Why banks must keep faith in their living wills

Why spend millions of pounds developing a plan to safely manage the collapse of a stricken bank only for it to be ignored when an institution is actually in peril?

It is the question executives at some of the world’s biggest lenders were asking on a call organised by the Institute of International Finance in recent weeks, as the industry tries to draw lessons from the way in which Swiss regulators forced Credit Suisse into the arms of domestic rival UBS.

Banks’ bewilderment at the shotgun marriage of Switzerland’s largest lenders is understandable. It flies in the face of the regulatory framework imposed since the global financial crisis that requires big banks to make so-called living wills designed to limit the damage to the financial system if they collapse.

Swiss central bank governor Thomas Jordan said that relying on living wills when a bank is actually imploding was not an option in a “extremely fragile environment”.

Given many executives believe the wider environment would have to be extremely fragile for a really major bank to fail, the decision by Swiss regulators has merely confirmed a long-held belief that such resolution plans are merely an academic exercise not worthy of much effort.

“There was frustration,” said one of the more than 100 people who took part on the IIF call.

A resolution expert at one large UK bank told the Financial Times that the group is currently spending tens of millions of pounds on small army of consultants to help craft a resolution plan that might never be read, let alone called upon in a crisis.

But despite the frustration, it’s far from clear that the actions of Swiss authorities have dealt a hammer blow to the case for resolution planning.

“Resolution planning helps make banks resolvable even if the plans are not followed to the letter when an actual resolution situation happens,” said Nicolas Véron of the Bruegel Institute.

It is a view echoed by regulators. “Even if we never use a resolution plan, the fact that it is there as the default . . . can have a positive impact on the willingness of parties to come to another solution,” one told the FT.

The work may be costly and its conclusions left on the shelf when an emergency erupts, but some executives acknowledge there is value in effectively planning for a bank’s funeral.

“We produce hundreds and hundreds of pages of the stuff,” says the head of one large UK bank. “Of course you’re not going to follow it, it’s an entirely theoretical exercise. Still, as a framework I don’t think it’s terrible.”

The work both creates options if a crisis does strike and allows banks to accumulate knowledge along the way, forcing management to confront potential risks and contemplate the unthinkable.

But the type of risks such plans need to consider may have to widen given how Credit Suisse and Silicon Valley Bank, a Californian lender that US authorities had to shut down, failed.

Both were hit by a crisis of confidence that triggered a catastrophic run on deposits, not a scenario typically envisaged by the resolution planning born from the financial crisis when stricken balance sheets were the problem.

Given technology now allows customers to whip away deposits with a couple of clicks on an app, it’s a risk that banks cannot afford to ignore.

With the IMF warning this week of an “acute risk” to the global financial system if stubbornly high inflation forces central banks to keep raising interest rates, this is no time for banks to dismiss resolution planning.

Long live living wills.