FDIC Vice Chair Hoenig Challenges FSB Bank Resolution Mandates

FDIC Vice Chair Thomas M. Hoenig argued that mandating increased levels of debt in order to facilitate the resolution of failing banks is "paradoxical" because it may "undermine the very financial stability being sought." In a speech titled: "The Relative Role of Debt in Bank Resiliency and Resolvability" presented to the Peterson Institute for International Economics, the FDIC Vice Chairman acknowledged that the conversion of debt into equity or a revised debt instrument has "long proven useful" in transitioning failed banks to solvency. But he suggested that the best approach to the issue will recognize that different financial firms use different business models and a blanket rule that mandates resolution strategies for only one model may be self-defeating.

Vice Chair Hoenig was primarily concerned with the Financial Stability Board's Total Loss-Absorbing Capacity model ("TLAC"), which requires large and interconnected banks to hold certain levels of long-term debt. The proposed U.S. version, he noted, would require global, systemically important banks to maintain TLAC-related debt at their holding companies with restrictions on ownership. To meet the proposal's goals, he argued, firms would have to maintain current levels of debt as well as add debt to their balance sheets. These added pressures, he asserted, "would encourage firms to add risks that may be inconsistent with conventional safety and soundness principles or what [firms] would otherwise do."

He proposed alternative solutions that relied less on debt, and pleaded with his audience to rid itself of the one-size-fits-all mentality. One strategy, he explained, might be a "bridge bank," in which the FDIC is the appointed receiver of the insured depository institution when the holding company declares bankruptcy. This strategy would place certain assets of the old bank in the receivership and the rest in the new bridge bank. He argued that this approach could require less debt and allow the critical operations of the bank to continue after its failure.

Vice Chair Hoenig concluded that a case-by-case balance of debt and added equity for each firm is the best approach.