US regulators warned Tuesday that 11 giant banks have unrealistic contingency plans in the event of bankruptcy and warned that if they fail they could plunge the world into a new financial crisis.
The Federal Reserve and Federal Deposit Insurance Corporation said the 11 titans, popularly known as "those too big to fail," must make better plans to restructure their firms if they get into trouble.
FDIC Vice Chairman Thomas Hoenig said they had failed to show "how, in failure, any one of these firms could overcome obstacles to entering bankruptcy without precipitating a financial crisis."
"The plans provide no credible or clear path through bankruptcy that doesn't require unrealistic assumptions and direct or indirect public support," Hoenig warned.
The group comprises JPMorgan Chase, Goldman Sachs, Deutsche Bank, Bank of America, Bank of New York Mellon, Barclays, Citigroup, Credit Suisse, Morgan Stanley, State Street and UBS.
- Living will -
Wayne Abernathy, executive vice president at the American Bankers Association, said the banks will now be able to rework their plans based on the FDIC's criticism.
Up until this point, the industry has not known what regulators wanted, he complained, rejecting the calls from some expert critics and US lawmakers for large banks to be broken up.
"This isn't a question of whether a bank is too big," Abernathy said. "This is a question of a tool that needs to be refined."
Under the Dodd-Frank Act enacted in response to the 2008 financial crisis, the banks must demonstrate a strategy "for rapid and orderly resolution" in the event of bankruptcy or major financial distress.
But the submissions by the financial giants fail to adequately prepare a so-called "living will" that could avert disaster, FDIC said.
The rule was intended to address the problem of having financial institutions that are "too big to fail" because their demise could wreak havoc on the broader economy.
Tuesday's announcement marks a second rejection of the banks' planning by regulators. US financial agencies found fault with the original bank submissions in April 2013.
- Excessively leveraged -
Regulators have noted "some improvements" since the first round, but still point to huge flaws. The banks have until July 2015 to make "significant progress" to address the shortcomings identified.
At a recent congressional; hearing, Senator Elizabeth Warren pointedly questioned Fed Chair Janet Yellen on the adequacy of the industry's contingency plans.
She suggested some of the banks should be broken up and noted that JPMorgan is far bigger than Lehman Brothers was when it failed in the early stages of of the 2008 financial crisis.
Hoenig warned that banks today are "generally larger, more complicated and more interconnected" than they were prior to 2008.
The large banks are also generally "excessively leveraged" compared with the banking industry as a whole, he added.
The regulators listed a series of actions expected of banks in their next submissions, such as simplifying their legal structure and amending financial contracts with counterparties in an insolvency.
Abernathy said the suggested measures were possible, but warned against indiscriminate moves to break up the financial behemoths.
Replacing the 11 banks with 40 smaller banks would "reduce diversification" and the banks' "ability to handle the transactions their customers need," he said. "I think that's economic chaos."