The Federal Reserve Board released supervisory expectations for recovery planning governing the largest United States bank holding companies in a new supervisory letter.
Spurred by the failure of many large financial institutions to have adequate plans in place to rapidly respond to severe stress at the onset of the recent financial crisis, the Fed released SR 14-8, instructing the eight domestic bank holding companies designated as posing an elevated risk to U.S. financial stability to develop “a menu of options” to remedy financial weakness and maintain market confidence without extraordinary government support.
The letter supplements prior guidance from the Fed found in SR 12/17/CA 12/14.
The recovery process begins when a firm “is experiencing or is likely to encounter considerable financial distress but could reasonably return to a position of financial strength if appropriate actions are taken in a timely manner,” working closely with relevant supervisors, the Fed explained. “A firm in recovery has not yet deteriorated to the point where resolution proceedings or bankruptcy are imminent.”
Options for consideration should include the possible sale, transfer, or disposal of significant assets, portfolios, legal entities, or business lines. Recovery options should be actionable and executable within a reasonable period of time, the Fed added, and should consider possible impediments to execution or potential mitigation strategies, such as legal and regulatory preconditions, interconnectivity among the firm’s operations, tax consequences, and market conditions.
The plan itself must cover four elements: internal governance (a description of how the plan was developed, approved, and updated, with descriptions of the triggering events for the recovery process); recovery options (detailing the choices included in the plan to remedy financial weakness and maintain market confidence, such as sales or transfers); execution plan (featuring the steps necessary to execute each option listed on the plan with estimated time frames for implementation and a plan describing the methods and forms of communication with various stakeholders); and impact assessment (a holistic consideration and description of the expected impact for each recovery option, including financial, business, and critical operation).
Senior management must be responsible for the integration of recovery planning into the operating process (just like contingency, strategic, and resolution planning), the Fed said, with oversight provided by the Board of Directors.
On at least an annual basis, the bank should test the effectiveness of its recovery options, subject to a range of internal and external stresses, considering the potential consequences for U.S. financial stability of executing each option, such as the impact on creditors, clients, and depositors.
How will a bank know if its plan is working? “At a minimum, the firm’s internal governance should lead to a response from the firm prior to the imposition of remedial actions by the Federal Reserve or other responsible supervisors,” according to SR 14-8. “A firm should aim to have the ability to take timely action to address signs of weakness or risk before the onset of significant financial deterioration.”
To read SR 14-8, click here.
Why it matters: The Fed has identified recovery planning as central to ensuring the ongoing resiliency of a firm’s consolidated operations and has made it a core area of supervisory focus for achieving the objectives of the supervision framework for large institutions. Regulatory guidance intended to respond to risks posed by the business models of the largest globally active financial institutions has often created spillovers for smaller financial institutions. By keeping abreast of the Fed’s activities with respect to recovery planning for the country’s largest financial institutions, smaller financial institutions will be better prepared as the impact of the Fed’s activities trickles down to them.