Strategies mandated for big banks to adopt bankruptcy when needed are unlikely to work in the context of another widespread financial crisis – according to some experts – a report issued Monday from the congressional watchdog agency stated.
The report also states that – because of the uncertainty regarding the effectiveness of bankruptcy declarations – some experts say it is important not to repeal Orderly Liquidation Authority (OLA) adopted under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank).
In its report, “Financial Company Bankruptcies: Experts Had Mixed Views on Companies’ Controls for Mitigating Obstacles,” the Government Accountability Office (GAO) stated that strategies required by regulations implementing Dodd-Frank were likely to work if the bankruptcy were isolated to a single institution. But that success scenario evaporates when many banks enter bankruptcy, the report indicates.
The strategies are those adopted by the five U.S. global systemically important bank holding companies (GSIBs) in their 2017 resolution plans to mitigate financial and legal obstacles to orderly resolution under the U.S. Bankruptcy Code. The resolution plans were mandated for the big banks by Dodd-Frank.
According to the GAO report, most experts it consulted said a GSIB likely could execute its “single point of entry” (SPOE) strategy successfully if its failure affected only itself.
An SPOE is a resolution strategy in which only the GSIB holding company enters bankruptcy. Under that approach, GAO noted, the holding company provides its subsidiaries with capital and liquidity to keep them solvent and enable their orderly wind-down or sale.
However, recognizing that they could fall short of the capital and liquidity required to keep their subsidiaries solvent or to fend off legal challenges, the GSIBs in their 2017 plans estimated the financial needs of subsidiaries under SPOE, pre-positioned loss-absorbing capital and long-term debt at key subsidiaries, conducted legal analysis to identify potential creditor challenges, and took other actions, the GAO said.
GAO noted that both the Federal Deposit Insurance Corp. (FDIC) and Federal Reserve found no deficiencies with the GSIBs’ 2017 plans.
However, the congressional watchdog agency said it found split views on those plans, with some experts criticizing their ultimate success.
“But most viewed success as unlikely if the failure occurred during a widespread market disruption,” the report notes. Some experts consulted by the agency, in addition, said it was important not to repeal OLA adopted under Dodd-Frank, which allows the federal government, if warranted, to resolve a GSIB outside of the bankruptcy code.
“Because no GSIBs have gone through bankruptcy using SPOE, the potential controls cannot be known,” the GAO stated.
The report also notes:
- “Most experts viewed GSIB controls to mitigate financial obstacles as potentially somewhat effective. But some expressed concerns about the controls, partly because of the difficulty of forecasting capital and liquidity needs of subsidiaries and uncertainty about future events in a GSIB failure,” the GAO stated. “To further mitigate financial obstacles, experts’ suggestions included that the federal government provide a failed GSIB’s subsidiaries with access to liquidity to promote market confidence. But a few experts said that such access would create moral hazard and reduce market discipline.”
- Experts consulted by GAO had mixed views on the potential effectiveness of GSIB controls to mitigate creditor challenges and other legal obstacles, but supported certain bankruptcy code amendments to further mitigate the obstacles. “Most experts generally supported amending the Code to limit creditors from challenging a GSIB’s provision of capital and liquidity to its subsidiaries before filing for bankruptcy. But some were concerned about tradeoffs between interests of creditors and the public associated with such an amendment,” the report stated.