U.S. financial regulators voted in favor of two proposals to strengthen the regulatory framework for non-bank financial institutions.
The Financial Stability Oversight Council (FSOC), a coalition of the nation’s top financial regulators led by the Treasury Department, agreed to adopt new guidance that enhances scrutiny of systemically important financial institutions (SIFI), such as asset managers, non-bank lenders, non-bank payment service providers, and cryptocurrency asset firms.
The SIFIs are deemed to be too big to fail because any disruption to their operations would trigger ramifications for the financial system. They could receive bailouts and subsidies and, as a result of federal legislation, are subject to rigorous regulation.
The series of proposals were submitted in the wake of the banking crisis earlier this year that led to the largest bank failures in U.S. history.
Officials put together the guidance to ensure a robust approach to identify, assess, and address threats and risks to the financial sector. It aims to enhance procedural protections, affirm extensive engagement with companies’ financial regulators, and eliminate prerequisites for SIFI designations.
The subject of designations has been a point of contention in the finance sector. Regulators, including Treasury Secretary Janet Yellen, say fast-tracking designations remove “inappropriate hurdles” that can take up to six years.
However, while officials say the banking system is sound and resilient, the changes function as necessary tools to flag any additional action needed to respond to challenges and crises in the financial sector effectively.
“The banking system as a whole remains strong,” Ms. Yellen said at a meeting of the FSOC on Nov. 3. “But recent stresses in some financial sectors arising from the onset of the pandemic and the sudden failures of some regional banks underscore the continuing need to remain vigilant to threats to ensure the resilience of the financial system and our economic strength.”
Federal Reserve Chair Jerome Powell, who’s an FSOC member, supported the guidance as the new rules “strike an appropriate balance between the activities-based approach and preserving designations as one of the tools that is available to the council.” The regulatory documents also provide the public transparency on how regulators view and use the tools afforded to them to support financial stability, he said.
Gary Gensler, the head of the Securities and Exchange Commission (SEC), says these efforts are “consistent with Congress’ vision.”
Under the landmark Dodd-Frank Act, which was instituted after the global financial crisis of 2008–09, the FSOC was established and now behaves as a research, advisory, and coordination body. But it also has been afforded the power to determine what SIFIs require supervision by the U.S. central bank’s regulators.
The FSOC’s latest actions extend the public “a robust structure to monitor and address” cumulative risks that could dismantle the financial system, Ms. Yellen said.
Opposition to the FSOC Guidance
Critics say that speeding up the designation of SIFIs and eliminating procedural requirements are unnecessary regulatory steps.Bob Broeksmit, the president and CEO of the Mortgage Bankers Association (MBA), for example, purports that it would negatively affect the mortgage market and consumers.
“FSOC’s plans are unnecessary, and should regulators use their authority to designate independent mortgage bank servicers as SIFIs, [it] would negatively affect the mortgage market and consumers,” Mr. Broeksmit wrote, adding that banks’ share of mortgage origination and servicing has been on the decline for the past 15 years.
In addition, the entities listed as SIFIs already endure intense scrutiny by the SEC, says Bryan Corbett, president and CEO of the Managed Funds Association.
“Alternative asset managers do not pose a systemic risk and are already subject to the SEC’s robust regulatory regime. FSOC’s adoption of the flawed guidance will hurt financial stability,” Mr. Corbett said in a statement. “SIFI designation for alternative asset managers is inappropriate as they do not carry the same risks as banks and will do nothing to curtail systemic risk in the market.”
However, applying extra layers of protection and restoring “critical elements” of FSOC can remedy “tremors in one corner of the financial system,” noted Mr. Gensler.
According to Mr. Broeksmit, the MBA is worried that FSOC members are gutting the previous mandates to perform a cost-benefit analysis and assess “any obligation to consider the likelihood that an entity might fail.”
Under the current proposal, a cost-benefit analysis is determined to be unnecessary, negating the common belief that risk-based capital rules boost financial risk. This, industry experts say, is why regulatory cost-benefit analysis is critical in the marketplace.
Ultimately, Michael Lewis, a partner at Sidley Austin LLP, recommends that companies affected by the new FSOC decision must “adjust relative risk in light of the consequences associated with potential designation as systemically important.”
There will be a public comment period for the proposals.
