Whether or not it happens this week, the Dodd-Frank Act process of designating nonbank “systemically important financial institutions” is expected to go dormant sometime soon.
The Financial Stability Oversight Council is scheduled to meet on Friday to discuss, among other things, the designation status of Prudential Financial, the last remaining nonbank SIFI.
It’s not clear that regulators will vote on rescinding the insurer’s designation this week — that may very well come later this year — but with President Trump’s banking team largely in place, the council likely already has the two-thirds vote it needs. The Treasury Department, which leads the FSOC, expressed skepticism about the labeling of individual nonbanks in a report last fall, throwing its support behind an approach to investigate risky activities across the system. The council doesn't have the power to regulate activities directly, but it can urge its member regulators to do so.
Yet while there are no signs that the administration plans to officially scrap the designations process altogether — an effort that would almost certainly require congressional action — the future of the process is dim.
In the wake of the last crisis, policymakers saw the SIFI label as a way to guardrail nonbank financial companies, subjecting them to additional scrutiny. The idea was to avoid a repeat of the fall of the nonbank American International Group, whose stunning collapse in 2008 helped spark more panic in the financial system at the time. Ultimately, AIG was bailed out by the government.
AIG was just one of the nonbanks eventually designated by regulators, along with MetLife, General Electric’s financing arm and Prudential. Such firms were to be subject to higher standards set by the Fed.
But those labels didn’t stick for long. GE won its bid for de-designation in the summer of 2016 after selling off billions of dollars in assets. MetLife successfully overturned its label in district court — and while the case was appealed to the D.C. Circuit under President Obama, it was ultimately dropped by the Trump administration after the elections. And just last fall, regulators voted to remove the label from AIG, despite its considerable political baggage as a central player in the crisis, citing fundamental changes to its business structure.
Prudential is expected to be the last nonbank to escape the SIFI label, raising the prospect that the entire idea, a key part of the Dodd-Frank Act, is now effectively moot. Critics argue that the insurer "has neither shrunk nor substantially simplified," although the company has long said that it should not have been designated in the first place.
Supporters of SIFI designations say they are hopeful the approach will come back under future administrations.
“I think in the next progressive administration it will be a tool that’s used — hopefully aggressively,” said Gregg Gelzinis, a research associate for economic policy at the Center for American Progress.
Exactly how — or when — a future administration might utilize the powers is up for debate.
“There are two likely scenarios. There’s the designation yo-yo, where designations come and go with a new president,” said Justin Schardin, a fellow at the Bipartisan Policy Center. “Or, more likely I think, we don’t have any nonbank SIFIs until the next time there’s a systemic problem at a nonbank, whether it’s a crisis or just a major new story.”
In either scenario, there are likely to be startup costs associated with tapping this process again after four, eight — or even more — years out of rotation. Assuming it’s taken up again at all.
“I certainly think the longer this tool goes without being used — or without the work behind the scenes being put in — it becomes harder,” Gelzinis said.
Putting the process on the back burner risks creating “a knowledge gap on the universe of firms” that potentially warrant enhanced scrutiny, he added. The SIFI labeling process involves several rounds of research and investigation and that work is valuable whether or not it ultimately leads to a designation. But it’s an open question to what extent that analysis will continue absent a clear focus on designating risky firms.
It’s also worth watching on Friday whether Treasury Secretary Steven Mnuchin makes good on a plan to raise the threshold for nonbank SIFIs to be evaluated from $50 billion to $250 billion — to mirror recent legislative reforms lifting the cutoff for heightened regulatory standards for traditional banks.
Doing so could prove risky, observers warn. Unlike for banks, the threshold for examining nonbanks does not automatically come with new requirements. It’s a starting point for evaluations.
“The idea that we wouldn't even take a first glance at these firms [below $250 billion] is quite unfortunate,” said Gelzinis. “Even if regulators decide not to designate those firms today, every time they do the research and analysis they are building an understanding of how risk can affect the system.”
Mnuchin has not done away with the FSOC, as some had initially feared, but in moving away from designations he is upending one of its central functions, a decision that is likely to have lasting consequences.
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