Systemically important financial institution

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This article is about banks, insurance companies and financial market infrastructure providers deemed systemically important by regulators. For a listing of the banks, see list of systemically important banks.


A systemically important financial institution (SIFI) is a bank, insurance company, or other financial institution whose failure might trigger a financial crisis.

Overview[edit]

As the 2007-2012 global financial crisis has unfolded, the international community has moved to protect the global financial system through preventing the failure of SIFIs, or, if one does fail, limiting the adverse effects of its failure. In November 2011, the Financial Stability Board published a list of global systemically important financial institutions (G-SIFIs).[1]

The Basel Committee on Banking Supervision introduced new regulations (known as Basel III) that also specifically target SIFIs. The main focus of the regulations is to increase bank capital requirements and to introduce capital surcharges for systemically important banks.[2] However, some economists have warned that the tighter Basel III capital regulation, which is primarily based on risk-weighted assets, may further negatively affect the stability of the financial system.[3][4]

It's important to note that both the Financial Stability Board and the Basel Committee are only policy research and development entities. They do not establish laws, regulations or rules for any financial institution directly. They merely act in an advisory capacity. It's up to each country's specific lawmakers and regulators to enact whatever portions of the recommendations they deem appropriate. Each country's internal financial regulators make their own determination of what is a Systemically Important Financial Institution. Once those regulators make that determination, they may set specific laws, regulations and rules that would apply to those entities.

Virtually every Systemically Important Financial Institution operates at the top level as a holding company made up of numerous subsidiaries. It's not unusual for the subsidiaries to number in the hundreds. Even though the uppermost holding company is located in the home country, where it is subject, at that level, to that home regulator, the subsidiaries may be organized and operating in several different countries. Each subsidiary is then subject to potential regulation by every country where it actually conducts business.

At present (and for the likely foreseeable future) there is no such thing as a global regulator. Likewise there is no such thing as global insolvency, global bankruptcy, or the legal requirement for a global bail out. Each legal entity is treated separately. Each country is responsible (in theory) for containing a financial crisis that starts in their country from spreading across borders. Looking up from a country prospective as to what is a Systemically Important Financial Institution may be different than when looking down on the entire globe and attempting to determine what entities are significant.

The degree of interconnectedness between financial institutions is almost completely unknown at any specific point in time. When trouble breaks out, fear and contagion effects are extremely unpredictable. Therefore determining exactly what entities are significant is a difficult assignment, as the real certainty is determinable only well after the fact.

Definition[edit]

As of November 2011, a standard definition of systemically important financial institution had not been decided.[5] However, the Basel Committee has identified factors for assessing whether a financial institution is systemically important: its size, its complexity, its interconnectedness, the lack of readily available substitutes for the financial infrastructure it provides, and its global (cross-jurisdictional) activity. In some cases, the assessments of experts, independent of the indicators, will be able to move an institution into the SIFI category or remove it from SIFI status.

Banks[edit]

Asia[edit]

Banks in Japan deemed systemically important are stress tested by the International Monetary Fund (IMF). Banks in China are mostly state run and are stress tested by the national banking authority.

United Kingdom and European Union[edit]

Global Systemically Important Banks (G-SIBs) are determined based on four main criteria: (a) size, (b) cross-jurisdiction activity, (c) complexity, and (d) substitutability. The list of G-SIBs is published annually by the Financial Stability Board (FSB). The G-SIBs must maintain a higher capital level – capital surcharge – compared to other banks.

In November 2013,[6] the FSB updated the list of G-SIBs, and the following banks were included: Bank of America, Bank of China, Bank of New York Mellon, Barclays, BBVA, BNP Paribas, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, Groupe BPCE, Group Crédit Agricole, HSBC, ING Bank, Industrial and Commercial Bank of China Limited, J.P. Morgan Chase, Mitsubishi UFJ FG, Mizuho FG, Morgan Stanley, Nordea, Royal Bank of Scotland, Santander, Société Générale, Standard Chartered, State Street, Sumitomo Mitsui FG, UBS, Unicredit Group, Wells Fargo.

Compared with the group of G-SIBs published in 2011, three banks have been added: BBVA, Standard Chartered and Industrial and Commercial Bank of China Limited; and three banks removed: Dexia, as it is undergoing an orderly resolution process, and Commerzbank and Lloyds, as result of a decline in their global systemic importance.

United States[edit]

Stress testing[edit]

In the USA, the largest banks are regulated by the Federal Reserve (FRB) and the Office of the Comptroller of Currency (OCC). These regulators set the selection criteria, establish hypothetical adverse scenarios and oversee the annual tests. 19 banks operating in the U.S. (at the top tier) have been subject to such testing since 2009. Banks showing difficulty under the stress tests are required to postpone share buybacks, curtail dividend plans and if necessary raise additional capital financing.

Market-based bank capital regulation ERNs[edit]

Stress testing has limited effectiveness in risk management. Dexia passed the European stress tests in 2011. Two months later it requested a €90 billion bailout guarantee.(Goldfield 2013)[7] Goldfield, a former Senior Partner of Goldman Sachs and Economics Professors, Jeremy Bulow at Stanford and Paul Klemperer at Oxford, argue that Equity Recourse Notes' (ERNs), similar in some ways to contingent convertible debt, (CoCos), should be used by all banks rated SIFI, to replace non-deposit existing unsecured debt. "ERNs would be long-term bonds with the feature that any interest or principal payable on a date when the stock price is lower than a pre-specified price would be paid in stock at that pre-specified price."(Goldfield 2013)[7] Through ERNs, distressed banks would have access to much needed equity as willing investors purchase tranches of ERNs similar to pooling tranches of subprime mortgages. In this case however, the market, not the public takes the risks. Banking can be pro-cyclical by contributing to booms and busts. Stressed banks become reluctant to lend since they are often unable to raise capital equity through new investors.[8] (Goldfield et al 2013)[7] claim that ERNs would provide a "counterweight against pro-cyclicality."

Resolution plans[edit]

The Dodd-Frank Wall Street Reform and Consumer Protection Act requires that bank holding companies with total consolidated assets of $50 billion or more and nonbank financial companies designated by the Financial Stability Oversight Council for supervision by the Federal Reserve submit resolution plans annually to the Federal Reserve (FRB) and the Federal Deposit Insurance Corporation (FDIC). Each plan, commonly known as a living will, must describe the company's strategy for rapid and orderly resolution under the Bankruptcy Code in the event of material financial distress or failure of the company.

The top most group that must file resolution plans includes U.S. bank holding companies with $250 billion or more in total nonbank assets, and foreign-based bank holding companies with $250 billion or more in total U.S. nonbank assets.

Starting in 2014 Category 2 firms will be required to submit resolution plans while category 1 firms will submit there 3rd resolution plans.[9]

Non-bank entities[edit]

The concept of a systemically important financial institution in the U.S. extends well beyond traditional banks and is often included under the term Non-banking financial company. It includes large hedge funds and traders, large insurance companies, and various and sundry systemically important financial market utilities. For historical background see Subprime mortgage crisis solutions debate#Arguments for a systemic risk regulator

Regarding which entities will be so designated the Dodd-Frank Act of 2010 contains the following in TITLE I—FINANCIAL STABILITY, Subtitle A—Financial Stability Oversight Council, Sec. 113. Authority to require supervision and regulation of certain nonbank financial companies (2) considerations:

  • the extent of the leverage of the company;
  • the extent and nature of the off-balance-sheet exposures of the company;
  • the extent and nature of the transactions and relationships of the company with other significant nonbank financial companies and significant bank holding companies;
  • the importance of the company as a source of credit for households, businesses, and State and local governments and as a source of liquidity for the United States financial system;
  • the importance of the company as a source of credit for low-income, minority, or underserved communities, and the impact that the failure of such company would have on the availability of credit in such communities;
  • the extent to which assets are managed rather than owned by the company, and the extent to which ownership of assets under management is diffuse;
  • the nature, scope, size, scale, concentration, interconnectedness, and mix of the activities of the company;
  • the degree to which the company is already regulated by 1 or more primary financial regulatory agencies;
  • the amount and nature of the financial assets of the company;
  • the amount and types of the liabilities of the company, including the degree of reliance on short-term funding; and
  • any other risk-related factors that the Council deems appropriate.

FSOC subsequently issued clarification under Final Rule on Authority to Designate Financial Market Utilities as Systemically Important, which includes the following chart recasting the above statutory requirements into a six-category FSOC analytical framework including:

  • size
  • interconnectedness
  • lack of substitutes
  • leverage
  • liquidity risk and maturity mismatch
  • existing regulatory scrutiny
Statutory considerations: Category or categories in which this consideration would be addressed:
(A) The extent of the leverage of the company Leverage
(B) The extent and nature of the off-balance-sheet exposures of the company Size; interconnectedness
(C) The extent and nature of the transactions and relationships of the company with other significant nonbank financial companies and significant bank holding companies Interconnectedness
(D) The importance of the company as a source of credit for households, businesses, and State and local governments and as a source of liquidity for the United States financial system Size; substitutability
(E) The importance of the company as a source of credit for low-income, minority, or underserved communities, and the impact that the failure of suchcompany would have on the availability of credit in such communities Substitutability
(F) The extent to which assets are managed rather than owned by the company, and the extent to which ownership of assets under management is diffuse Size; interconnectedness; substitutability
(G) The nature, scope, size, scale, concentration, interconnectedness, and mix of the activities of the company Size; interconnectedness; substitutability
(H) The degree to which the company is already regulated by 1 or more primary financial regulatory agencies Existing regulatory scrutiny
(I) The amount and nature of the financial assets of the company Size; interconnectedness
(J) The amount and types of the liabilities of the company, including the degree of reliance on short- term funding Liquidity risk and maturity mismatch; size; interconnectedness
(K) Any other risk-related factors that the Council deems appropriate Appropriate category or categories based on the nature of the additional risk-related factor

The following are quotes from the FSOC final rule regarding each element of the six factor framework.

Interconnectedness Interconnectedness captures direct or indirect linkages between financial companies that may be conduits for the transmission of the effects resulting from a nonbank financial company's material financial distress or activities.

Substitutability Substitutability captures the extent to which other firms could provide similar financial services in a timely manner at a similar price and quantity if a nonbank financial company withdraws from a particular market. Substitutability also captures situations in which a nonbank financial company is the primary or dominant provider of services in a market that the Council determines to be essential to U.S. financial stability.

Size Size captures the amount of financial services or financial intermediation that a nonbank financial company provides. Size also may affect the extent to which the effects of a nonbank financial company's financial distress are transmitted to other firms and to the financial system.

Leverage Leverage captures a company's exposure or risk in relation to its equity capital. Leverage amplifies a company's risk of financial distress in two ways. First, by increasing a company's exposure relative to capital, leverage raises the likelihood that a company will suffer losses exceeding its capital. Second, by increasing the size of a company's liabilities, leverage raises a company's dependence on its creditors' willingness and ability to fund its balance sheet. Leverage can also amplify the impact of a company's distress on other companies, both directly, by increasing the amount of exposure that other firms have to the company, and indirectly, by increasing the size of any asset liquidation that the company is forced to undertake as it comes under financial pressure. Leverage can be measured by the ratio of assets to capital, but it can also be defined in terms of risk, as a measure of economic risk relative to capital. The latter measurement can better capture the effect of derivatives and other products with embedded leverage on the risk undertaken by a nonbank financial company.

Liquidity risk and maturity mismatch Liquidity risk generally refers to the risk that a company may not have sufficient funding to satisfy its short-term needs, either through its cash flows, maturing assets, or assets salable at prices equivalent to book value, or through its ability to access funding markets. For example, if a company holds assets that are illiquid or that are subject to significant decreases in market value during times of market stress, the company may be unable to liquidate its assets effectively in response to a loss of funding. In order to assess liquidity, the Council may examine a nonbank financial company's assets to determine if it possesses cash instruments or readily marketable securities, such as Treasury securities, which could reasonably be expected to have a liquid market in times of distress. The Council may also review a nonbank financial company's debt profile to determine if it has adequate long-term funding, or can otherwise mitigate liquidity risk. Liquidity problems also can arise from a company's inability to roll maturing debt or to satisfy margin calls, and from demands for additional collateral, depositor withdrawals, draws on committed lines, and other potential draws on liquidity.

A maturity mismatch generally refers to the difference between the maturities of a company's assets and liabilities. A maturity mismatch affects a company's ability to survive a period of stress that may limit its access to funding and to withstand shocks in the yield curve. For example, if a company relies on short-term funding to finance longer-term positions, it will be subject to significant refunding risk that may force it to sell assets at low market prices or potentially suffer through significant margin pressure. However, maturity mismatches are not confined to the use of short-term liabilities and can exist at any point in the maturity schedule of a nonbank financial company's assets and liabilities.

Existing regulatory scrutiny The Council will consider the extent to which nonbank financial companies are already subject to regulation, including the consistency of that regulation across nonbank financial companies within a sector, across different sectors, and providing similar services, and the statutory authority of those regulators.

Insurance[edit]

The International Association of Insurance Supervisors (IAIS) has compiled a list of Global Systemically Important Insurers (G-SIIs). Subjecting insurers to enhanced supervisory oversight is however up to individual jurisdictions.

Financial market utilities[edit]

Americas[edit]

The U.S. government legislation defines the term financial market utilities (FMU) for other organizations that play a key part in financial markets such as clearing houses settlement systems. They are entities whose failure or disruption could threaten the stability of the financial system.

Asset Managers[edit]

United States[edit]

It is widely anticipated that the Financial Stability Oversight Council will eventually designate certain significant asset managers as nonbank systematically important financial institutions (Nonbank SIFIs).[10] The FSOC recently asked the U.S. Treasury Department’s Office of Financial Research (OFR) to undertake a study that provides data and analysis on the asset management industry.[11] The study analyzed the industry and describes potential threats to U.S. financial stability from vulnerabilities of asset managers. The study suggested the industry’s activities as a whole make it systemically important and may pose a risk to financial stability. Furthermore, it identified the extent of assets managed by the major industry players. This request for the study is considered by some as a first step in by the FSOC in reviewing the industry and individual player to determine which are systematically important. Once designated as systematically important those entities will be subject to additional oversight and regulatory requirements.[10]

In 2013, the Treasury Department's Office of Financial Research released its report on Asset Management and Financial Stability, the central conclusion was that the activities of the asset management industry as a whole make it systemically important and may pose a risk to US financial stability. Furthermore, in 2014 the Financial Stability Board and the International Organization of Securities Commissions issued the Consultative Document which proposed methodologies for identifying globally active systemically important investment funds. Both reports further the conclusion that is likely the U.S. Financial Stability Oversight Council will designate a few large US asset managers as systemically important.[12]

See also[edit]

References[edit]

  1. ^ Financial Stability Board (November 2011). "List of Systemically Important Financial Institutions". 
  2. ^ BCBS (November 2011). "Global systemically important banks: Assessment methodology and the additional loss absorbency requirement – final document". BIS. 
  3. ^ Slovik, Patrick (February 2012). "OECD study on regulation of systemically important banks". OECD. 
  4. ^ Slovik, Patrick (February 2012). "Abstract: Systemically Important Banks and Capital Regulation Challenges". St. Louis: Research Division of the Federal Reserve Bank (RePec). 
  5. ^ "Some banks will be disappointed not to be on the G-Sifi list for regulation". The Observer. 6 November 2011. Retrieved 9 November 2011. 
  6. ^ 2013 update of group of global systemically important banks(G-SIBs)
  7. ^ a b c Jeremy Bulow; Jacob Goldfield; Paul Klemperer (29 August 2013). "Market-based bank capital regulation". Retrieved 29 August 2013. 
  8. ^ Tim Harford (28 August 2013). "Markets must force banks, like petulant toddlers, to grow up". Financial Times. Retrieved 29 August 2013. 
  9. ^ "2014 Resolution planning: The guidance you won’t receive". http://www.pwc.com/us/en/financial-services/regulatory-services/publications/resolution-planning-wave-1.jhtml. PwC Financial Services Regulatory Practice, April, 2014. 
  10. ^ a b "Nonbank SIFIs: Up next, asset managers". http://www.pwc.com/us/en/financial-services/regulatory-services/publications/nonbank-sifi-asset-manager.jhtml. PwC Financial Services Regulatory Practice, October, 2013. 
  11. ^ http://www.gpo.gov/fdsys/pkg/FR-2012-04-11/pdf/2012-8627.pdf
  12. ^ "Nonbank SIFIs: No solace for US asset managers". http://www.pwc.com/us/en/financial-services/regulatory-services/publications/dodd-frank-act-nonbank-sifis-asset-management.jhtml, February, 2014. 

External links[edit]