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Resolution plans

What Is Resolution Plans?

Resolution plans are comprehensive blueprints developed by large financial institutions detailing how they would be rapidly and orderly resolved in the event of severe financial distress or failure. These plans are a critical component of modern financial stability and the broader banking regulation landscape, designed to prevent a failing institution from posing a significant threat to the wider financial system. The objective of a resolution plan is to ensure that a firm can be wound down without resorting to taxpayer-funded bailouts or causing widespread contagion.

History and Origin

The concept of resolution plans emerged prominently in the aftermath of the 2008 global financial crisis. Prior to the crisis, the failure of large, complex financial institutions often left regulators with limited options beyond costly government interventions or chaotic bankruptcies that could destabilize markets. The crisis highlighted the dangers of firms being deemed "too big to fail," necessitating a new approach to managing systemic risk.

In the United States, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 introduced specific requirements for resolution plans, often referred to as "living wills." Section 165(d) of the Dodd-Frank Act mandated that large banking organizations and certain other firms periodically submit these plans to the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC). This legislative measure aimed to ensure that even the largest financial entities could be resolved in an orderly manner, protecting the financial system and taxpayers from potential losses. The Federal Reserve explicitly states that the Dodd-Frank Act requires these plans from large banking organizations and other designated firms.4

Key Takeaways

  • Resolution plans are detailed strategies for the orderly winding down of large financial institutions.
  • They are a regulatory requirement designed to prevent systemic disruptions and taxpayer bailouts.
  • The plans aim to ensure a firm's failure can be managed under normal insolvency regimes like bankruptcy.
  • Regulators, such as the Federal Reserve and FDIC, review these plans to assess their credibility and feasibility.
  • They are a key tool in addressing the "too big to fail" problem, aiming to impose losses on shareholders and creditors rather than taxpayers.

Interpreting Resolution Plans

Interpreting resolution plans involves assessing their credibility and effectiveness in facilitating an orderly resolution. Regulators scrutinize these plans to determine if the proposed strategies adequately address potential impediments to resolution under standard insolvency laws, such as the U.S. Bankruptcy Code. Key areas of focus include how the firm would manage its capital and liquidity during distress, maintain critical operations, and unwind complex cross-border operations.

The review process involves assessing the firm's proposed strategy for separating its core business lines and ensuring continued access to financial market infrastructure. A credible resolution plan demonstrates that the firm has conducted thorough stress testing and can realistically execute its plan without causing a broader financial meltdown. Regulators also evaluate the firm's internal governance and information systems to ensure they can support the rapid decision-making and data provision necessary during a crisis.

Hypothetical Example

Consider a hypothetical global investment bank, "GlobalSolve Inc.," with extensive operations worldwide, including derivatives trading, asset management, and commercial lending. Regulators require GlobalSolve to submit a comprehensive resolution plan.

GlobalSolve's resolution plan would outline, among other things:

  1. Organizational Structure: How its numerous subsidiaries and legal entities are structured and funded, identifying any interdependencies that could complicate resolution.
  2. Core Business Lines: Which business lines are critical to financial market functioning (e.g., payment systems, clearing services) and how they could be maintained or smoothly transitioned during a resolution.
  3. Liquidity and Capital: A detailed analysis of GlobalSolve's liquidity sources and uses, along with its capital requirements, under various stress scenarios, demonstrating how it would fund its operations during a wind-down.
  4. Operational Continuity: How essential services like IT systems, human resources, and data management would be maintained for critical operations, even if the parent company were to fail.
  5. Divestiture Strategy: How non-core assets or problematic divisions could be rapidly divested or spun off to reduce complexity and minimize systemic risk.

In the event of GlobalSolve facing severe distress, its resolution plan would guide regulators and the firm itself through a structured process designed to contain the failure and facilitate its liquidation without broader disruption.

Practical Applications

Resolution plans are primarily a tool for regulatory framework and oversight, serving several critical practical applications:

  • Enhancing Resolvability: They compel large institutions to identify and remove impediments to their own orderly resolution, making them inherently less "too big to fail." This often leads to internal reorganizations, simplified legal structures, and improved risk management capabilities.
  • Informing Regulatory Action: The plans provide regulators, such as the FDIC, with crucial insights into a firm's operations, vulnerabilities, and potential resolution strategies. This informs supervisory actions and helps authorities prepare for potential crises. The FDIC plays a significant role in developing and implementing the framework for orderly resolution of systemically important financial companies.3
  • Facilitating Cross-Border Cooperation: For global financial institutions with operations spanning multiple countries, resolution plans necessitate coordination between home and host country regulators. The Financial Stability Board (FSB) has issued principles to enhance the cross-border effectiveness of resolution actions.2 This international cooperation is vital for managing the failure of complex entities and mitigating global financial instability.
  • Guiding Crisis Management: While ideally, resolution would occur under bankruptcy, in extreme scenarios, mechanisms like the Orderly Liquidation Authority (OLA) provided under Title II of the Dodd-Frank Act exist as a backstop. Resolution plans help outline how such authorities might be invoked and executed.

Limitations and Criticisms

Despite their importance, resolution plans face several limitations and criticisms:

  • Complexity and Feasibility: Critics argue that for truly large and globally interconnected financial institutions, the sheer complexity makes a rapid and orderly resolution extremely challenging in practice, especially under severe market stress. A 2024 report summarized by Freshfields highlights that while progress has been made, the U.S. resolution framework is complex and requires continuous assessment of its effectiveness, particularly for global systemically important banking organizations (GSIBs).1
  • Information Asymmetry: Regulators rely heavily on information provided by the institutions themselves, which may not always paint a complete picture of vulnerabilities or operational difficulties.
  • Dynamic Nature of Finance: The financial landscape is constantly evolving, and a resolution plan, once drafted, may quickly become outdated due to new business ventures, technological advancements, or unforeseen market shocks.
  • Political Will: The actual execution of a resolution plan during a crisis still depends on the political will and swift decision-making of authorities, which can be influenced by public sentiment and perceived economic impact.
  • Cross-Border Challenges: Despite efforts by bodies like the FSB, achieving seamless cross-border recognition and enforcement of resolution actions remains a significant hurdle due to differing national laws and regulatory priorities.

Resolution Plans vs. Living Will

The terms "resolution plan" and "living will" are often used interchangeably, particularly in the context of U.S. financial regulation. A "living will" is simply the common, more accessible term for a financial institution's resolution plan.

Both terms refer to the same document: a strategic guide detailing how a large, complex financial firm could be wound down in an orderly fashion without disrupting the broader financial system or relying on taxpayer support. The Federal Reserve, for instance, uses both terms to describe the plans required under the Dodd-Frank Act. While "resolution plan" is the formal regulatory designation, "living will" gained popularity to convey the proactive, preventative nature of the planning, much like an individual's medical living will guides future decisions. The underlying purpose and content of a resolution plan and a living will are identical.

FAQs

Q: Which financial institutions are required to submit resolution plans?
A: Typically, large bank holding companies and certain non-bank financial companies designated by the Financial Stability Oversight Council (FSOC) are required to submit resolution plans to the Federal Reserve and the FDIC. The specific thresholds and frequency of submission depend on the size and complexity of the institution.

Q: What happens if a firm's resolution plan is deemed inadequate?
A: If regulators determine that a firm's resolution plan is not credible or would not facilitate an orderly resolution, they can require the firm to revise the plan. Repeated deficiencies can lead to more stringent prudential requirements, or, in extreme cases, even require the firm to divest assets or restrict its growth until the issues are addressed.

Q: Are resolution plans made public?
A: Resolution plans typically have both confidential and public sections. The public portions usually provide a summary of the firm's resolution strategy, while the highly sensitive operational and financial details remain confidential to avoid disclosing proprietary information or vulnerabilities.

Q: How do resolution plans help avoid taxpayer bailouts?
A: By requiring firms to pre-plan their own orderly demise, resolution plans aim to ensure that in a crisis, losses can be imposed on the firm's shareholders and creditors rather than falling to the taxpayers. This reduces the incentive for government intervention and strengthens market discipline, aligning with the principle of deposit insurance in protecting small depositors while exposing larger creditors to risk.