ECONOMIC REPORT OF THE PRESIDENT

Figure 6-18 shows that the SRISK measure has receded since the financial
crisis but remains just above the level prior to the financial crisis.
Resolving Failure
Under the Dodd-Frank Act, bankruptcy is the first, and preferred,
option to resolve a failing financial institution and protect the financial stability
of the United States. To that end, the Act requires systemically important
financial institutions to periodically submit living wills to the Federal
Reserve and the FDIC that detail a process for their orderly resolution under
the bankruptcy code in the event of material financial distress or failure. If
the banks’ plans are determined not to be credible and the banks do not
remedy those shortcomings in the allotted period of time, the regulators
may require the banks to take certain actions to simplify their structures,
including divestment of certain assets or operations. As a result, banks have
increased their focus on their resolvability.
The Federal Reserve and FDIC finalized rules relating to living wills
in October 2011. The latest round of evaluations by the agencies, completed
in April 2016, examined each living will of the eight systemically important
domestic banks. The agencies jointly determined that five of the eight
institutions’ living wills were “not credible or would not facilitate an orderly
resolution under the U.S. Bankruptcy Code,” and issued split determinations
on two institutions’ living wills (FRB 2016). Only one bank, Citigroup,
did not fail both the Fed and FDIC’s evaluations. Those banks receiving
joint negative determinations were given until October 2016 to address
the specified deficiencies. If these firms do not mitigate the deficiencies by
the October deadline, the agencies may jointly impose stricter prudential
requirements, which may include measures to restrain the growth of these
firms. The two banks that received split determinations must address their
plans’ shortcomings by the next filing deadline of July 1, 2017. While the
2016 determinations revealed that much work remains, it was also a step
forward from the previous round of feedback given in August 2014 that had
identified broad shortcomings across 11 banking institutions evaluated.
The Dodd-Frank Act also created a new resolution mechanism, the
Orderly Liquidation Authority (OLA), that could be used to resolve a failing
firm while limiting systemic risk and imposing all losses on the firm’s creditors.
Together with financial reforms that are intended to increase the safety
and soundness of individual financial firms, these reforms are intended to
lower the risk to the broader financial system should a particular firm fail,
thus lowering the necessity of a bail-out. The DFA also restricts the Federal
Reserve’s emergency lending powers, making it harder for the Fed to lend
to a particular insolvent firm or remove toxic assets during a financial crisis.
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