OFR_2016_Financial-Stability-Report

2.6 Systemic Footprints of Largest U.S. Banks
The largest U.S. banks lie at the center of the financial system, and
the potential impact of a large bank failure remains substantial. A
number of metrics suggest the systemic footprint of U.S. global systemically
important banks (G-SIBs) in the U.S. financial system has
changed little since the crisis. Persistently low long-term interest
rates challenge earnings and may motivate risk-taking. Regulators
have criticized resolution plans, called “living wills,” for these firms as
unrealistic, and this essential financial stability safeguard still needs
policymaker attention.
Reform efforts have
reduced the probability
and immediacy of
a large bank failure.
However, the largest
U.S. banks remain a
potential source of
systemic risk because
of their size, complexity,
and interconnectedness.
The largest and most interconnected U.S. banks have become more resilient
since the financial crisis. Reform efforts have focused on capital,
liquidity, and stress testing. These efforts have reduced the probability and
immediacy of a large bank failure. However, the largest U.S. banks remain
a potential source of systemic risk because of their size, complexity, and
interconnectedness.
Moreover, G-SIB business models and risk profiles are evolving in
response to earnings challenges from low interest rates, competition from
shadow banks, and enhanced regulatory requirements. Low net interest
income could spur these banks to seek higher-margin — and often riskier
— income sources. Over time, more risk-taking at U.S. G-SIBs could
undermine higher capital buffers if that risk is not captured by higher capital
standards or stress tests.
Changes in business models at individual U.S. G-SIBs could also lead to
more similar risk profiles over time. Some U.S. G-SIBs are expanding their
fee income from investment banking and asset management as commercial
banking income declines. Increasing convergence in business models could
create new channels of contagion as these banks become more vulnerable
to common shocks. Supervisory monitoring and stress testing will need to
evolve to keep pace.
Recent research highlights that a variety of U.S. G-SIBs’ market indicators
are inconsistent with the view that enhanced regulation has reduced their
riskiness (see Sarin and Summers, 2016). We might expect enhanced regula6-
tory capital and liquidity requirements to result in large declines in measures
of large U.S. banks’ market risk. However, no such declines are seen.
Also, weaknesses in U.S. G-SIBs’ living wills suggest managing a large
bank failure under the U.S. Bankruptcy Code may still be difficult. The
orderly liquidation authority of the Dodd-Frank Act provides an alternative
resolution mechanism. However, the authority has significant preconditions,
including consultation with the President. Better living wills would
enhance financial stability, particularly if risks at large banks stay high.
68 2016 | OFR Financial Stability Report