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Too big to fail may mean too big to be left alone when it comes to governmental oversight. New government rules are being put in place to make sure that next time a financial crisis hits, it won’t be as unexpected and there will be plans in place to resolve the issue, hopefully without a taxpayer bailout. Bank regulators are currently overhauling rules for banks that have over $10 billion in assets, making them submit to yearly exams that will monitor their financial health.  These new regulations are a part of the 2010 Dodd-Frank law that requires significantly more oversight for banks and their operations. The first of these tests are due in either 2012 or 2013.

Looking Over Their Shoulders

The financial crisis of 2008 almost brought the United States to its knees and signaled a heightened awareness of the need for more direct oversight. If the government had known they would have been held responsible for the tab due on reckless fiscal behavior, they would have been far more interested in the bank workings years before. Just like disaster response teams imagine serious disasters to build plans that will help them respond in the event of a major disaster, now regulators will create scenarios where the worst happens and banks must respond with a plan on how to deal with all the scenarios given based on their current financial standing. These are being referred to as “stress scenarios.” These plans will be submitted to the appropriate regulatory agencies that will also help strategize potential solutions to fiscal disasters that have not yet taken place. Included in the new regulations is the requirement for a “living will.” Just like an individual who is ill may decide to create a plan whereby the disposal of assets and decision on care are pre-planned in the event of death, now banks are being required to create a living will for the disposal of their assets and management decisions should the bank fail.

A New Plan

In the past, the major way to determine a bank’s health was through capital tests.  If the bank had sufficient capital it would relate to how much dividends might increase for investors and is thought to clearly align with the health of the bank. While those tests continue to help regulators determine whether a bank might be in trouble or not, it does not address the potential for failure. New rules are being set up to plan in the event of bank failure instead of assuming that most banks will not fail due to government intervention.  With the first of these rounds of stress tests schedule for late 2012 or early 2013, it may yet prove to be an apocalyptic year (at least on paper) for many major banks. Now, they have to prove they can not only run their business in a good year, but also take care of business in the event of a major financial disaster. This may mean a more conservative approach to banking with a focus on the bank’s accountability to limit their liability and having an exit strategy should they fail. It might also lead to requirements for higher reserves or a limitation on the types of risky financial behavior that led to the financial crisis of 2008.