U.S. Regulators Fault 3 Foreign Banks Over ‘Living Wills’

WASHINGTON—U.S. regulators added three foreign-owned banks to the list of big financial firms that haven’t shown they can collapse without causing broader economic damage.

The Federal Reserve and the Federal Deposit Insurance Corp. found shortcomings in the “living wills,” or bankruptcy plans, of the U.S. units of BNP Paribas SA,HSBC Holdings PLC and Royal Bank of Scotland Group PLC. The banks could face sanctions if they don’t fix the issues by the end of this year, when new drafts of the plans are due, the regulators said.

BNP and HSBC declined to comment, while Royal Bank of Scotland had no immediate comment.

The regulators’ move echoes a similar rebuke issued to 11 of the largest U.S. banks in August. Among the biggest firms, Wells Fargo & Co. was the only bank that persuaded regulators it could go through bankruptcy without serious damage to the financial system. These 11 banks could face sanctions if they don’t make significant progress on the plans by July.

The living wills are a requirement of the 2010 Dodd-Frank financial-overhaul law and spell out how a firm would wind down its operations under the U.S. bankruptcy code if it got into trouble. The plans must show the bank is able to be unwound without broad negative repercussions. If the plans aren’t credible and remain so after repeated warnings, regulators can impose sanctions, including forcing a firm to sell subsidiaries or break apart.

The FDIC found the three foreign-owned firms’ plans were “not credible,” but the Fed stopped short of that finding, regulators said in a statement. Both agencies must agree a bank’s plan is “not credible” before they can begin the process of considering sanctions, which could take two years or more.

The Fed and FDIC split along similar lines when rejecting the living wills of the 11 other large banks in August. But they also promised to be harsher in the future if banks don’t make improvements.

Karen Shaw Petrou, managing partner of policy analysis firm Federal Financial Analytics Inc., said Monday’s decision “is going to be a significant strategic event” for the foreign-owned firms, which will need to “look very hard at their U.S. operations to identify what the problems…are and whether they can be resolved to U.S. satisfaction without damage to the franchise.”

All three of the foreign-owned firms filed versions of the living wills with regulators in 2013 and 2014. The regulators said the 2014 plans made improvements from the 2013 versions but still needed improvement, including “ensuring the continuity of shared services that support critical operations and core business lines” and demonstrating “the ability to produce reliable information in a timely manner” across all operations. They said the firms must amend certain financial contracts to ensure counterparties can’t terminate them upon a bankruptcy filing, a scenario that could cause problems for a struggling firm.

Separately, the judge presiding over Metlife Inc.’s lawsuit challenging its designation as a “systemically important financial institution” has asked the Fed and FDIC to consider giving the insurer an extension of about six months to file its first living will document, according to a March 6 court filing. U.S. District Judge Rosemary Collyer said the existing July 1 deadline “might make it difficult for the court to rule” on various motions before MetLife “begins to expend time and money to prepare” its document.

According to the court filing, the Fed and FDIC are considering the request and plan to vote on a possible extension by March 30.

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