There are two ways to look at the âliving willsâ that big banks have to produce, which five megalenders have not done to regulatorsâ satisfaction.
Thereâs the literal use of living wills, which is to provide a blueprint for regulators to wind down a wounded giant in a clean and orderly way.
Past crises donât create much confidence that the so-called resolution of a big bank would be particularly orderly. However, itâs also fair to note that living wills werenât in existence during the Great Recession, so their effectiveness has yet to be tested.
But the real use of living wills is as a backdoor way to test a bankâs risk management and operational controls.
Consider, for instance, the report card on J.P. Morgan Chase
Â , one of the five banks on the naughty list. Jamie Dimonâs house of horrors, as it were, did get some good marks â for instance, itâs reduced its reliance on short-term wholesale funding, and itâs keeping better track of securities put up as collateral.
It got bad grades in areas including relying on funds overseas to prop up its U.S. operations in the event of its heading toward collapse, an overly complex legal-entity structure and a failure to show sufficiently how its trading portfolio could be wound down if counterparties were afraid to trade with it.
Put differently, J.P. Morgan Chase is being graded both on factors impacting how it operates right now, as well as on the do-not-break-except-in-event-of-fire plan thatâs being kept under glass.
Other report cards, both for banks that passed, like Citi
Â , and for those that failed, like State Street
Â , were written similarly.
There are mumblings on Twitter, and surely in bank boardrooms, that living-will exercises are useful only for the lawyers. Thereâs something to the Mike Tyson adage that everyone has a plan until they get punched in the face. A living will might not get executed to the letter or even spirit if a megafirm were to blow up.
That said, living wills are changing the ways these big banks operate. The recent and successful lawsuit by MetLife against federal regulators shows there will be very few opportunities for the government to hold the feet of these big financial institutions to the fire.
Stress tests are one. The living-will process is another. And thatâs why itâs healthy that banks and their army of lawyers engage with regulators on plans they may never use.