Sunday, April 17, 2011

Systemically Important Financial Institutions

FT: Financial Groups Seek to Avoid ‘Important’ List; US Regulators Divided on Systemic Risk List; HSBC Chairman Calls for ‘Systemic’ List of Banks Reuters
Reuters: No Deal Yet on Which Banks Face Extra Cap Rules-FSB; Over 80 Banks Should Be Systemically Important-HSBC

Under the Dodd-Frank Act (DFA), the Financial Stability Oversight Council (FSOC), a group of US financial regulators, has the authority to designate a financial institution as systemically important. If designated, such institutions will be subject to tighter liquidity and capital standards as well as closer supervision pursuant to Title VIII of the DFA so that they would not increase liquidity or credit risks enough to threaten the stability of the entire financial system. Financial institutions have been desperately lobbying to avoid being designated as systemically important since the designation would likely to be a “scarlet letter,” a sign that their profits would be reduced due to higher capital and liquidity requirements.

Currently, there is a split among regulators over which financial institutions should be on the list. The Federal Reserve and the Treasury want to designate only a few (less than 10) as systemically important. Federal Reserve Governor Daniel Tarullo said the “initial list…should not be a lengthy one…in part it’s because some of the obvious pre-crisis candidates – the large freestanding investment banks – have either become bank holding companies, been absorbed by [them], or gone out of existence.” On the other hand, the Federal Deposit Insurance Corporation (FDIC), in charge of winding down systemically important financial institutions, prefers to designate about 30 to 40 financial institutions systemically important including hedge funds and insurance companies.

While the FSOC has yet to finalize the list, every bank holding company with over $50 billion in assets will be automatically included in the list. Those institutions include Bank of America, MetLife, AIG, Prudential, and Hartford Financial Services. Insurance companies argue that they do not deserve to be designated as systemically important since they have stable funding and are not subject to “bank-type runs.” They also argue that their businesses are not dangerously related to other financial institutions. However, Viral Acharya, a professor at New York University, says that insurance companies as big buyers of corporate bonds may be systemically important. If they stop buying corporate bonds during a crisis, it would affect banks’ funds as corporations have to rely on banks.

Globally, the Group of 20 countries (G20) has agreed to require systemically important global financial institutions to hold more capital. The Financial Stability Board has been working on proposals regarding how many financial institutions would be required to hold how much additional capital. The proposals will be available during the G20 summit in November.

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