United States
Financial Sector Assessment Program-Review of the Key Attributes of Effective Resolution Regimes for the Banking and Insurance Sectors-Technical Note

This Technical Note reviews the key attributes of effective resolution regimes for the banking and insurance sectors in the United States. The United States’ resolution regime for financial institutions has been significantly enhanced since the financial crisis. Over the past several years, the U.S. authorities have undertaken significant efforts to develop the capability to deploy the Orderly Liquidation Authority, if and when needed, to safeguard financial stability. Of particular importance is the development of the so-called single point of entry strategy, designed to take advantage of most systemically important financial institutions in the United States being organized under a holding company structure.

Abstract

This Technical Note reviews the key attributes of effective resolution regimes for the banking and insurance sectors in the United States. The United States’ resolution regime for financial institutions has been significantly enhanced since the financial crisis. Over the past several years, the U.S. authorities have undertaken significant efforts to develop the capability to deploy the Orderly Liquidation Authority, if and when needed, to safeguard financial stability. Of particular importance is the development of the so-called single point of entry strategy, designed to take advantage of most systemically important financial institutions in the United States being organized under a holding company structure.

Introduction

1. This review of the United States’ resolution framework against the Financial Stability Board’s KAs of Effective Resolution Regimes was completed as part of the FSAP update. It was conducted by Ross Leckow and Alessandro Gullo (Legal Department, IMF), Marc Dobler and Constant Verkoren (Monetary and Capital Markets Department, IMF), and Till Redenz and Masakazu Masujima (both external experts engaged by the IMF) from February 18 to March 9, 2015.6 The team reviewed the framework of laws, rules, guidance and arrangements in place as of the date of the completion of the review, as supplemented by information provided by the U.S. authorities as of May 2015, and held extensive meetings with U.S. officials, and additional meetings with banking and insurance sector experts and stakeholders (including auditors, lawyers, and associations). The team extends its thanks to the authorities who provided excellent cooperation.

2. The review covers the resolution frameworks that apply to the insurance and banking sectors only. The review of the banking sector is based upon a review of federal and state legislation and discussions with the three federal banking agencies (FBAs)—the FDIC, the FRB and the Office of the Comptroller of the Currency (OCC)—and a selection of state bank regulatory authorities. The review of the insurance sector is based upon a review of federal and state legislation (see paragraph 39) and discussions with the relevant federal agencies and bodies (including, the Federal Insurance Office (FIO) and the FRB) and state-level agencies and bodies (including, the NAIC, as well as selected state insurance authorities).

3. The U.S. authorities agreed to be evaluated according to the revised draft KA AM.7 Since the AM will not be finalized until it is tested in other countries, no ratings were assigned in this review. The authorities provided a comprehensive self-assessment as well as detailed responses to further questions. In keeping with the AM, the team did not have access to confidential recovery and resolution plans and accordingly, made no judgment as to the resolvability of individual firms. The parameters for the review are described in more detail below.

4. The evaluation was made in the context of the U.S. financial system’s structure and complexity. The AM must be capable of application to a wide range of financial sectors with varying degrees of complexity. To accommodate this breadth, a proportionate approach is adopted commensurate with the complexity, interconnectedness, size, risk profile and cross-border reach of the financial system under review. A review of compliance with the KAs is not, and is not intended to be, an exact science. Judgment is required and a review of one jurisdiction may not be directly comparable to another.

A. Institutional and Market Structure—Overview

5. The United States has a large, diverse financial sector with assets equivalent to 480 percent of gross domestic product (GDP). The system has global implications reflecting not only its sheer size—for example, the eight U.S. G-SIBs account for 22 percent of the total assets of all the G-SIBs—but also the high potential for spillovers and implications for cross-border operations and flows, highlighted during the global financial crisis. Depository institutions (mostly banks), pension funds, mutual funds and insurance companies account for around 70 percent of the financial sector assets.

Banking sector8

6. The banking sector holds 16 percent of all assets held by financial institutions and remains less concentrated than peer countries. Banks are the second largest financial sector after pension funds. The overall number of banks has been on a downward trend since early 1990s and reached an all time low in first quarter of 2014. While the U.S. banking system is less concentrated than in other industrialized countries, the five largest banks account for about 45 percent of the U.S. banking system’s total assets (twice the share of 10 years ago).

7. Banks’ balance sheets and income statements have strengthened. The total number of firms on the FDIC’s problem bank list has fallen to 329 at end September 2014, from a peak of 888 in March 2011.9 Compared to before the crisis, banks now hold more liquid assets, grant fewer loans and hold fewer trading account assets (both in absolute and relative terms). At the same time, banks have attracted more deposits, hold more capital, and are less leveraged. Profits have reached pre-crisis levels (in nominal terms) mainly due to lower provisions and lower interest expenses. However, the results from the Comprehensive Capital Analysis and Review stress tests show that, if hit by a severe global market shock, banks’ capital ratios would fall significantly and banks would face sizable losses on their loan portfolios and trading activities.10

Insurance sector

8. The U.S. insurance market is the largest in the world. The insurance sector assets correspond to a half of banking sector assets and life insurers account for the largest portion. There were 4,538 insurance companies reporting to the NAIC at the end of 2013. The total premium volume in 2013 of $1.56 trillion accounted for 33 percent of the global market. There are three main sectors—life, property and casualty (P&C), and health insurance. Key specialist insurance lines (i.e., those which must be written in separate companies) are financial guaranty, mortgage insurance, and title insurance. The insurance sector in the United States is less concentrated than in other industrialized countries. Most of the large insurance groups are domestically owned and although there are internationally active insurance groups, most business is written in relation to U.S. risks. There are no large conglomerate groups offering both banking and insurance services. Four large insurance groups11 do however have deposit-taking institutions and are regulated by the FRB as Saving & Loan Holding Companies (SLHCs). Three U.S. insurers, American International Group (AIG), MetLife, and Prudential have been identified as G-SIIs by the Financial Stability Board (FSB).

9. The insurance sector has been gradually improving its capital position in recent years but risks remain. Capital adequacy at the legal entity level, measured by the regulators’ risk-based capital (RBC) requirements, has improved since the financial crisis. Large life insurance groups have expanded non-traditional insurance products. Although the investment risks fall to policyholders, insurers typically provide (often complex) guarantees to policyholders and are exposed to significant risk if economic growth falters again or remains low for long. Direct writers of life insurance, annuities and health products like disability income and long-term care will face the greatest risk due to the long-term nature of their interest guarantees.

Securities and derivatives markets

10. The debt securities market is dominated by corporate debt securities, treasury securities and Government-Sponsored Enterprises (GSE) backed securities. The nominal value of outstanding debt securities at end-2013 amounted to about $39 trillion (230 percent of GDP). Corporate bonds, including Asset Backed Securities (ABS), accounted for a third of this, of which half were issued by non-financial corporations and 10 percent by ABS issuers (down from 30 percent before the crisis). GSEs are the only segment that is now larger than before the crisis.

11. The U.S. derivatives market represents one third of the world market. The notional amount of outstanding derivatives contracts, which totaled $237 trillion at end 2013, has been relatively stable since 2010. 12 The market is dominated by a small group of large financial institutions—four large commercial banks represent 93 percent of the total banking industry notional amounts. Derivative contracts are concentrated in interest rate products, which comprise 82 percent of total derivative notional amounts. Swap contracts represent the bulk of the derivatives market (64 percent of all notional amounts) followed by futures and forwards (18 percent) and options (14 percent).

B. Review of the Preconditions for Effective Resolution Regimes

Precondition A: A well-established framework for financial stability, surveillance and policy formulation13

12. Title I of the Dodd Frank Act (DFA)14 established the Financial Stability Oversight Council (FSOC) charged with monitoring and identifying emerging risks to financial stability across the entire financial system, identifying potential regulatory gaps, and coordinating the agencies’ responses to potential systemic risks. The FSOC is composed of the Treasury Secretary (who is also the chair); the heads of the three FBAs; the heads of the Consumer Financial Protection Bureau (CFPB), Securities and Exchange Commission (SEC), Commodity Futures Trading Commission (CFTC), Federal Housing Finance Agency (FHA), and National Credit Union Administration (NCUA); and an independent member with insurance expertise appointed by the President and confirmed by the Senate. Members are advised by the Directors of the OFR and the FIO—new U.S. Treasury offices created by DFA—and by nominated representatives of state insurance commissioners, banking supervisors, and securities commissioners. One of the FSOC’s tasks is the designation, as appropriate, of nonbank financial companies if the FSOC determines that material financial distress at the nonbank financial company, or the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the nonbank financial company, could pose a threat to U.S. financial stability. Once designated, these nonbank financial companies are subject to consolidated supervision by the FRB and to enhanced prudential standards. The FSOC has designated four nonbank financial companies—AIG, General Electric Capital Corporation, MetLife, and Prudential Financial—to date.

13. The DFA requires the FRB to conduct and publish summary results of annual stress tests of systemic nonbank financial companies and BHCs with $50 billion or more in assets. Such companies also are required to conduct their own stress tests on a semiannual basis. The DFA requires financial companies with more than $10 billion in assets to conduct annual stress tests in accordance with regulations established by the respective primary FBA.

Precondition B: An effective system of supervision, regulation and oversight of financial institutions

Banking supervision and regulation

14. The United States operates under a “dual banking system.” A bank charter may be issued by the federal government or by a state. Federal bank charters for national banks and federal savings associations are issued by the OCC. Each of the 50 states has a banking authority that charters banks under its own laws and regulations. These banks are generally referred to as “state banks” or “state savings associations.” Each U.S. bank, whether chartered under state or federal law, is subject to regulation, supervision, and examination by a primary FBA as follows:15

  • OCC: Charters, regulates, and supervises all national banks and federal savings associations and licenses and supervises federal branches and agencies of foreign banks.

  • FRB: Regulates and supervises state chartered banks that are members of the Federal Reserve System (“state member banks”). It is also responsible for regulating and supervising any company that owns or controls a national or state bank. Certain BHCs that, along with their depository institution subsidiaries, meet enhanced capital and managerial standards, may elect to become financial holding companies (FHCs) and engage in a broader array of financial activities, including securities, insurance, and merchant banking. The FRB is the consolidated supervisor of all BHCs, FHCs and SLHCs, which, like BHCs, may choose to be treated as FHCs if they engage in a broader array of financial activities, and their depository institution subsidiaries meet enhanced capital and managerial standards.

  • FDIC: Regulates and supervises state banks that are not members of the Federal Reserve System (“nonmember banks”) and state chartered savings associations jointly with state banking authorities. In addition, as a consequence of its deposit insurance function, the FDIC has the authority to examine for deposit insurance purposes any bank, either directly or in cooperation with state or other federal supervisory authorities, and has “backup enforcement authority” over all banks. This means it can recommend that another federal banking agency take action against a bank in appropriate circumstances and may take such action directly if the other agency does not take action.16

15. Foreign banking organizations (FBOs) have been able to conduct business in the United States broadly under the same powers, and subject to the same limitations, which apply to domestic banks. No FBO may establish a branch or an agency without the prior approval of the FRB. All banks and branches or agencies of FBOs have a primary federal regulator. If the FBO chooses a federal license for a branch or agency, then it is supervised and examined by the OCC. If an FBO elects to open a branch or agency under a state license, then it is typically examined by the state banking authorities and also by the FRB on a joint or alternate (i.e., rotating) basis.

16. Since the 2010 U.S. FSAP, important changes have taken place in the legal and regulatory framework for banks. The DFA requires that large BHCs and systemically designated nonbank SIFIs be subject to enhanced prudential standards; provides for the consolidated supervision of all designated nonbank SIFIs; gives the authorities enhanced resolution powers for nonbank SIFIS (see below); and provides for the strengthened supervision of systemically important payment, settlement, and clearing utilities. With regard to enhanced group powers, the DFA (i) tightens the limitations on transactions between a BHC, a subsidiary bank, and its affiliates; (ii) incorporates financial stability into the analysis of transactions governed by the Bank Holding Company Act (BHC Act) and the Bank Merger Act;17 (iii) incorporates financial stability considerations into the supervision of holding companies and enhances the requirement for holding companies to be eligible to engage in expanded activities; (iv) generally eliminates the limitations under the Gramm-Leach-Bliley Act that restricted the FRB’s ability to examine, obtain reports from, or take enforcement action against a functionally regulated subsidiary of a BHC, such as a broker-dealer or insurance company;18 (v) authorizes the FRB to examine the activities of nonbank subsidiaries of holding companies—other than functionally regulated subsidiaries—subject to the same standards, and with the same frequency as if such activities were conducted in the organization’s lead subsidiary depository institution; (vi) prohibits a depository institution that is subject to a formal enforcement order with respect to a significant supervisory matter from converting its charter except under certain circumstances.

17. Regulations also require that FBOs with U.S. non-branch assets of $50 billion or more establish a U.S. intermediate holding company (IHC). The foreign-owned U.S. IHC generally will be subject to the same risk-based and leverage capital standards applicable to U.S. bank holding companies. It will include (with some exceptions) all its U.S. bank and nonbank subsidiaries (e.g., broker-dealers, finance companies, and special purposes entities) but not foreign branches. IHCs will be subject to the Federal Reserve’s rules requiring regular capital plans and stress tests.

18. The assessment of the Basel Core Principles for Effective Supervision (BCP)19 found that the FBAs have improved considerably in effectiveness since the previous FSAP but the system remains fragmented. In response to global and domestic reforms, particularly the DFA, the FBAs have stepped up their supervisory intensity, especially for large banking organizations, putting emphasis on banks’ capital planning, stress testing and corporate governance. To match, the FBAs have also enhanced their supervisory capacity, adding significantly to their staffing numbers and skills base. These improvements were reflected in the high degree of compliance with the BCP assigned under the assessment. Shortcomings were observed particularly in the treatment of concentration risk and large exposures, but they did not raise concerns overall about the authorities’ ability to undertake effective supervision. It was also noted that many requirements of the BCP are not established in U.S. law, regulation, or supervisory guidance, rather are in practice determined by the supervisor. While the legislative reforms delivered some rationalization of supervisory responsibilities they did not fundamentally address the fragmented regulatory system. The problems inherent in multiple regulators with distinct but overlapping mandates remain, with the new challenge of delineating responsibilities with a stand-alone consumer protection agency. While the FBAs are committed to making the revised arrangements work and cooperation has clearly improved, substantial duplication of effort remains.

Insurance supervision and regulation

19. Since the last FSAP, important changes have also taken place in the supervisory framework for insurance firms. In contrast to the banking sector, the insurance sector is primarily regulated and supervised at the state level. The establishment of the FIO has created a mechanism for identifying national priorities for reform and development. The extension of the FRB’s responsibilities to cover consolidated supervision of insurance groups has strengthened supervision of the affected groups (which now cover around 30 percent of total premium income in the United States.). State regulators have also been progressing important reforms such as the solvency modernization initiative, strengthening group supervision and international cooperation. The role of each authority is as follows:

  • State regulators: State insurance departments carry out licensing, supervision and examination of insurance companies and intermediaries under powers set out in state legislation. A commissioner heads the department and exercises all formal powers. Some commissioners are elected, but most are appointed by the state governor. While arrangements vary among states, funding is usually raised from the insurance markets via fees and levies. Insurance departments’ budgets are generally subject to the state budgeting processes. Insurance departments also collect premium taxes for the states, which are a significant part of state governments’ revenues.

  • NAIC: The NAIC is a regulatory support organization for state insurers and plays an important role in promoting consistency across state regulation. Through NAIC, state regulators establish model laws, regulations, best practices, and examination handbooks, and coordinate their regulatory oversight. NAIC has around 470 staff, which compares with 11,529 employed by the states. NAIC’s Financial Analysis Working Group is composed of 18 senior financial experts who review all “nationally significant companies” (around 1,600 companies, representing 85 percent of the market) based on annual and quarterly statements and other information. Their objective is to provide a peer review process for domestic state regulators, who retain responsibility for any action. NAIC has implemented a number of key reforms, some of which reflect the recommendations of the 2010 FSAP, including establishing supervisory colleges for all U.S. based internationally active insurance groups and an increasing number of memoranda of understanding between United States and international regulators.

  • FRB: As part of the response to the 2008 financial crisis, the FRB was given responsibility to regulate and supervise large nonbank financial groups (including insurance groups). The FRB is not responsible for licensing or regulating individual insurance companies, but has a role in insurance regulation and supervision through its primary federal responsibility for consolidated regulation of: (i) BHCs—to the extent that there are one or more insurance companies as well as at least one bank in the group (there are no such groups at present); (ii) SLHCs to the extent that there are one or more insurance companies as well as at least one savings and loan company in the group—there are 15 such groups at present, including four of the largest insurers in the country; and (iii) FSOC designated NBFCs that are, or have material subsidiary, insurance companies.

  • FIO: The FIO was established in the Department of Treasury and has a broad monitoring role of the insurance sector and its regulation, a lead role in international aspects of insurance regulation and specific responsibilities in relation to systemic risk in the insurance sector. The FIO represents the United States in the International Association of Insurance Supervisors. The FIO has no authority to license or regulate insurance companies. In December 2013, it released a “Modernization Report” pursuant to Title V of the DFA, with 18 near-term recommendations for state regulators, and nine recommendations with regard to direct federal involvement, as well as proposals for reform to increase federal oversight of the sector over the long term.

20. Overall, the assessment of the Insurance Core Principles20 found a reasonable level of observance of the standards. Regulation benefits from a sophisticated approach to legal entity capital adequacy (the risk based capital or RBC approach). Regulation and supervision continue to be conducted with a high degree of transparency and accountability. FRB supervision is bringing an enhanced supervisory focus to group-wide governance and risk management and peer group review and challenge through the processes of the NAIC is a source of strength. Lead state regulation is developing and a network of international supervisory colleges has been put in place. Cooperation between state and federal regulators is developing, but has further to go. Key areas to address include:

  • The valuation standard of the state regulators, especially for life insurance, and group capital standards;

  • Gaps in governance and risk management requirements and in market conduct and intermediary supervision;

  • Governance and funding arrangements for state insurance regulators;

  • The objectives of state regulators and scope for conflict between FRB objectives and policyholder protection;

  • The complex and fragmented regulatory system.

21. The fragmentation at the supervisory level is replicated in the resolution context. Each of the 50 states has a distinct legal framework for insurance resolution and a distinct resolution authority (i.e., the state insurance commissioner). NAIC has played an important role in promoting greater uniformity in the legal and policy frameworks for resolution at the state level. In particular, it has, over the years, developed and promoted the adoption of model insurance resolution laws by its member states. Most states have based their legislative frameworks on one of these models.21 While each model law has sought to codify existing practice and precedent, the lack of complete harmonization could, to some extent, hinder the resolution of a systemically important insurance group that has multi-state operations.

Precondition C: Effective protection schemes for depositors, insurance policy holders and other protected clients or customers, and clear rules on the treatment of client assets

Banking sector

22. The United States has two federally-mandated deposit insurance schemes.22 Deposits in banks and savings associations (thrifts) are insured by the FDIC; while deposits in credit unions are insured under a separate legislative mandate by the NCUA. Both cover deposits for each account ownership category, per depositor and institution up to the statutory limit of $250,000. The FDIC manages the Deposit Insurance Fund (DIF) and the NCUA a National Credit Union Share Insurance Fund (NCUSIF); both are backed by the “full faith and credit” of the U.S. Government.

23. Deposit insurance coverage is high by international standards (Figure 2). The DFA permanently raised the deposit insurance coverage to $250,000, equivalent to nearly five times per capita GDP. Also, different account balances are not aggregated when determining coverage. Depositors can secure much higher total coverage by opening multiple accounts at the same bank under different “ownership capacities” e.g., an individual account, a joint account with a spouse, a trust account, and a retirement account each of which can be covered up to $250,000. U.S. depositors are well aware of this treatment and structure their accounts accordingly.23

Figure 1.
Figure 1.

Summary of Primary Federal Supervisory Responsibilities

(June, 2014)

Citation: IMF Staff Country Reports 2015, 171; 10.5089/9781513544045.002.A001

Source: Federal Reserve Board
Figure 2.
Figure 2.

Coverage Ratio

(% of per capita GDP)

Citation: IMF Staff Country Reports 2015, 171; 10.5089/9781513544045.002.A001

Sources: IMF staff calculations.

24. Deposit insurance funds were depleted during the crisis. As noted in the 2010 FSAP, public confidence in the deposit insurance schemes remained high throughout the crisis, however, the paid-in deposit insurance funds proved inadequate. The DIF, which stood at $52.4 billion or 1.22 percent of insured deposits prior to the crisis, reached a deficit of $8.2 billion by end September 2009. As in the previous banking crisis the FDIC was forced to substantially increase assessments on the industry in a pro-cyclical way i.e., raising levies at a time of financial stress. Additionally, the FDIC’s line of credit from the U.S. Treasury was increased from $30 billion to $100 billion.

25. A number of measures were enacted following the crisis to strengthen the DIF but not the credit union scheme. The DFA raised the target minimum designated reserve ratio (DRR) to 1.35 percent (to be reached by end September 2020), from 1.15 percent (by 2016). However, the most important change was to remove the “hard cap” and give the FDIC Board discretion to set a higher target without having to cease assessments (and pay dividends) at 1.35 percent. Removing this cap was a recommendation of the 2010 FSAP and the FDIC Board has used the discretion to set a two percent target. The credit union scheme is unchanged, however, and requires reform.

Insurance sector

26. Insurance policyholders are protected against loss arising from the insolvency of insurance companies by state guaranty associations. All U.S. insurance companies are required to be members of associations covering life and health insurance and, through separate organizations, property and casualty. These associations are established by state laws (based upon NAIC’s Life and Health Insurance Guaranty Association Model Act and Property and Casualty Insurance Guaranty Association Model Acts). Payments are triggered by the insolvency of an insurer and the issuance of an order of liquidation. Laws differ on the extent of coverage and maximum amount per policyholder (between $100,000 and $500,000 depending on the product and state). Liabilities that require coverage are typically paid out over a number of years. Associations rely primarily on estate assets to fund their payment obligations. The Guaranty System has access to additional funds through ex post assessments of other insurers writing the same class of business in the same state to make payments to policyholders, i.e., it is not pre-funded. State laws set limits on assessment—typically, at 2 percent per year of each insurer’s prior year premium income in the state.

Precondition D: A robust accounting, auditing and disclosure regime24

27. U.S. accounting standards (U.S. GAAP) are established by the Financial Accounting Standards Board (FASB). Both the FASB and International Accounting Standards Board are currently working on a convergence program, designed to bring U.S. and international financial reporting standards into a single framework.

28. Financial statement audit requirements are robust, having been considerably strengthened in 2002 with the passage of the Public Company Accounting Reform and Investor Protection Act (also known as the Sarbanes-Oxley Act). The Sarbanes-Oxley Act enhanced audit scrutiny, toughened auditor independence requirements, required various management attestations about the reliability of financial accounts, and expanded disclosure requirements with the objective of providing the users of financial statements with greater security as to their accuracy and reliability.

Precondition E: A well-developed legal framework and judicial system

29. The United States possesses an independent judiciary and well-regulated accounting, auditing, and legal professions. The judicial system is comprised of both federal and state systems. Judges in both federal and state courts must be members of the bar and generally have significant experience as practicing lawyers before becoming judges. Federal judges are appointed by the President with the advice and consent of the Senate and receive lifetime appointments. States vary in their methods of judicial appointment. Some follow a system similar to the federal system, i.e., the state governor appoints judges with some input from the legislature. Some states, however, appoint judges through a general election.

30. Lawyers must receive a license to practice law from a state or states. All states but one (Wisconsin) require applicants who are not already members of another state’s bar to pass a bar examination prior to receiving a license. In addition to controlling admission into the profession, the states also regulate the profession. Regulation is often delegated to a self regulatory organization, i.e., a state bar association. Lawyers are also subject to ethical standards set by the states.

C. Resolution Regime Reforms

31. The resolution regime for financial institutions has been significantly enhanced since the financial crisis. Title II of the DFA creates an OLA that permits the FDIC to be appointed as receiver for a failing systemically important financial company (formally a “covered financial company”)25 whose disorderly collapse would pose substantial risks to the financial system and the broader economy. The definition of “financial company” and thereby scope of application of Title II are (i) bank holding companies; (ii) nonbank financial companies that are supervised by the FRB pursuant to section 113 of the DFA; and (iii) financial companies that are predominantly engaged in activities that are financial in nature or incidental thereto as set forth in FRB regulations.26 In addition, subsidiaries of companies described above, other than a subsidiary that is an IDI or an insurance company, may be resolved using OLA powers if they are predominantly engaged in activities that are financial in nature or incidental thereto. Title II is triggered only by a recommendation of two-thirds of the directors of both the FRB and the board of the FDIC and a determination by the Secretary of the Treasury, in consultation with the President (sometimes referred to as the “three keys process”), that inter alia the company is in default or in danger of default; the failure of the company and its resolution under otherwise applicable federal or state law would have serious adverse effects on financial stability in the United States; resolution under the bankruptcy law would not be appropriate; and resolution under the new regime would avoid or mitigate these adverse effects. The SEC or the FIO would substitute for the FDIC in the “three keys” recommendation process if the firm or its largest domestic subsidiary is, respectively, a broker-dealer or an insurance company, with the FDIC being consulted in both cases.

32. Title II of the DFA gives the FDIC, as receiver for the failed SIFI, powers similar to those it has when acting as a receiver for a bank. Specifically, the FDIC may stabilize the company with loans or guarantees, sell assets or operations, and transfer assets and liabilities to a bridge company. The act requires the FDIC to ensure that creditors and shareholders of the failed company bear losses and that directors and management responsible for the company’s failure are removed.

33. The DFA also allows the FDIC to obtain temporary funding for a resolution by borrowing from the Treasury via the OLF subject to certain limits.27 Importantly, any borrowings from the Treasury must be repaid through proceeds from the sale of the failed company’s operations. If such proceeds are insufficient to fully repay all borrowings from the Treasury, assessments would be made on certain creditors of the failed firm and, if necessary, on financial companies, including bank holding companies that have $50 billion or more in total assets, and nonbank financial companies supervised by the FRB. One final provision of importance is the prohibition on taxpayers bearing any losses in the resolution of a company that has been put into receivership under Title II.28 This provision seeks to prevent any future government bailouts for failing financial institutions, no matter how systemic their failure might be.

34. The following types of financial institutions cannot be resolved using the OLA powers:

  • IDIs: IDIs (i.e., banks and savings and loans associations)29 including those that could be systemically significant or critical in the event of failure, are excluded from the definition of financial company and resolved pursuant to the FDI Act.

  • U.S. branches of FBOs: Uninsured30 branches of FBOs operating in the United States must have either a state or federal license. With respect to a federally licensed branch of a FBO, the legal framework in the United States generally provides that such a branch is resolved in accordance with Federal law—specifically, the International Banking Act (IBA). The two largest federally licensed branches had assets of about $80 billion at end of September 2014. One of these, however, has grandfathered deposit insurance and would be resolved under the FDI Act (see essential criteria 1.2). The legal framework generally provides that a branch of a FBO that is licensed by a state is resolved by the state resolution authority in accordance with that state’s law. The ten largest state-licensed branches by assets (ranging from $78 billion to $150 billion at end September) are New York licensed. There may be cases, however, where the resolution framework under Federal law would apply to the property and assets of a state-licensed branch.31

  • Insurance companies: Insurance companies (as opposed to their holding companies) cannot be resolved using the OLA powers, and are also not subject to the Federal Bankruptcy Code, instead they must be resolved pursuant to state legislation. A resolution proceeding for an insurer is referred to as a “receivership,” and may take the form of conservation, rehabilitation or liquidation. A receivership can be commenced against an insurer in the insurer’s domiciliary state (the state in which the insurer is incorporated), and is governed by the law of that state. In some circumstances, the laws of other states may also be implicated. For example, a guaranty fund in a state in which a policyholder of the insolvent insurer resides is governed by that state’s law. As a result multiple state legislation and state guaranty funds would come into play in the failure of a large insurance group writing business across multiple states. Title II provides that if the appropriate state regulator does not commence the resolution of the insurance company within 60 days of a systemic risk determination by the Treasury Secretary with respect to the insurance company, then the FDIC shall have the authority to stand in the place of the appropriate regulatory agency and file the appropriate judicial action in the appropriate state court to place such company into orderly liquidation under the laws and requirements of the state.

35. A comprehensive recovery or resolution planning process helps to promote resolvability of complex financial firms. The U.S. authorities view recovery planning as an integral part of the framework for the consolidated supervision of large financial firms. Hence, such firms are expected to prepare, and periodically update, plans for remedying potential financial or operational weaknesses via predefined recovery options. In addition, Title I of the DFA32 mandates certain firms (i.e. all BHCs with consolidated assets of at least $50 billion and each NBFC that is supervised by the FRB) to produce plans for their rapid and orderly resolution under the U.S. Bankruptcy Code in the event of material financial distress or failure.33 These so-called “living wills” provide the FDIC, in its capacity as receiver under OLA, with a thorough understanding of, among others, the firms’ structures, critical functions and critical shared services, and intra-group financial linkages and funding sources. In turn, the living wills can inform resolvability assessments prepared by the FDIC for financial firms whose failure could adversely impact U.S. financial stability. Moreover, they support the FDIC’s own planning for the exercise of its OLA under Title II of the DFA (and the FDI Act, as appropriate). In principle, the power to require firms to take measures that seek to remove obstacles to resolvability under Title I, as provided to the FRB and FDIC, can also contribute to achieving greater resolvability under OLA.

36. The FDIC has focused on developing a SPE strategy for deploying OLA powers.34 SPE is a resolution strategy that would take advantage of most U.S. SIFIs being organized under a non-operating parent holding company structure, either a BHC or a FHC, which are required to act as a “source of strength” to their banking subsidiaries.35 Their balance sheets predominantly comprise long-term debt and investments and loans in subsidiaries, with the operating liabilities of the group36 typically residing at the operating company (e.g., bank) level. The FDIC would initiate an OLA receivership at a single point, the top tier U.S. holding company, while the group’s operating subsidiaries (e.g., IDI, broker-dealer etc.) would not be subject to a resolution proceeding. This would have the significant benefit of keeping numerous group subsidiaries and affiliates interconnected through legal structure, funding sources, intra-company arrangements (including cross-default provisions and cross-guarantees) and group services, open for business. The FDIC would immediately establish a bridge financial company into which it would transfer the assets of the parent holding company, including ownership interests in, and intercompany loans to, these operating subsidiaries. Rights related to equity, subordinated debt and senior unsecured debt of the holding company would be terminated, leaving only a residual claim on the receivership. Under the SPE strategy these residual claims would be met through a securities-for-claims exchange six to nine months later, in a new (and listed) financial company, which would assume the assets and liabilities of the bridge bank. The effect would be to bail-in the creditors of the failed holding company and recapitalize the group, via the parent bridge providing capital and liquidity as needed to subsidiaries (see EC3.10 for further details).

37. Making an SPE workable in practice requires a number of challenges to be resolved. Adequate capital and debt needs to be issued by the holding company so that sufficient quantities can be bailed-in to cover the group’s losses, support subsidiaries and restore market confidence in the bridge and successor entity. The FSB recently issued a proposal 37 for minimum total loss absorbing capital (TLAC), including internal TLAC for G-SIBs.38 Other challenges include giving cross-border effect to resolution measures; preserving critical access to Financial Market Utilities; and ensuring the continuity of essential group operational services (e.g., group treasury, human resources and IT services). With regard to the former, the recent International Swaps and Derivatives Association (ISDA) Resolution Stay Protocol (see EC4.3) adopted by 18 global major banks is a positive development but further reforms are required. Many of the remaining impediments are intended to be addressed through effective recovery and resolution planning. Progress on these issues is essential for a successful implementation of a SPE strategy under Title II.

38. The challenges may be more substantive for insurance groups. Insurance companies have different liability structures than banks that may lend themselves more to a MPE resolution strategy, where different entities in the group including at the operating level enter separate resolution proceedings. Most loss absorbing capacity is at the level of the operational insurance subsidiaries, with a view to protecting policy holders at the state level. Moreover, much less progress has been made with regard to recovery and resolution planning for insurance groups and a significant added complication is the extensive communication and coordination that would be required between the FDIC, multiple state insurance regulators and potentially the insurance guaranty system to successfully implement a SPE strategy for an insurance SIFI.

Detailed Review

39. The table that follows sets forth a detailed review of the consistency of the U.S. resolution regime for the banking and insurance sectors with the KA. There are several parameters for this review that are worth noting at the outset:

  • First, the review is based upon a draft rather than a final version of the assessment methodology.

  • Second, the review pertains only the banking and insurance sectors. Accordingly, certain essential criteria (EC) are not reviewed in this exercise e.g., because they pertain to the resolution of financial market infrastructures.

  • In addition, within the banking and insurance sectors, there are multiple resolution regimes that are relevant. As a result, the description and findings sections for most EC in the following table describe separately the resolution regime applicable to (i) “covered financial companies” under Title II of the DFA (which generally may include systemically important holding companies for banks and insurance companies, as well as nonbank/noninsurance company subsidiaries of those holding companies); (ii) domestic banks under the FDI Act, and U.S. branches of FBOs under the IBA and New York (NY) state law (the key jurisdiction for systemic branches) for KA 1 and 7; and (iii) the state resolution regime for insurance companies. Appendix I summarizes the resolution regimes which apply to different types of financial groups and companies in the United States. Figure 1 highlights the resolution regimes reviewed under this assessment. As it could not be assumed that all systemic banking and insurance companies could be resolved at the holding company level using Title II resolution powers (an MPE strategy may be preferred or prove necessary) the resolution regimes which apply at the operating company level also were reviewed.

  • Finally, it is not possible to provide a complete or comprehensive picture of the state insurance resolution regime. While NAIC has played an important role in promoting uniformity, state-based resolution regimes vary in their scope and content. This review is based upon an analysis of NAIC model laws and the legislation of two key jurisdictions (New York and New Jersey), as well as discussions with NAIC staff, and representatives of the state insurance departments of New York, New Jersey, California, Nebraska, Connecticut, Pennsylvania and Texas. On this basis, the mission has sought to develop an understanding of general characteristics and approaches to insurance resolution across states and to draw broad conclusions. However, such conclusions need to be viewed against this background.

Figure 3.
Figure 3.

Resolution Regimes Covered

Citation: IMF Staff Country Reports 2015, 171; 10.5089/9781513544045.002.A001

1 Stylized group structure for illustrative purposes only. See published sections of resolution plans at http://www.federalreserve.gov/bankinforeg/resolution-plans.htm for actual group structures2 DFA only applies if systemic risk determination is made, otherwise resolved under Bankruptcy code3 Foreign regimes for FBOs not assessed

40. In undertaking the review of the insurance resolution regime, the team looked for specific guidance in the current draft of the AM and the insurance annex to the KAs. The Key Attributes envisage a system in which an administrative authority, in the interest of financial stability, will be vested with broad powers to act quickly to resolve any financial institution that could be systemically important or critical at failure. While discussions continue at the international level on effective resolution strategies for insurance entities, the AM broadly requires the same tools—which can be applied with same speed and flexibility—for systemically important insurance as well as banking entities.39 With respect to the timelines required for resolution, the AM acknowledges that “it is not necessarily inconsistent with the KA if the resolution regime makes provision for a court order or confirmation for the exercise of resolution powers to be effective” but notes that “it is important to ensure that any requirement for court approval does not impede rapid intervention and the ability to achieve the objectives of resolution.” As will be discussed below, the time-lines required for court approval in the U.S. insurance resolution context may not, in all cases, enable the resolution authorities to achieve the “rapid intervention” envisaged under the KA. While extended timeframes may be appropriate for the exercise of some resolution powers (such as policy transfer and run off), they may be insufficient for other resolution powers that need to be applied more urgently e.g., the transfer of qualified financial contracts (QFCs) of systemic entities. Indeed, the KA and the AM only recognize the need for the application of longer timeframes for policy transfer and run-off; otherwise they assume that same timeframes should apply to the application of resolution powers to systemic insurance companies and banks. The description and analysis of the resolution powers set out below needs to be read against this background and the requirements of the current version of the AM.

41. The challenges involved in applying the draft AM to insurance companies should be noted. It remains a subject of debate as to what degree the KA and the AM may need further modification to address the specific features of insurance companies.40 For example, it is not clear whether all the resolution powers envisaged in KA 3 (e.g., asset management companies) are necessary for insurance resolutions, or whether all of the objectives of resolution envisaged in KA 2 are appropriate in the context of insurance resolution. These are questions which may require further discussion within the international community.

Table 1.

Detailed Report

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