Federal Reserve Board Establishes Key Rule That Will Let Regulator Identify Systemically Important Nonbank Financial Institutions

The Federal Reserve Board has moved closer toward being able to designate certain firms as Systemically Important Nonbank Financial Institutions. Earlier this month it set up a key rule that lets the Financial Stability Oversight Council name these SIFIs. The Federal Reserve would be their consolidated supervisor.

The rule defines when a firm is “predominantly” involved in financial activities. An SIFI would need to have at least $50 billion in overall consolidated assets or have risk exposures that could harm the US financial system should it fail. Among the companies that will likely get the SIFI designation are Prudential Financial Inc., GE Financial, MetLife Inc., and American International Group Inc.

A company will be considered as primarily involved in activities that the Bank Holding Company Act deems “financial in nature,” if at least 85% of its assets or revenues are related to such activities. However, the Fed has decided that involvement in physically settled derivatives transactions would generally not be considered a financial activity. This is to protect companies, such as manufacturers and farmers, that work with derivatives to hedge against supply price modifications.

The list of activities (encompassing 12 pages) that are considered financial in nature include: investing for others, lending, insuring against harm or loss, offering investment or financial advisory services, underwriting, selling interests in asset pools, servicing loans, and underwriting. SIFIs will have to turn in reports to the Federal Reserve, the Federal Deposit Insurance Corp., and FSOC about their credit exposure to other key nonbank financial institutions and key bank holding companies. They also will need to report on credit exposure to entities that are significant to them.

The new rule provides definitions for the terms “significant bank holding company” and “significant nonbank financial company.” These terms are key because when FSOC is deciding whether a company is an SIFI that the Fed must supervise, it has to look at the nature and extent of that firm’s transactions and its relationships with other key SIFIs and key holding companies.

Establishing which nonbank companies can qualify as SIFIs takes a way a key stumbling block that was preventing FSOC from being able to identify them. The Fed has the power to make SIFIs get rid of operations that it considers too high risk, raise capital levels so that they factor in the risk levels involved, and outline living wills to help close down an institution should it fail.

The new rule to designate SIFIs doesn’t go into effect until May 6. However, it is unlikely that FSOC will name any nonbank firms as SIFIs for a while. Some firms are expected to oppose such a designation because of the burdens it comes with it.

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