficient liquidity during a resolution. T¹², ¹³he potential for the political will to use tough resolution tools, like imposing losses on creditors (bail-in), to waver during a severe crisis also remains a point of contention. F¹¹or instance, some critiques point to instances where the Orderly Liquidation Authority (Title II of Dodd-Frank) was not invoked for failing institutions, raising doubts about its practical application.

¹⁰## Resolution Planning vs. Contingency Planning

While both [resolution planning] and [contingency planning] involve preparing for adverse events, their scope and focus differ significantly in the financial context.

Resolution Planning

• Focus: Specifically addresses the orderly wind-down or restructuring of a large, systemically important financial institution to prevent broader financial system disruption.
• Trigger: Applies when a firm is in severe financial distress or on the verge of failure, aiming to avoid a taxpayer [bailout].
• Regulator Involvement: Mandated by regulators (e.g., Federal Reserve, FDIC) for specific institutions, with detailed requirements for "living wills" and external review.
• Outcome: Aims for a structured [bankruptcy] or [receivership] process that maintains financial stability and critical functions.

Contingency Planning

• Focus: A broader corporate strategy for preparing for and responding to a wide range of potential disruptions, including operational failures, natural disasters, cyberattacks, or minor financial setbacks.
• Trigger: Can be activated by various internal or external events that threaten business continuity, not necessarily leading to an insolvency scenario.
• Regulator Involvement: Generally an internal corporate governance practice, though some aspects might be subject to general [regulatory framework]s.
• Outcome: Aims to resume normal business operations, minimize losses, and protect reputation, often involving disaster recovery or business continuity strategies.

In essence, resolution planning is a highly specialized form of contingency planning tailored for the systemic risks posed by large financial institutions, whereas contingency planning is a more general risk management practice applicable across all industries and event types.

FAQs

What is a "living will" in finance?

A "living will" is another term for a [resolution plan], a document submitted by large financial institutions detailing how they would be rapidly and orderly resolved under bankruptcy or other statutory resolution mechanisms in the event of severe financial distress or failure. I⁸, ⁹ts purpose is to ensure that the firm's collapse does not destabilize the broader financial system.

Why is resolution planning necessary?

[Resolution planning] is necessary to prevent a repeat of the 2008 [financial crisis], where the failure of large, interconnected institutions threatened the global economy and necessitated costly government bailouts. It aims to create a framework for winding down such firms in an orderly manner, protecting taxpayers and maintaining [financial stability].

⁶, ⁷### Which institutions are required to submit resolution plans?
In the United States, large bank holding companies and certain non-bank financial companies designated as systemically important are required to submit [resolution plan]s to the Federal Reserve and the FDIC. The specific thresholds and filing frequencies can vary based on the institution's size and complexity.

³, ⁴, ⁵### What happens if a firm's resolution plan is deemed inadequate?
If a firm's [resolution plan] is deemed inadequate by regulators, the firm may be required to resubmit a revised plan. Persistent deficiencies can lead to more severe consequences, such as restrictions on growth, increased [capital requirements], or other punitive measures until the issues are addressed.¹, ²