Lew’s comments, made during testimony before the Senate
Banking Committee in a broad-ranging hearing on regulatory
issues, marked a rare occasion where he publicly waded into the
thorny debate over cross-border regulations for swaps.

Lew told lawmakers that an April 18 letter to him signed by
foreign officials including European Commissioner Michel Barnier
was “ill-informed.”

In that letter, the finance ministers complained about a
“lack of progress” in developing workable cross-border rules
with the U.S. Commodity Futures Trading Commission and U.S.
Securities and Exchange Commission, the two independent
regulators charged with overseeing the $630 trillion
over-the-counter market.

“An approach in which jurisdictions require that their own
domestic regulatory rules be applied to their firms’ derivatives
transactions taking place in broadly equivalent regulatory
regimes abroad is not sustainable,” said the letter, which was
signed by nine officials from around the world.

“I did say to them quite directly that it was not a helpful
way to promote conversations with two independent regulatory
agencies to write a letter like that that didn’t even reflect
the state of affairs,” Lew said, in response to questioning by
Senate Banking Committee Ranking Member Mike Crapo.

He added that the SEC and CFTC have been “making real
progress” on the issue.

The SEC and the CFTC won broad new powers in the Dodd-Frank
law to police the swaps market. A provision in the law calls for
them to extend their rules overseas if trading in other
countries could have a “direct and significant” effect on the
United States.

However, there has been a major debate over how to interpret
that provision.

Foreign regulators have voiced strong opposition to an
initial proposal put forth last year by CFTC Chairman Gary
Gensler, saying it was far too aggressive and could lead to
duplicative regulation.

The CFTC has since scaled back the scope of its plan through
temporary exemptions.

Meanwhile, earlier this month the SEC released its own
proposal for how to address cross-border trades.

The SEC’s proposal is considered by most to be a
middle-of-the-road approach between what the CFTC proposed and
what foreign regulators have demanded.

It has won some praise so far from Wall Street, but was
harshly rebuked by liberal groups as well as in an opinion piece
in the New York Times, which accused the agency of caving into
Wall Street’s demands.

The SEC’s Trading and Markets Acting Division Director John
Ramsay late last week wrote a response to the paper criticizing
the op-ed.

“The rules that the SEC has proposed are robust and designed
to address systemic risk flowing back to American shores while
also promoting strong rules around the world,” Ramsay wrote.

(Reuters) – Senate Democratic leaders plan to hold a vote next week on President Barack Obama’s choice to lead the Consumer Financial Protection Bureau, a Senate Democratic aide said on Wednesday, but they are not expected to muster enough votes to confirm him.

Republicans have bitterly opposed the nomination of Richard Cordray, who has been leading the consumer agency since January 2012 in a temporary position, and Democrats are not expected to gather the 60 votes that would be needed to overcome Republican objections.

Republicans have argued that before confirming Cordray, Democrats must first agree to change the consumer bureau, which they want to be run by a bipartisan commission rather than a single director.

They have also want more congressional oversight of the bureau’s budget.

Senate Majority Leader Harry Reid plans to try and clear the way for an official vote sometime next week, though exact timing is uncertain, said Reid’s spokesman Adam Jentleson.

He added that no deal had been made with Republicans to change the consumer bureau.

Republicans also are blocking several of Obama’s other nominees for top positions, angering the White House and congressional Democrats.

When asked if Reid may consider making changes to Senate rules that require 60 votes to approve a nominee instead of a simple majority of the 100 senators, Jentleson said a rule change is possible, but the options are still being discussed.

Congress created the consumer bureau as part of the 2010 Dodd-Frank law. It is charged with overseeing mortgages, credit cards and other products to keep Americans from falling prey to financial scams.

But the financial industry argued that the new bureau’s authority was too broad and Republicans refused to confirm Obama’s initial choice as director, Elizabeth Warren, who is now a U.S. senator from Massachusetts.

Obama eventually gave Cordray the job on a temporary basis through a move known as a “recess appointment,” a procedural maneuver used to evade Senate confirmation.

In January of this year, he nominated Cordray for a full term.

Obama’s recess appointments to the National Labor Relations Board, made around at the same time that Cordray was appointed to lead the consumer bureau, were ruled invalid by a court this year.

Cordray was not directly involved in that court case, but the same argument could be applied to challenge his position, legal experts have said.

(Reporting by Emily Stephenson; Additional reporting by Richard Cowan and Sarah N. Lynch; Editing by Vicki Allen)

Fed Governor Daniel Tarullo said that the limit, known as a leverage ratio, may have been set too low in Basel III, a worldwide agreement aimed at making banks safer after the devastating 2007-09 financial crisis.

“The new Basel III leverage ratio … may have been set too low,” said Tarullo, the Fed’s regulation czar, adding that the central bank could use its powers to “set a higher leverage ratio for the largest firms.”

The debate about too-big-to-fail banks – which are perceived as implicitly relying on taxpayers to bail them out no matter how risky their business conduct – has heated up in Washington in the last few weeks.

Critics of Basel III, including many regulators, have said it is too easy on the banks, and that it relies too much on letting banks use complex calculations to determine how much equity they should hold.

Many of the signatories of Basel III across the world, the Fed included, have missed the January deadline set by global leaders to introduce the global pact.

Tarullo expected the rules that the Fed is drawing up with two other regulators – the Federal Deposit Insurance Company and the Office of the Comptroller of the Currency (OCC) – to come out in the next couple of months.

Under Basel III, the leverage ratio stands at 3 percent. Tarullo declined to say by how much it should go up.

Two senators, Sherrod Brown and David Vitter, have introduced a bill that would set the leverage ratio for the biggest banks at 15 percent, a requirement so onerous that it could force them to carve up their businesses.

GovTrack, a website that calculates the likelihood of U.S. laws being adopted, attributes only a 1 percent chance to the proposal becoming law. Still, the bill has caused a flurry of headlines, and is hotly debated.

Banks complain equity is the most expensive way to fund their business, but it is the safest from a taxpayer’s or a regulator’s perspective. That is because shareholders are the first to lose their money in case of bankruptcy.

Tarullo also said he favored setting minimum requirements for how much long-term debt banks must hold. This debt buffer, which could be converted to equity if the bank failed, would absorb losses in case of financial trouble.

The main threat to bank stability was their reliance on short-term funding, Tarullo said, suggesting that big banks could be allowed to hold less capital than their peers if they relied less on short-term funding.

(Reporting By Emily Stephenson and Douwe Miedema; editing by Andrew Hay)

Fed Governor Daniel Tarullo said in a speech that the
leverage ratio – which limits the amount of money a bank can
borrow to fund its business – established by the international
agreement, known as Basel III, may have been too low.

“To me, at least, the important question is not whether
capital requirements for large banking firms need to be stronger
than those included in Basel III and the agreement on capital
surcharges, but how to make them so and with what specific risks
in mind,” he said.

The proposal comes as the Federal Reserve and other bank
regulators finalise U.S. rules to implement the global Basel III
capital accord, which was crafted in the wake of the devastating
2007-09 financial crisis.

A number of U.S. and international regulators have since
criticized the agreement as too easy on the banks or said it
relies too much on letting banks use complicated calculations of
the riskiness of their assets to determine how much capital to
maintain.

Many of the signatories across the world, the Fed included,
have missed the January deadline set by global leaders for
introducing these tougher rules to make banks safer. The Fed has
indicated it will introduce the rules this year.

Tarullo said he expected the final U.S. version to be
released in the next few months. He declined to specify how high
regulators should set the leverage ratio for the biggest banks.

U.S. regulators have said a section of the 2010 Dodd-Frank
law that authorizes them to impose tougher restrictions on the
biggest, most interconnected banks would allow them to
significantly ramp up capital requirements for those firms.

Tarullo also said on Friday that regulators are leaning
toward setting minimum requirements for how much long-term debt
banks must hold. This debt buffer, which could be converted to
equity if the bank failed, would absorb losses in case of
financial trouble, he said.

European bankers have been lobbying the Federal Reserve, and
Fed board member Daniel Tarullo in particular, to try to beat
back new rules that would force foreign banks to lump all their
U.S. subsidiaries under a single holding company.

Such entities would face the same capital requirements that
U.S. banks must meet, and the biggest banks would need to hold
liquidity buffers in their U.S. holding companies.

“The proposal, in its current form, would result in an
increase in the instability of the financial system,” Deutsche
bank said in a letter, which was dated Monday and posted to the
Federal Reserve’s website on Wednesday.

The German bank, whose balance sheet is the size of around
80 percent of the German economy, said the plan would lead to a
higher concentration of risk in U.S. banks and deviate from
globally harmonized regulatory regimes.

Deutsche unexpectedly announced it would raise 2.8 billion
euros ($3.69 billion) in equity capital this week, and sell 2
billion euros of hybrid debt to investors on top of that.

The plan should leave it sufficiently capitalized under “all
scenarios,” Deutsche said, even if the Fed’s proposed bank
safety rules aren’t final yet. But analysts continued to worry
the German lender was borrowing too much.

The bank could face a 12 billion euro capital shortfall at
its U.S. Taunus unit, according to analysts at Espirito Santo
Investment Bank, while replacing the intra-group funding
Deutsche provides to the unit might be prohibitively expensive.

“Having to find independent funding for Taunus could likely
be so expensive that it negates its business model,” the
Espirito Santo analysts said in a note.

Foreign banking groups and financial regulators have also
registered concerns in letters to the Fed, arguing the proposal
could create an inconsistent regulatory burden for foreign banks
and hamper banks’ ability to react in a crisis.

The Fed said when it proposed the new rules in December that
the goal was to crack down on risks to U.S. markets posed by big
banks that do business globally.

The United States traditionally relied on foreign
supervisors to watch overseas banks, allowing them to hold less
capital than their domestic counterparts, on the assumption that
the parent company was sufficiently capitalised.

That policy ended after the Fed extended hundreds of
billions of dollars in emergency loans to overseas banks during
the financial crisis, which sparked fears foreign banks were not
sufficiently capitalized in the United States.

Officials from the German bank and from BNP Paribas
have met with Tarullo to talk about the proposal,
Reuters has reported.

The Financial Stability Oversight Council, which was set up
after the 2007-2009 crisis to watch for developing threats to
the financial system, also urged a reform of market benchmarks
after a global rate-rigging scandal hit the Libor interbank
rate.

“Technological failures, natural disasters, and cyberattacks
can emanate from anywhere, at any time,” the report said.
“Preparation and planning to address these potential situations
are essential to maintain the strength and resilience of our
financial system.”

The FSOC, a powerful body chaired by Treasury Secretary Jack
Lew, voted on Thursday to adopt its annual report, which
includes a set of recommendations to other regulatory agencies.
The heads of those agencies are members of the council.

Regulators need to keep a close eye on operational risks,
the FSOC said, after a year in which a hurricane disrupted stock
exchanges and cyber attacks hit banks such as JPMorgan Chase
and Wells Fargo.

The council also pointed to technological malfunctions
plaguing the initial public offerings of BATS Global Markets and
Facebook.

Short-term funding markets for banks remain susceptible to
bank runs, singling out money market funds and the so-called
triparty repo market — jointly often referred to as the shadow
banking market, the group said.

“We need to strengthen markets that may be susceptible to
destabilizing runs and fire sales,” Lew said at an open meeting
of the council to consider the report.

The FSOC in the past has used its authority to take on the
issue of a reform of money market funds, urging the Securities
and Exchange Commission to come up with a plan after the
securities watchdog failed last year to agree on new rules.

The council also urged overhauling the housing finance
system in its report and said America should work with foreign
regulators to improve benchmark rates such as Libor, which have
been proven prone to manipulation in recent years.

The group repeated a call to Congress to raise the U.S.
legal borrowing limit, which it said was more of a concern to
markets than the combination of deep spending cuts and tax
increases known as the fiscal cliff that was largely averted
this year.

“The inability of the Treasury to borrow might cause an
interruption of principal and interest payments on U.S.
sovereign debt, which financial markets regard as one of the
safest assets,” the report said.

The group also warned about potential financial risks from
ultra-low interest rates, with signs of an erosion in corporate
borrowing standards and covenants, and greater issuance of
risky, high-yielding bonds. These conclusions mirrored similar
findings from the International Monetary Fund last week.

Mary Miller, Treasury’s undersecretary for domestic finance, said in prepared remarks for a speech at an economic conference in New York that it is not necessarily true that the biggest banks borrow more cheaply than smaller competitors can.

And even if they do enjoy such a subsidy, she said, it may not be because markets believe they are “too big to fail.”

“In the wake of the financial crisis, the largest banks’ borrowing costs have not only increased more than those of some regional bank competitors, but have also increased to higher absolute levels,” Miller said.

The debate has resurfaced in recent weeks over whether the 2010 Dodd-Frank law and other measures did enough to crack down on JP Morgan Chase & Co, Citigroup, Bank of America Corp and other big banks.

Many politicians and some regulators argue some banks are still so big that the government would support them, as was done during the 2007-2009 crisis, rather than let their failure threaten the stability of the financial system.

Because markets also believe the government would step in, these critics say, the biggest banks have the unfair advantage that they can issue debt more cheaply than smaller banks can.

Miller said this view is mistaken because the 2010 Dodd-Frank oversight law forbids regulators from bailing banks out with taxpayer funds.

As an alternative, Dodd-Frank required U.S. banking regulators to prepare for how to liquidate a massive failed bank in a future crisis.

Even if big banks do have lower funding costs, that could be explained by other factors, she said. For example, financial giants may have greater liquidity and a bigger pool of potential investors than smaller competitors.

“Research shows that large non-financial corporations enjoy a similar funding advantage over their smaller and less-diversified peers,” Miller said.

She also said regulators are making progress with efforts to make the financial system safer, such as boosting banks’ equity capital ratios and bringing transparency to the over-the-counter derivatives market.

(Reporting By Emily Stephenson)

The Consumer Financial Protection Bureau said these
financial advisers use more than 50 different credentials, some
of which they can simply buy online.

This creates a confusing array of titles that leaves older
Americans vulnerable to abuse, the CFPB’s report said. It noted
that it is often impossible to distinguish between the titles,
which do not clearly indicate what training advisers received
and which are not overseen by a single regulator.

“A senior choosing between an Accredited Retirement Advisor
and an Accredited Estate Planner will likely do so without
knowing which one is required to have five years of experience
and some graduate level education and which is not,” CFPB
Director Richard Cordray said.

The report calls for state and federal regulators to require
tougher training before people can obtain designations to work
with seniors and to set standards of conduct for advisers who
claim those certifications.

Congress created the consumer bureau as part of the 2010
Dodd-Frank law and gave it oversight of products such as
mortgages, student loans and credit cards.

Through its office of older Americans, the bureau has been
looking at the problems retired people face in managing their
finances.

As part of Dodd-Frank, Congress told the CFPB to look into
special titles that identify financial professionals as having
expertise or training to work with older people.

The bureau found that a variety of financial professionals,
including investment advisers, broker-dealers, accountants and
insurance agents, obtain such titles. CFPB officials said they
believe tens of thousands of people use these titles.

They may be overseen by the U.S. Securities and Exchange
Commission (SEC), the self-regulatory Financial Industry
Regulatory Authority or by state regulators, which do not all
have uniform requirements for people who work with seniors. The
bureau itself has limited authority over this issue, CFPB
officials said.

That can mean seniors misjudge the training their advisers
have received. Even some industry professionals reported
confusion about what the various designations indicate, CFPB
officials said on Thursday.

Confusion about designations also can open seniors up to
worse abuses, the bureau said.

For example, some designated advisers hold events that are
billed as educational seminars for older people but actually are
held to sell investment products and other services, the report
said.

Cordray said seniors and people with elderly parents need
more transparency. He said his own father is 95 years old.

“He should not have to fend off unscrupulous advisers who
are trying to raid the life savings of seniors,” Cordray said.

In addition to pushing for tougher standards for
designations, the report calls for the SEC to create a tool
consumers could use to verify credentials and determine what
training their financial adviser completed to receive it.

The CFPB used research from other regulatory agencies, as
well as information gathered from roundtable sessions with
financial planners, insurance and securities industry experts,
consumer advocates and others, the report said.

The team from the Federal Deposit Insurance Corp has hosted more than two dozen meetings with bond investors, analysts and other stakeholders to lay out in detail how a failing firm would be liquidated.

One of the goals of the roadshow was to warn Wall Street not to count on a repeat of the government bailouts of the 2007-2009 financial crisis, when Washington stepped in to rescue AIG and other financial institutions out of fear that a collapse would be disastrous for the world economy.

People present at these meetings say the FDIC makes a compelling case, and there are signs that the roadshow is gradually succeeding in shifting market perceptions.

Some bond investors are demanding higher yields on bank debt that they now see as riskier because of the FDIC’s plan, said Brian Monteleone, a bank credit analyst at Barclays who has participated in the FDIC meetings.

Moody’s Investors Service said in March that it may downgrade some bank bonds by year-end since the United States appears less likely to bail them out. The credit rating agency has assigned a negative outlook on bonds from JPMorgan Chase & Co, Bank of America Corp, Citigroup Inc, Wells Fargo & Co, Goldman Sachs Group Inc and Morgan Stanley.

The evidence of the FDIC’s persuasiveness is anecdotal at this point, however as data on bank credit default swaps, used by investors to protect themselves against default, have not shown a clear shift.

However, investors and analysts say they are studying how to price the heightened risk based on the FDIC’s plan, and expect to see more movement in the coming months.

“To get sophisticated investors to invest better, this is how you do it,” said David Hendler, a senior analyst at CreditSights who hosted a conference with an FDIC official for investors. “You put more of their skin in the game.” Bond investors will have more to lose, Hendler explained.

The debate over whether Washington has solved “too big to fail” will not be settled until another crisis tests whether U.S. and overseas financial stewards have the confidence and skill to gently take down a failing mega-bank without triggering a crippling market shock.

Still, the FDIC believes that if markets know what to expect and stay calm when a financial giant gets into trouble, Washington will also be less likely to panic and enact another bailout like that of insurer AIG in 2008, say people familiar with the agency’s thinking. The FDIC also hopes investors will be more likely to scrutinize mega-bank activity , curbing risky activity if they are convinced the era of government bailouts is over.

The FDIC declined to comment for this story.

The agency has posted on its website slide presentations it has used to show how it would exercise its liquidation authority. (link.reuters.com/dez37t)

HAIRCUTS

FDIC staff began hosting small gatherings and teleconferences in early 2012 with Wall Street to discuss the details and repercussions of a bank failure, such as what happens to subordinated debt, secured lenders, and bridge financing, according to documents on the FDIC website.

Under the FDIC plan, the agency would take over the top-level holding company, which is usually owned by public shareholders and financed in part by bond investors. The FDIC would then use capital from the holding company to rescue failing subsidiaries, such as deposit-taking banks or trading arms.

Shareholders of the holding company would be wiped out and bondholders would be forced to take a “haircut,” meaning they are paid less than what they are owed.

The FDIC could then form a “bridge” holding company with new leadership, likely pulled from a list the agency is drafting of veteran banking executives and others, according to a person familiar with the agency’s plans.

James Campbell, a research analyst covering big financial companies for the California Public Employees’s Retirement System (CalPERS), said the FDIC’s plan to keep bank subsidiaries from insolvency would go a long way toward protecting depositors and reducing the risk to the financial system.

Still, some investors who have met with the FDIC say there are significant issues to be resolved, such as how to deal with a failed bank’s overseas subsidiaries, which are subject to foreign insolvency practices. Unless these concerns are addressed, creditors of subsidiaries will likely take their money back and feed a panic.

“There are too many connections that credit investors do not understand, so you just assume you need to sell not only the entity that is in trouble, but everything that is connected to it,” said David Knutson, a senior research analyst at Legal & General Investment Management, a unit of Legal & General Group Plc that buys bonds. He has been to multiple FDIC presentations.

The FDIC released a report with United Kingdom regulators in December explaining how they would work together to resolve a U.S. holding company with London-based subsidiaries.

One person with knowledge of the FDIC’s work said regulators now have a better understanding than before the financial crisis of the different laws, bank structures and other factors that could complicate the resolution of a global bank failure. The person called it a “transformational shift” in international dialogue.

DOWNSIZING

The FDIC and the Federal Reserve have asked banks to draft so-called “living wills” to lay out how they could be dismembered if they suffered mortal losses.

The Office of the Comptroller of the Currency has also had some preliminary conversations with bank executives about how to simplify bank structures. In the last month, the office has discussed pushing big banks to assess how many subsidiaries they operate and how they are aligned, an OCC official said.

That could eventually make it easier to sell off subsidiaries to help a bank recover from a downturn or to resolve a failed firm, said the official, who did not want to be identified as the early discussions are not public.

For banks, a workable FDIC liquidation plan could stave off political pressure for more drastic financial reforms following the 2010 Dodd-Frank law, such as calls to break up the big banks and legislation to limit bank size. These proposals may currently be long shots, but another financial blowup could spark the political will necessary to make them a reality.

“Some of us see it as the key to a safer financial system,” said Wilson Ervin, a New York-based senior adviser to the chief executive of Credit Suisse Group AG. “And some pragmatic types realize that if you don’t have a solution to ‘too-big-to-fail,’ then the regulations and restrictions will keep coming, and you won’t really have a good argument to stop them.”

Federal Reserve Board Governor Daniel Tarullo has said the central bank may require big bank holding companies to issue minimum levels of long-term debt. The idea is to make sure they have enough obligations to slash for the FDIC to recapitalize a failing business. But a minimum could force some banks to use costlier forms of borrowing and even pressure them to sell off parts of their business.

“It creates market pressure to downsize,” said former FDIC Chairman Sheila Bair. “That’s what it means to end ‘too-big-to-fail.’ It’s a good thing, not a bad thing, that their funding costs go up.”

The Fed has said settling the minimum debt issue is an agency priority this year.

Darrell Duffie, a finance professor in the business school at Stanford University, said regulators are making progress toward resolving the challenges of shutting down a mega-bank.

“There are still a few missing pieces to the puzzle,” he said. “With some work over the next years, I think there is going to be a significant improvement in the ability to allow banks to fail.”

(Reporting By Emily Stephenson in Washington and David Henry in New York; Editing by Karey Van Hall, Tiffany Wu, and Theodore d’Afflisio)

The team from the Federal Deposit Insurance Corp has hosted
more than two dozen meetings with bond investors, analysts and
other stakeholders to lay out in detail how a failing firm would
be liquidated.

One of the goals of the roadshow was to warn Wall Street not
to count on a repeat of the government bailouts of the 2007-2009
financial crisis, when Washington stepped in to rescue AIG
and other financial institutions out of fear that a
collapse would be disastrous for the world economy.

People present at these meetings say the FDIC makes a
compelling case, and there are signs that the roadshow is
gradually succeeding in shifting market perceptions.

Some bond investors are demanding higher yields on bank debt
that they now see as riskier because of the FDIC’s plan, said
Brian Monteleone, a bank credit analyst at Barclays who has
participated in the FDIC meetings.

Moody’s Investors Service said in March that it may
downgrade some bank bonds by year-end since the United States
appears less likely to bail them out. The credit rating agency
has assigned a negative outlook on bonds from JPMorgan Chase &
Co, Bank of America Corp, Citigroup Inc,
Wells Fargo & Co, Goldman Sachs Group Inc and
Morgan Stanley.

The evidence of the FDIC’s persuasiveness is anecdotal at
this point, however as data on bank credit default swaps, used
by investors to protect themselves against default, have not
shown a clear shift.

However, investors and analysts say they are studying how to
price the heightened risk based on the FDIC’s plan, and expect
to see more movement in the coming months.

“To get sophisticated investors to invest better, this is
how you do it,” said David Hendler, a senior analyst at
CreditSights who hosted a conference with an FDIC official for
investors. “You put more of their skin in the game.” Bond
investors will have more to lose, Hendler explained.

The debate over whether Washington has solved “too big to
fail” will not be settled until another crisis tests whether
U.S. and overseas financial stewards have the confidence and
skill to gently take down a failing mega-bank without triggering
a crippling market shock.

Still, the FDIC believes that if markets know what to expect
and stay calm when a financial giant gets into trouble,
Washington will also be less likely to panic and enact another
bailout like that of insurer AIG in 2008, say people
familiar with the agency’s thinking. The FDIC also hopes
investors will be more likely to scrutinize mega-bank activity ,
curbing risky activity if they are convinced the era of
government bailouts is over.

The FDIC declined to comment for this story.

The agency has posted on its website slide presentations it
has used to show how it would exercise its liquidation
authority. ()

HAIRCUTS

FDIC staff began hosting small gatherings and
teleconferences in early 2012 with Wall Street to discuss the
details and repercussions of a bank failure, such as what
happens to subordinated debt, secured lenders, and bridge
financing, according to documents on the FDIC website.

Under the FDIC plan, the agency would take over the
top-level holding company, which is usually owned by public
shareholders and financed in part by bond investors. The FDIC
would then use capital from the holding company to rescue
failing subsidiaries, such as deposit-taking banks or trading
arms.

Shareholders of the holding company would be wiped out and
bondholders would be forced to take a “haircut,” meaning they
are paid less than what they are owed.

The FDIC could then form a “bridge” holding company with new
leadership, likely pulled from a list the agency is drafting of
veteran banking executives and others, according to a person
familiar with the agency’s plans.

James Campbell, a research analyst covering big financial
companies for the California Public Employees’s Retirement
System (CalPERS), said the FDIC’s plan to keep bank subsidiaries
from insolvency would go a long way toward protecting depositers
and reducing the risk to the financial system.

Still, some investors who have met with the FDIC say there
are significant issues to be resolved, such as how to deal with
a failed bank’s overseas subsidiaries, which are subject to
foreign insolvency practices. Unless these concerns are
addressed, creditors of subsidiaries will likely take their
money back and feed a panic.

“There are too many connections that credit investors do not
understand, so you just assume you need to sell not only the
entity that is in trouble, but everything that is connected to
it,” said David Knutson, a senior research analyst at Legal &
General Investment Management, a unit of Legal & General Group
Plc that buys bonds. He has been to multiple FDIC
presentations.

The FDIC released a report with United Kingdom regulators in
December explaining how they would work together to resolve a
U.S. holding company with London-based subsidiaries.

One person with knowledge of the FDIC’s work said regulators
now have a better understanding than before the financial crisis
of the different laws, bank structures and other factors that
could complicate the resolution of a global bank failure. The
person called it a “transformational shift” in international
dialogue.

DOWNSIZING

The FDIC and the Federal Reserve have asked banks to draft
so-called “living wills” to lay out how they could be
dismembered if they suffered mortal losses.

The Office of the Comptroller of the Currency has also had
some preliminary conversations with bank executives about how to
simplify bank structures. In the last month, the office has
discussed pushing big banks to assess how many subsidiaries they
operate and how they are aligned, an OCC official said.

That could eventually make it easier to sell off
subsidiaries to help a bank recover from a downturn or to
resolve a failed firm, said the official, who did not want to be
identified as the early discussions are not public.

For banks, a workable FDIC liquidation plan could stave off
political pressure for more drastic financial reforms following
the 2010 Dodd-Frank law, such as calls to break up the big banks
and legislation to limit bank size. These proposals may
currently be long shots, but another financial blowup could
spark the political will necessary to make them a reality.

“Some of us see it as the key to a safer financial system,”
said Wilson Ervin, a New York-based senior adviser to the chief
executive of Credit Suisse Group AG. “And some pragmatic types
realize that if you don’t have a solution to ‘too-big-to-fail,’
then the regulations and restrictions will keep coming, and you
won’t really have a good argument to stop them.”

Federal Reserve Board Governor Daniel Tarullo has said the
central bank may require big bank holding companies to issue
minimum levels of long-term debt. The idea is to make sure they
have enough obligations to slash for the FDIC to recapitalize a
failing business. But a minimum could force some banks to use
costlier forms of borrowing and even pressure them to sell off
parts of their business.

“It creates market pressure to downsize,” said former FDIC
Chairman Sheila Bair. “That’s what it means to end
‘too-big-to-fail.’ It’s a good thing, not a bad thing, that
their funding costs go up.”

The Fed has said settling the minimum debt issue is an
agency priority this year.

Darrell Duffie, a finance professor in the business school
at Stanford University, said regulators are making progress
toward resolving the challenges of shutting down a mega-bank.

“There are still a few missing pieces to the puzzle,” he
said. “With some work over the next years, I think there is
going to be a significant improvement in the ability to allow
banks to fail.”