It's no surprise that big banks find the exercise difficult. With thousands of legal entities spread around the world, in businesses ranging from trading derivatives to warehousing metals, their operations test human understanding, let alone effective management. Hence events such as JPMorgan Chase's "London Whale" fiasco, in which the bank lost $6.2 billion in a unit that was supposed to be managing its cash. The banks' scale and interconnectedness explain why governments feel compelled to rescue them when they get into trouble, rather than face the potentially disastrous consequences of standing aside.
The Fed and the FDIC have decided to demand better. In a harshly worded statement, they described the living wills submitted last year by 11 large banks as "not credible." They complained about "unrealistic" assumptions and the banks' "failure to make, or even identify, the kinds of changes in firm structure or practices that would be necessary to enhance the prospects for orderly resolution."
If used to the full extent allowed by the Dodd-Frank Act, the living will is a powerful regulatory tool. If banks can't make a convincing case they are no longer too big to fail, regulators can require them to raise more loss-absorbing capital, for instance, or even divide them into smaller, more manageable pieces. It's good to see that regulators are serious about turning the exercise into a real test.
For the process to be credible, though, the living wills must also eventually convince investors, whose preferential treatment of banks deemed too big to fail creates an incentive to stay that way. So far, only a small and superficial part of the resolution plans have been made public. Much more could be published without surrendering competitive intelligence and it will take no less to convince investors that bailouts are a thing of the past.
The Fed and the FDIC have given the banks until July 2015 to show "significant progress" on their living wills. That progress should be for all to see.