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By Lisa Lambert

WASHINGTON, April 13 (Reuters) - U.S. regulators failed five big banks on Wednesday, including JP Morgan and Wells Fargo, on their plans for a bankruptcy that would not rely on taxpayer money, giving them until Oct. 1 to make amends or risk sanctions.

The move officially starts a long regulatory chain that could end with breaking up the banks. Nearly a decade after the financial crisis, it underscored how the debate about banks being "too big to fail" continues to rage in Washington and exasperate on Wall Street.

Wednesday's announcement was the first time the two major banking regulators, the Federal Reserve and the Federal Deposit Insurance Corporation, issued joint determinations flunking banks' plans, commonly called "living wills."

If the five, which also included Bank of America Corp , State Street Corp and Bank of New York Mellon Corp., do not correct serious "deficiencies" in their plans by October, they could face stricter regulations, like higher capital requirements or limits on business activities, regulators said.

If the deficiencies persist for two years, then the banks will have to divest their assets. They have until July 2017 to address more minor "shortcomings."

The requirement for a living will was part of the Dodd-Frank Wall Street reform legislation passed in the wake of the 2007-2009 financial crisis, when the U.S. government spent billions of dollars on bailouts to keep big banks from failing and wrecking the U.S. economy.

The plans are separate from the Fed's stress tests, where banks demonstrate stability by showing how they would withstand economic and financial shocks in hypothetical scenarios.

"The FDIC and Federal Reserve are committed to carrying out the statutory mandate that systemically important financial institutions demonstrate a clear path to an orderly failure under bankruptcy at no cost to taxpayers," FDIC Chairman Martin Gruenberg said in a statement. "Today's action is a significant step toward achieving that goal."

But the agency's vice chairman, Thomas Hoenig, who was a voting member of the Federal Open Market Committee during the crisis, said the plans show that no firm is "capable of being resolved in an orderly fashion through bankruptcy."

"The goal to end 'too big to fail' and protect the American taxpayer by ending bailouts remains just that: only a goal," he said.

The three remaining large, systemically important banks, which the U.S. government considers "too big to fail," did not fare much better in their evaluations, but sidestepped potential sanctions because they were not given joint determinations.

The FDIC alone determined the plan submitted by Goldman Sachs was not credible, while the Federal Reserve Board on its own found Morgan Stanley's plan not credible. Citigroup's living will did pass, but the regulators noted it had "shortcomings."

The regulators' report coincided with the start of banks earnings reporting period and bank shares rallied. Wells Fargo shares rose 2.3 percent, JP Morgan was up 4.3 percent, Citigroup rallied 5 percent, Bank of America and Bank of New York Mellon gained more than 3 percent each, and State Street was up 2.8 percent.

Goldman Sachs said in a statement it has made "significant progress" and Morgan Stanley said resolution planning is one of its "highest priorities."

Citigroup was will work to address the shortcomings, Chief Executive Michael Corbat said in a statement.

The deficiencies across the five banks largely revolved around liquidity, governance and operations.

While JPMorgan has "made notable progress in a range of areas," the regulators said it "has key vulnerabilities," including an inability to estimate the liquidity needed and available for funding bankruptcy resolution and insufficient resources for winding down derivatives if its credit ratings are cut.

On a conference call on JPMorgan's earnings, bank executives expressed disappointment with the determination and Chief Executive Officer Jamie Dimon said the bank has "tons of liquidity."

"It's more about reporting, legal entities and things like that," he said. "And if other firms can satisfy that I'd be surprised if we can't."

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