Washington, D.C. — With the landmark financial regulation law known as Dodd-Frank set to turn 9 this month—weakened since enactment as a result of actions by conservative judges, Congress, and the Trump administration—the Center for American Progress today released a new proposal that seeks to substantially improve the regulation and oversight of systemic shadow banks. CAP’s proposal would ensure that the 15 to 25 riskiest insurance companies, hedge funds, asset management firms, and other shadow banking entities face strong regulation and oversight—and would make it difficult for regulators to release these firms from enhanced safeguards.
“The 2007–2008 financial crisis demonstrated that devastating risks to financial stability could develop outside of the traditional banking sector. Dodd-Frank took important steps to address the risks posed by shadow banks and their activities, but the past two years have shown the clear weaknesses in those authorities,” said Gregg Gelzinis, policy analyst for Economic Policy at CAP and author of the proposal. “Policymakers should be more concerned with protecting the economy, workers, and families from the risks posed by large, complex, and interconnected shadow banks than with shielding these well-connected financial institutions from commonsense regulation.”
Dodd-Frank’s key mechanism to address the risks posed by systemic shadow banks—the Financial Stability Oversight Council’s (FSOC) systemically important financial institution (SIFI) designation authority—has been vulnerable to conservative judges seeking to limit the executive branch’s ability to regulate corporations and to deregulatory actions by the Trump administration. This has left the financial system, and the entire U.S. economy, vulnerable to risks in the shadow banking sector. In 2008, the collapse of systemically important, lightly regulated financial institutions such as the investment bank Lehman Brothers and the insurance company AIG helped set in motion the financial crisis.
CAP’s proposal would eliminate the embedded bias and vulnerabilities in the current designation process that make it far too difficult to regulate systemic shadow banks and easy to deregulate them. All insurance companies, hedge funds, investment banks, asset managers, and other nonbank financial companies that meet certain size and risk thresholds would be automatically designated as SIFIs and subjected to enhanced financial safeguards. Specifically, CAP’s proposal would:
- Bolster the FSOC’s shadow bank designation authority. Shadow banks that meet specific quantitative thresholds should be automatically subjected to enhanced supervision and regulation, tailored to their respective risk profiles. The FSOC should have the authority to de-designate firms on an individual basis if the council determines, after conducting a rigorous data-driven analysis, that material distress at the firm and the nature, scope, size, scale, concentration, interconnectedness, and/or mix of the activities at the firm would not threaten financial stability in a period of broader stress in the financial system. The public, however, should be granted legal standing to contest such de-designations.
- Grant the FSOC authority over systemically risky activities. The FSOC should have direct rulemaking authority to regulate systemically risky activities across the financial sector. An activity’s primary regulator should supervise the implementation and ongoing compliance of the rules promulgated by the FSOC. If no one regulator has jurisdiction over the activity, the FSOC should determine the appropriate regulator to fulfill that supervisory role. The council should also have the authority to complete congressionally mandated rulemakings for which the primary regulator or regulators missed the deadline prescribed in statute.
- Enhance the FSOC’s institutional capacity. The council and the Office of Financial Research (OFR) should be given minimum staffing and budget floors. The floors should double the council’s budget and staffing and increase the OFR’s budget and staffing by about 50 percent, relative to Obama administration levels. The FSOC chair and the OFR director should have discretion to set budget and staffing levels above such floors. The OFR director should no longer be required to consult with the treasury secretary on the agency’s budget and should be given additional authority to acquire and share regulatory data from and between FSOC members.
- Increase the FSOC’s transparency. The council should be required to release transcripts of its meetings on a five-year time delay. The FSOC should be required to hold a public meeting and a press conference at least once per quarter. All voting members of the council should have to testify before Congress together annually on financial stability efforts, and they should have to either certify that their respective agencies are taking all reasonable steps to ensure financial stability and to mitigate systemic risk or detail the additional steps their agencies should take to do so.
Click here to read “Strengthening the Regulation and Oversight of Shadow Banks” by Gregg Gelzinis.
For more information on this topic or to speak with an expert, contact Allison Preiss at [email protected] or 202.478.6331.