What Is a Living Will in Banking Regulation?

Introduction: The Origin of the Banking "Living Will"

The phrase "living will" normally brings to mind medical instructions, but in the world of finance it has a very different meaning. A banking living will, also called a "resolution plan" or "recovery and resolution plan" (RRP), is a detailed strategy that large and complex financial institutions must submit to regulators explaining how they can be rapidly wound down in an orderly fashion if they approach failure. Crafted after the 2008 global financial crisis, living wills are designed to protect taxpayers, depositors, and the broader economy from the kind of systemic domino effect that followed the collapse of Lehman Brothers.

Why Living Wills Became Mandatory

The 2008 crisis exposed critical weaknesses in the way global banks were supervised. Regulators struggled to unwind sprawling cross-border balance sheets, identify who was owed what, and maintain confidence in the financial system. The U.S. responded with Title I of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which compels bank holding companies with $250 billion or more in total consolidated assets — and systemically important non-bank financial companies — to file living wills annually or biennially. Similar frameworks now exist in the European Union, United Kingdom, and other jurisdictions.

Preventing "Too Big to Fail"

Before living wills, many market participants assumed governments would bail out giant banks to avoid chaos, creating the moral hazard known as "too big to fail." By forcing institutions to pre-plan for their own funeral, regulators hope to shift responsibility and cost away from taxpayers and toward shareholders and creditors, thereby reinstating market discipline.

Key Components of a Banking Living Will

Regulatory guidance is granular, but most living wills share several foundational elements:

1. Corporate Structure Mapping

Banks must provide a clear, legal-entity chart that traces ownership relationships across domestic and international subsidiaries. This map highlights core business lines such as retail banking, investment banking, asset management, and payment operations, allowing authorities to isolate critical functions during a crisis.

2. Critical Operations Identification

Institutions must list the vital services that must continue during a resolution, for example wire-transfer networks, clearing and settlement, or access to ATM networks. This enables regulators to determine what must be preserved or transferred to a bridge institution.

3. Liquidity and Funding Analysis

A living will details how much liquidity is available under stress, where that liquidity sits within the group, and how it can be distributed across legal entities. Contingency funding sources — such as central-bank discount windows or pre-arranged repo lines — are also spelled out.

4. Derivatives and Off-Balance-Sheet Exposures

Because derivatives contracts can accelerate rapidly during distress, banks must catalog notional amounts, counterparties, collateral arrangements, and termination clauses. The plan must show how the bank would manage mass close-outs without destabilizing markets.

5. Communications Strategy

Public confidence is paramount. Therefore, living wills include templates and timelines for communicating with employees, customers, counterparties, rating agencies, and the media during a resolution weekend.

6. Governance and Triggers

The document specifies who on the board and senior management will make critical decisions, and what quantitative or qualitative triggers would activate the resolution plan — for instance, regulatory capital falling below a threshold or a liquidity coverage ratio (LCR) breach.

Single Point of Entry vs. Multiple Point of Entry

Two main resolution strategies dominate regulatory discourse:

Single Point of Entry (SPE)

In this approach, the top-tier holding company enters bankruptcy or special resolution, while healthy subsidiaries continue operating. Losses are pushed up to the holding company, and its equity and long-term debt are written down or converted to equity (bail-in). The Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) favor SPE for large U.S. banks.

Multiple Point of Entry (MPE)

Here, separate resolution proceedings are conducted for key subsidiaries across jurisdictions. This model can be useful for banks with geographically ring-fenced operations, such as some European bank groups. Each entity can be resolved locally, allowing sovereign regulators to prioritize domestic financial stability.

The Role of "Total Loss-Absorbing Capacity" (TLAC)

A living will is only effective if there is sufficient capital and eligible long-term debt in the right place to absorb losses. The Financial Stability Board introduced TLAC standards that require global systemically important banks (G-SIBs) to maintain a minimum percentage of loss-absorbing instruments. These instruments ensure bail-in can occur without recourse to public funds.

Regulatory Review and Feedback

Living wills are far from a box-ticking exercise. In the U.S., the Federal Reserve and the FDIC jointly evaluate each submission. They assess credibility, the feasibility of execution within a real-world time frame, and whether obstacles such as foreign regulatory barriers or derivative close-out clauses remain unresolved. If deficiencies are identified, the agencies can impose penalties, restrict growth, or ultimately break up the institution.

Global Coordination Challenges

Many G-SIBs operate in over 50 countries, raising questions about how cross-border claims, ring-fencing, and conflicting legal frameworks would interact during a crisis. Memoranda of understanding (MOUs) and crisis-management groups (CMGs) aim to harmonize efforts, but critics argue that genuine cooperation may evaporate under severe stress. Living wills force banks to anticipate these roadblocks and provide work-arounds, such as pre-positioning capital or negotiating contractual recognition of bail-in in foreign governing law.

Benefits Beyond Crisis Preparedness

Preparing a living will is resource-intensive, yet many banks report side benefits:

• Enhanced data architecture, because mapping legal entities uncovers reporting gaps.

• Streamlined organizational structures, as redundant subsidiaries are merged or dissolved.

• Stronger day-to-day liquidity management, thanks to stress-testing tools developed for resolution planning.

• Better stakeholder transparency, which can translate into lower funding costs.

Ongoing Debates and Future Developments

Although living wills have grown more robust, debates continue over their real-world effectiveness. Some policymakers push for simpler, smaller banks instead of complex resolution blueprints. Others argue for greater public disclosure of the plans to enhance market discipline. Moreover, emerging threats such as fintech disruptions and cyber-risk require living wills to evolve continuously.

Conclusion: A Crucial Pillar of Financial Stability

A banking living will is essentially an emergency manual that transforms a sprawling financial institution into a set of clear, actionable steps for orderly failure. While no plan can guarantee a risk-free resolution, living wills compel banks to confront unpleasant questions in advance, reduce taxpayer exposure, and strengthen global financial resilience. As economic conditions and technologies change, regulators and banks alike will keep refining these plans, ensuring that the next crisis, whenever it comes, can be managed with far less collateral damage.