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CNBC Explains: Bank living wills

Reviewing documents
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A bank's living will is a mandatory annual report required by regulators. The Federal Deposit Insurance Corp. and the Federal Reserve aim to ensure no bank's failure can create systemic collapses elsewhere and living wills are supposed to provide a clear path through bankruptcy and possible liquidation.

What are living wills for banks?

Bank holding companies with consolidated assets of $50 billion or more are required to submit living wills to regulators. A bank's living will is meant to guide that company's process of liquidation under U.S. bankruptcy code, should it fail. If living wills are found to be deficient or unable to provide an orderly liquidation, banks get a second chance to provide a better plan. If a bank cannot generate a credible living will after two attempts, it faces potential sanctions.

What do they contain?

A bank's living will is similar to a prepackaged bankruptcy plan. But unlike other businesses, regardless of a systemically important bank's health, it is required to generate one for regulators. The living will details a contingency plan for how the bank will sell off assets or be liquidated in a manner that does not generate chaotic aftershocks elsewhere in the financial system.

Why are they important?

In the wake of the global financial crisis, U.S. regulators determined the largest banks in the country needed to establish a plan for an orderly liquidation in the event that more Wall Street firms went bankrupt. The living will, meant to guide this process, is evaluated by regulators who determine whether each bank's liquidation plan is sufficient to prevent broader aftershocks to the financial system in the event that the firm fails. The idea behind bank living wills is to have a plan ahead of a major economic event, so that taxpayer bailouts are not required if and when another financial crisis unfolds.

Why did they start?

Banks were required to establish living wills by the Dodd-Frank Wall Street Reform and Consumer Protection Act, which became law in 2010. The FDIC and Fed required the most complex Wall Street firms to file beginning in 2012 "resolution plans," or living wills, which would guide regulators through the process of liquidating a bank without disrupting other parts of the global financial system.

How did they get that name?

The Federal Reserve refers to banks' liquidation and bankruptcy planning as "resolution plans," but says on its website they are also "commonly known as a living will." The term is more often applied to individual people, who create living wills to guide next of kin through final decisions being applied to a loved one who is sometimes unable to communicate decisions regarding medical care.