Debate rages on how to protect the highly interconnected financial system from risky activity. (Image: Thinkstock)
While industry interests are supporting the Financial Stability Oversight Council's new approach to evaluating markets' financial systemic risk based on activities of players and institutions, some academic researchers remain wary.
FSOC has been talking about taking an "activities-based approach," or focusing on what appear to be especially risky activities, such as some types of investment banking or speculative securities trading operations, rather than what appear to relatively stable businesses, such as selling life insurance policies designed with restrictions that keep panicked policyholders from rushing in to withdraw all of their cash value all at once.
Jeremy Kress, an assistant professor of business law at the University of Michigan Ross School of Business, told members of Congress Thursday that using activities-based rules to determine whether life insurers, asset managers or other "nonbank" companies are systemically important financial institutions (SIFIs) will fail, in part because FSOC lacks the authority it needs to set rules for companies that engage in many different types of activities.
Kress and others testified before the Senate Banking, Housing and Urban Affairs Committee on approaches to ensuring financial stability for nonbank financial institutions more than a decade after the financial crisis began.
FSOC last week voted to propose an activities-based approach to ferreting out risky activities. That's a departure from the previously used institution-based or "entity-based" designation strategy.
That approach resulted in about 30 U.S. banks and four nonbanks — American International Group Inc. MetLife Inc., Prudential Financial Inc., and General Electric's financing arm, GE Capital — getting SIFI designations from FSOC.
FSOC is a federal, multi-agency body that has the authority under the Dodd-Frank Act of 2010 to designate a company or an activity as systemically risky.
The four nonbank SIFIs have shed their too-big-to-fail labels.
Kress says that at least one of the de-designations was illegal.
FSOC de-designated Prudential in October 2018. Prudential had $100 billion more in assets at that point than it had when FSOC classified it as a SIFI, Kress said.
FSOC "violated its formal procedures by second-guessing the council's original assessment of Prudential's systemic importance … and performed misleading quantitative analyses," Kress alleged.
He said that FSOC had also dismissed evidence didn't follow the statutes.
Under the new expected framework, it is "unrealistic" to expect that regulators are going to identify and then supervise all financial activities that might push financial markets into trouble, Kress testified. Moreover, market players will likely just restructure or rename activities to bypass any coming regulation, he warned.
Kress favors identifying the actual companies who could upend the financial system and repeatedly warned of multiple gaps in the oversight of insurers, hedge funds and fintech firms.
