The US Treasury proposes tighter nonbank regulations to enhance financial stability in response to the recent banking crisis.
The US Treasury, under the leadership of Secretary Janet L. Yellen, has recognized the need for a stronger supervisory and regulatory framework in the wake of the recent banking crisis. As a result, the Treasury has proposed tighter regulations for nonbank financial institutions to bolster financial stability and prevent future disruptions. Yellen previously discussed the potential of a digital dollar, as well as the emerging competition from China in the economic aspect.
In response to the failure of two regional banks, the government intervened to safeguard the broader banking system and economy. These events highlighted the necessity for a robust framework that can identify, assess, and mitigate risks to the financial system. The Financial Stability Oversight Council (FSOC) convened to discuss and vote on two proposals aimed at enhancing the resilience of the US financial system. The first proposal involves a framework for addressing financial stability risks, while the second focuses on revising the guidance on nonbank financial company designations.
FSOC’s Proposed Analytic Framework for Financial Stability
To provide greater public transparency into the Council’s operations, the FSOC’s proposed analytic framework, which is open for public comment, outlines the common vulnerabilities and transmission channels through which financial shocks can propagate throughout the system. This marks the first instance that the FSOC has published such a document.
The framework places emphasis on a comprehensive and rigorous approach to risk mitigation, utilizing an extensive array of flexible tools to tackle both existing and potential financial vulnerabilities. Rather than prioritizing one type of tool over another, the Council focuses on tailoring its response to effectively address the specific risk in question.
When systemic risks arise from widely conducted activities in a particular sector or market, the FSOC often employs an activities-based approach. The Council has made recommendations in both traditional areas, such as money market and open-end funds, and emerging areas like crypto-assets.
Revising the Nonbank Financial Company Designation Guidance
In cases where systemic risks could stem from a specific entity, not under the jurisdiction of a regulator with adequate prudential or supervisory authorities, an entity-focused approach may be more suitable. This is the rationale behind the FSOC’s authority to designate nonbank financial companies for Federal Reserve Board supervision and enhanced prudential standards.
The Council aims to revise the existing guidance to overcome the challenges in utilizing its nonbank designation authority. The current guidance, established in 2019, introduced unnecessary obstacles as part of the designation process. These additional steps are not legally mandated by the Dodd-Frank Act and are based on a flawed understanding of the inception and costs of financial crises. It is estimated that a designation process incorporating these steps could take up to six years to complete—an unrealistic timeline that could hinder the Council from addressing emerging risks to financial stability in a timely manner.
Ensuring Transparency in the Nonbank Designation Process
The proposed guidance seeks to render the nonbank designation process more rigorous and transparent by implementing strong procedural protections. This includes substantial engagement and communication with companies under review, reducing administrative burdens while providing ample opportunities for these entities to voice their concerns. The Council will also collaborate with the company’s primary regulator during any designation review.
Hence, by offering the public more information about how nonbank designation fits into the Council’s broader approach to financial stability risk monitoring and mitigation, these proposed revisions represent a significant step toward strengthening safeguards for the US financial system.