Fed Proposes Definitions for Systemically Important Nonbank Financial Institutions

On February 8th the Fed published a proposed rule that would govern when a company is “predominantly engaged in financial activities” and when it would be considered “systemically important.” Various provisions of the Dodd Frank Act require regulations to be implemented for systemically important financial institutions, including general regulation on activity, as well as reporting and disclosure requirements.

Under the proposed rule, an institution could be considered “financial” if, in either of the past two years, 85% or more of its revenue is related to activities determined to be financial in nature (according to the Bank Holding Company Act). This calculation would include income from equity investments in other institutions that are primarily engaged in financial activities.

In order to be considered “systemically important” a company would have to control $50 billion or more in total consolidated assets or be determined by regulators to be “systemically important,” based upon a detailed analysis of the extent and nature of its transactions and relationships with other systemically important institutions. This determination by regulators may also incorporate an analysis of the credit exposure that a given institution has towards other systemically important financial institutions. The idea here is that the Dodd Frank Act recognizes that interconnectedness of financial institutions can result in contagion, whereby the problems that “infect” one institution may cause problems for other independent institutions that it’s engaged in financial relationships with. The “systemic risk” that is not incorporated or accounted for by this rule is the potential for unrecognized concentration of risk on a system-wide level, which could result in otherwise unanticipated and unforeseeable consequences due to events that would be insignificant absent this common exposure.