Print | Share | Reprint

Regulators set 3-step process for picking SIFIs

by William McConnell | Published October 12, 2011 at 3:15 PM

The Financial Stability Oversight Council on Tuesday unveiled a list of criteria and a three-stage process for selecting the nonbanks to be designated "systemically important financial institutions" and face Federal Reserve oversight, increased scrutiny and maybe increased capital requirements.

Moving to deflect congressional and financial industry criticism that it hadn't offered enough specifics on how it would make the selection, the FSOC, whose chairman is Treasury Secretary Timothy Geithner, announced a process that will start with six "uniform and quantitative thresholds," including size, interconnectedness, leverage, liquidity risk and maturity mismatch of assets and liabilities.

An institution that meets the size and any of one of the other thresholds will be subject to further evaluation. That evaluation will include examination of the risk the company poses to the broader financial system. A company's comments will then be solicited before a designation is made final. Any designation has to be approved by two-thirds of the FSOC members.

The FSOC said that in looking initially at a nonbank company's size, it would scan for companies with either $50 billion in global assets, $30 billion in gross credit default swaps, $3.5 billion in derivatives liabilities, $20 billion of outstanding loans or bonds issued, leverage ratios of over 15-to-1 or short-term debt exceeding 10% of consolidated assets. The thresholds could evolve as the government obtains more information from filings now required of nonbanks.

Vanguard Group Inc.; SLM Corp., parent of Sallie Mae; GE Capital Financial Inc.; Ally Financial Inc.; and insurance companies including Prudential Financial Inc. and Metropolitan Life Insurance Co. have been mentioned as possible candidates for nonbank SIFI designations.

Geithner called the SIFI designation of nonbanks "one of the most important things that the Dodd-Frank Act" added to regulators' tools in overseeing the economy.

"The United States in the decades before the crisis allowed a large amount of risk to build up in a variety of institutions outside the formal banking system," he said. "When the storm hit, that put enormous pressure on that system, causing a lot of tension and trauma across financial markets, amplifying the pressure on the formal banking system and adding to the broader damage caused by the economy as a whole." Geithner said the designation of nonbanks is vital to ensuring the safety of the economy as a whole.

"Building a more resilient, more stable financial system required more than building better-designed safeguards over what we traditionally think of as banks. We also have to have the capacity to extend those safeguards to institutions that provide functions like banks and could present risks to the broader system and therefore to the economy as a whole."

The Dodd-Frank Act, which requires financial firms whose failure could pose a threat to the U.S. economy be designated as SIFIs, set broad criteria. Banking institutions with more than $50 billion in assets and nonbanks that could pose threats to the economy and draw 85% of their revenues from financial activities could be designated. Regulators are supposed to consider size, interconnectedness, leverage, lack of substitutes for services, liquidity risk and existing regulatory scrutiny when deciding which firms are designated, but the law left the exact criteria to use to the FSOC.

The FSOC's first attempt to proceed quickly with the designation without offering any guidance beyond that in the statute drew heavy criticism from Capitol Hill and from the financial industry.

Kevin L. Petrasic, a partner in Paul Hastings LLC's global banking practice, said the most immediate impact of Tuesday's formal notice of rulemaking is to put off the designation of any nonbank SIFIs until next year. He noted that the FSOC will have to consider comments on its standards and assess them before even beginning the process of designating SIFIs.

"The bottom line is while we may have a lot of bank SIFIs, it may be awhile before we know how many and who are the nonbank SIFIs," he said.

The nonbank SIFIs, besides facing heightened oversight, will have to create living wills for their dissolution in the event of financial failure. The FSOC's action came on the same day regulators formally offered a proposal to implement the Volcker Rule, which bars proprietary trading by banks, bank holding companies and their affiliates and immediately drew warnings that their proposal was too strong and also too weak.

The 298-page proposed Volcker Rule was approved Tuesday by the Federal Reserve, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency and is due to be approved by the Securities and Exchange Commission Wednesday. The Commodity Futures Trading Commission will follow with a separate, but similar proposal.

The agencies made only one change from a widely circulated leaked draft -- deciding to ask for 90 days of comments rather than the 60 days that had been expected to be sought. The warnings that the proposal was too strong came from the banking and securities industries.

Securities Industry and Financial Markets Association president and CEO Tim Ryan warned the Volcker Rule proposal "may adversely impact market liquidity."

"SIFMA's primary concern is the potential negative impact of the proposed rule on market liquidity," he said in a statement.

He said that by narrowing an exemption that allows banks to engage in market making and imposing extensive compliance procedures, the regulators would be imposing burdens that "exceed congressional intent and could well depress the market-making functions of banks and their affiliated broker-dealers as well as the asset management alternative fund business."

American Bankers Association president and CEO Frank Keating warned the "oversized nature and complexity of this proposed rule will make it unworkable and will further inhibit U.S. banks' ability to serve customers and compete internationally."

Share:

Regulatory

Regulators set 3-step process for picking SIFIs

Free preview

Meet the journalists

William McConnell

Assistant Managing Editor: Regulatory & Arbitrage

Movers & Shakers

Video

Fewer deals despite discount debt

Sectors