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Treasury urges new process for determining ‘too big to fail’

Posted On: Nov. 20, 2017 11:10 AM CST

Treasury urges new process for determining ‘too big to fail’

The U.S. Treasury Department has recommended a different approach to evaluating the potential risks posed by nonbank financial companies rather than the current method that has led to several major insurers being tagged as “too big to fail.”

The Financial Stability Oversight Council has held the responsibility of evaluating companies and had designated four nonbank institutions as systemically important financial institutions since the financial crisis. Institutions designated as SIFIs are subject to stricter oversight and stricter capital requirements.

“The council’s authority to designate nonbank financial companies is a blunt instrument for addressing potential risks to financial stability,” the Treasury Department said in its report released on Friday. “Treasury recommends that the council prioritize its efforts to address risks to financial stability through a process that emphasizes an activities-based or industrywide approach.”

The department recommended a three-step process for assessing and addressing a nonbank company’s potential risks to financial stability, with the first step being a review of potential risks to financial stability from activities and products. If a potential risk to financial stability is identified, the next step would be to work with relevant regulators to address the risk. If a company could pose a risk to financial stability, the council should consider designation only after consultation with relevant regulators, according to the recommendations.

The council should revise its interpretive guidance to provide for assessment of the likelihood of a firm’s material financial distress to assess the extent to which a designation would promote U.S. financial stability, according to the recommendations. 

“The council should revise its interpretive guidance to provide that it will designate a nonbank financial company only if the expected benefits to financial stability outweigh the costs that designation would impose,” the report said. “Agency regulatory action is appropriate only if it does more good than harm, and there can be no confidence in this regard unless the council seeks to weigh the costs and benefits of its actions.”

The department also recommended that the council enhance its communication with nonbank financial companies under review for a potential determination, including having its analytical staff explain the specific risks that have been identified to the company during the preliminary review, which would allow them to act to mitigate those risks prior to a designation, according to the report. The council should also engage with the company’s primary financial regulator and publicly release an explanation of its decision for future designations and rescissions, according to the report. 

The department also recommended the council provide a clear “off-ramp” to designated nonbank financial companies for achieving a rescission of their designations, including clear guidance on the most important factors in its determination and a “more robust and transparent process” for its annual reevaluations, according to the report.

The American Council of Life Insurers praised the Treasury Department and secretary for the report, which it said correctly recognized that, among other things, designating insurers as systemic is not an effective or efficient approach for addressing potential risk to financial stability and that the FSOC should leverage the insights and expertise of state insurance regulators, including to address potential systemic risks.

“While ACLI is reviewing the entirety of the report, we are strongly encouraged by the emphasis on improved engagement and transparency in the designation process,” the organization said in its statement on Friday. “No life insurer should be designated as systemically important.” 

In July 2013, the council voted to designate New York-based American International Group Inc. and Norwalk, Connecticut-based General Electric Capital Corp. Inc. as SIFIs, with Newark, New Jersey-based Prudential Financial Inc. also designated as a SIFI in September 2013. 

In December 2014, the council voted to designate New York-based MetLife Inc. as a SIFI, but the insurer won a court challenge against the designation in March 2016 — a decision currently under appeal by the government. In June 2016, the council voted to rescind GE’s SIFI designation after the company changed its business by divesting assets and changing its funding model. 

The FSOC voted in late September to rescind AIG’s SIFI designation on a 6-3 vote — a decision that came nine years after the government injected more than $180 billion into the insurer to prevent its collapse amid the financial crisis. AIG was a key player in the credit default swaps market, and officials feared its collapse would cause spiraling problems with other financial institutions.