The Market Needs to See Banks’ Living Wills

The market can be invaluable in helping bank regulators discipline banks. Yet the market can only do this if banks' living wills are transparent and if the regulatory process on opining living wills is clear.

A number of big banks’ stock prices keep falling, while the cost of buying protection against their bonds continues to rise. These important market signals are the way that investors are shouting to anyone willing to listen that banks are facing significant headwinds to making more money and to being sufficiently well capitalized.

In my view, big banks’ earnings are unlikely to improve anytime soon, since bank earnings are very sensitive to low interest rates in most of the world or to negative rates in much of Europe and Japan. Moreover, many big banks have large exposures to commodity companies plagued by low prices, and to banks’ own ongoing litigation settlements.

The Federal Reserve and FDIC announced today that the living wills of five of the US’s eight global systemically important banks are not credible. If global systemically important banks’ living wills were publicly available, investors and bank analysts could avail themselves of an invaluable tool to pierce through the veil of opacity shrouding not only big banks’ multiple accounting standards, but also the types of derivatives they transact and the illiquid funds in which they invest.

Moreover, far from the public’s eyes, are big banks’ technological interconnections and shared liquidity facilities throughout all of its legal entities. Seeing the contents of banks’ living wills would also shed light on how interconnected systemically important banks are to each other, as well as to other financial institutions such as securities firms, insurance companies, and derivatives clearing houses globally. Importantly, banks disclose to bank regulators how they could be resolved in an orderly manner globally without taxpayer assistance, if they were to fail.

Presently in the US, banks with assets over $50 billion are in the throes of preparing their 2016 living wills according to Dodd-Frank Title I requirements. To the detriment of the market, we only have access to the executive summaries of banks’ living wills, which do not disclose much that is not already available in SEC filings or bank call reports.

At two conferences in 2014, I had the occasion to ask the FDIC’s Vice Chair Thomas Hoenig if he believed that banks’ living wills should be made public. He unequivocally said “yes,” both times. Unfortunately for the market, not to mention the interest of US taxpayers, his wish and mine has not come true.

Since we do not have access to banks’ entire living wills, at the very least banks should be required to make much better disclosures in the public portion of the living will, the executive summary. For example, material information is missing from Deutsche Bank’s living will; the bank does not mention, for example, that through one of its wholly owned legal entities, German American Capital Corporation (GACC), Deutsche owns a 25% stake in Las Vegas-based Station Casinos. I guess its derivatives and other illiquid investments do not sate management’s gambling appetite. Given the lack of detail in the executive summary, it is also unclear how an investment in a casino is compliant with the Volcker Rule.

UnitedHere, a labor union that represents workers in Canada and the United States, recently sent a letter to the Federal Reserve’s Governor Daniel Tarullo imploring that the Federal Reserve compel Deutsche to prove in its executive summary exactly how a casino plays out in its bank resolution strategy. According to Ken Liu, Research Director at UnitedHere, “Stations Casino is subject to unique regulations in the gaming industry. Certain regulatory approvals would be needed for the transfer of this stake in a potential Chapter 11 filing by either German American Capital Corporation, which directly holds the asset, or other reorganization or liquidation scenarios involving Deutsche’s U.S. operations.”

The market deserves to know whether Deutsche Bank has prepared a resolution strategy for GACC. Deutsche Bank’s executive summary also neglects to tell the market that GACC is one of the largest originators in the U.S commercial real estate market. It engages in large-scale loan warehousing and collateralized lending; thus, GACC faces significant liquidity and counterparty risks. Unfortunately, Deutsche Bank’s executive summary fails to provide any detail about GACC; as taxpayers, we should question whether Deutsche Bank is prepared to handle the possible need to dispose of its valuable casino holdings.

Also missing from systemically important banks’ executive summaries are material details as to their technological infrastructure, which links their multiple bank and non-bank legal entities. If Franz Kafka were alive today, he would no doubt find much inspiration for his writing in banks’ complexity. Executive summaries barely casts a light on bank holding companies’ multiple legal entities comprised of banks and non-banks, which then requires supervision multiple US bank and financial regulators.

Big banks are struggling with trading platforms that are often outdated and do not communicate with each other. This means that any data that it reports for capital or Volcker ratios, derivatives transactions, not to mention for living wills, cannot be trusted.

To really see whether we indeed are progressing to making banks in the US more safe and sound than they were in 2007-2008, making material disclosures from the living wills would go a long way to protecting taxpayers. Transparency in the living wills disclosure and process is critical for the market to be able to aid bank regulators to discipline banks.

Mayra Rodríguez Valladares is Managing Principal at MRV Associates, a New York based capital markets and financial regulatory consulting and training firm.

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