Designating Systemically Important Financial Institutions: Balancing Costs and Benefits

The Fed and other financial regulators are generally on the right track and striking the right balance in designating which non-bank financial institutions should be regulated as Systemically Important Institutions (SIFIs), testified Douglas Elliott, Brookings Fellow in Economic Studies, today before the House Financial Services Subcommittee on Financial Institutions and Consumer Credit.

In “Designating Systemically Important Financial Institutions: Balancing Costs and Benefits,” Elliott states, “designating non-bank SIFIs is by its nature a complex endeavor that requires a careful balancing act and substantial human judgment. The rules proposed by the regulators generally reflect those considerations and I believe that the resulting uncertainty about the ultimate outcomes is unavoidable, unless we either abandon the effort to designate such SIFIs or use cruder measurements that would almost certainly produce worse results. I am more concerned about whether those non-banks that are designated as SIFIs will be regulated in a way that fully reflects their differences with banks, but I am hopeful that this can eventually be worked out.

Elliott suggested five core principles to guide the designation process:

• No part of the financial industry should receive an automatic exclusion from SIFI status;
• There are no absolutes in SIFI designation—judgment is necessary;
• Regulators must weigh the safety benefits of designating a firm as a SIFI versus the costs;
• Regulation of designated non-bank SIFIs must be appropriate to their business models and coordinated with their existing regulators; and
• Similar activities should be regulated in similar ways with similar safety margins.

Some have asserted that a firm which is named as a SIFI would have an implicit government guarantee or at least seal of approval, giving firms a competitive advantage on their funding costs and their ability to sell products. Elliott testified that he does not believe this to be a significant issue because those firms are already viewed by the markets as being safer due to their size and importance. “Regardless of my own views, both the managements and investors of firms potentially designated as SIFIs are sending very strong signals that they see such a designation as a negative. I can assure you that a number of those firms are working very hard to avoid designation, as you have doubtless noticed yourselves. It seems very unlikely that this would be the case were there a significant financial advantage to the designation,” he testified.