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  • Regulating Systemically Important Financial Institutions That Are Not Banks

    Other financial institutions may be added as well, such as hedge funds or money market funds. Dodd-Frank also authorizes the FSOC to designate certain types of activities as systemic regardless of what institution is conducting them, giving the

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Regulating Systemically Important Financial Institutions That Are Not Banks - Brookings Institution

Certain financial institutions are so central to the American financial system that their failure could cause traumatic damage, both to financial markets and the larger economy. These institutions are often referred to as “systemically important financial institutions” or SIFIs. The Dodd-Frank Act, the comprehensive reform legislation signed into law during the summer of 2010, requires financial regulators belonging to the Financial Stability Oversight Council  (FSOC) [1] to name those financial institutions that it believes are systemically important. [2] Such SIFIs are to be supervised more closely and potentially required to operate with greater safety margins, such as higher levels of capital, and to face further limitations on their activities.

  • Under Dodd-Frank, financial regulators belonging to the Financial Stability Oversight Council (FSOC) are required to name entities that are deemed to need closer regulatory supervision and potentially required to operate with greater safety margins, such as higher levels of capital, and to face further limitations on their activities.
  • As the FSOC looks to designating life insurers and other non-banks as SIFIs, there is little known about how the regulatory change would affect them in practice, creating major uncertainty that would affect their business without adequate consideration of their real roles and structures.
  • Because these insurers are financial institutions with millions of customers, Elliott says it is important to think about whether they will be placed at a considerable disadvantage by rules that are ill-designed for their business, which could in turn hurt not just their customers but the overall economy given the industry’s size: there are nearly 900 life insurers that are responsible for $19.2 trillion worth of policies and certificates, and the industry is one of the largest sources of U.S. investment capital with $4.9 trillion invested in the domestic economy.
  • Once a non-bank financial institution has been designated as a SIFI, very real questions arise as to how best to regulate these institutions. The Fed has promised to pay careful attention to the differences between banks and other financial institutions that are designated as SIFIs. Elliott emphasizes it is crucial that they be rigorous in doing so.

Throughout Dodd-Frank the focus is principally on banks, particularly commercial banks, and the act effectively designates all commercial banking groups with $50 billion or more in assets as SIFIs. However, it requires regulators to consider whether other financial institutions are systemically important, leaving the decision about which non-bank financial institutions should receive that designation up to the FSOC, with advice from the Federal Reserve Board (Fed). The FSOC is in the process of determining what non-bank institutions it will designate as SIFIs, but it seems clear that several large life insurance groups and at least one large finance company (GE Capital) will be named. Eight “financial market utilities” have already been designated. (These are firms such as clearing houses that do the back office transactions that make many financial markets function.) Other financial institutions may be added as well, such as hedge funds or money market funds.

Dodd-Frank also authorizes the FSOC to designate certain types of activities as systemic regardless of what institution is conducting them, giving the regulators greater powers to control those activities. There is some potential for this to be invoked in regard to money market funds and that possibility has given the FSOC greater leverage in pushing for changes to the rules governing money market funds even if the systemic activities designation is never used. This paper will generally not discuss the activities clause, but will focus instead on the regulation of entire institutions designated as SIFIs.

Once a non-bank financial institution has been designated as a SIFI, very real questions arise as to how best to regulate these institutions. The Fed becomes the regulator for SIFI purposes, alongside the existing primary regulator. However, the Fed has little previous experience of overseeing some of these types of institutions, particularly insurers. Therefore, it needs to figure out how to evaluate their safety and how to coordinate with existing supervisors. Doubtless, the Fed will end up falling somewhere on a spectrum between simple reliance on existing regulatory paradigms and procedures and developing an entirely separate approach that may rely excessively on its prior experience as a banking supervisor.

The Fed should not simply defer to existing regulators and view non-bank SIFIs as safe if they say so. It has a legal obligation to form its own conclusions. Further, viewing the institutions systemically may provide a different perspective, perhaps pointing to systemic risks that would not be...

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