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June 21, 2012
Get to Work, the Financial Stability Oversight Council Is Told
    by Robert Kropp

The newly-formed Systemic Risk Council observes that two years after Dodd-Frank, most of its financial reforms have yet to implemented, and urges the Financial Stability Oversight Council to prioritize the identification of systemically important nonbank financial institutions.

The Dodd-Frank Wall Street Reform and Consumer Protection Act provided for a number of safeguards protecting against the forms of excessive risk-taking by financial institutions that led to the financial crisis of 2008. It established the Financial Stability Oversight Council (FSOC) and charged it with the responsibility of monitoring the nation's financial system to ensure its stability. The bill also mandated the formation of the Office of Financial Research (OFR) to improve the quality of financial data and provide more robust analysis.

As outlined in a fact sheet published this week by the newly-formed Systemic Risk Council (SRC), the FSOC is expected to significantly improve the risk management of large financial institutions, end the concept of too-big-to-fail, and identify threats to the financial system arising from the financial services market.

However, "After watching the slow progress of these bodies, we are concerned that little has been done to address systemic issues lurking throughout the financial system," Sheila Bair, Chair of the SRC and former Chair of the Federal Deposit Insurance Corp. (FDIC), said at a press conference held earlier this week. "No one is really focused on protecting the public at large."

The SRC was established by the CFA Institute, an association of investment professionals, and the Pew Charitable Trusts. In addition to Bair, its members include former government officials as well as financial and legal experts. Paul Volcker, the former Chair of the Federal Reserve System, serves as Senior Advisor.

"The FSOC's lack of progress has been disappointing," the SRC states in its fact sheet. "Perhaps the most glaring shortcoming is the FSOC's failure to designate any nonbank financial institutions as systemically important."

In the wake of the financial crisis, systemically important financial institutions (SIFIs) have been identified as having a disproportionately large effect on the global financial system. In 2011, the Basel Committee on Banking Supervision presented reforms to improve the resiliency of the global banking sector, stating "It is critical that banks' risk exposures are backed by a high quality capital base." But the Committee's reforms were limited to the banking sector.

Without designating nonbank financial companies as systemically important, "the FSOC continues to fail to fulfill its duties to recommend prudential measures in important respects," the SRC states.

In addition to failing to identify nonbanks as SIFIs, the FSOC has not yet taken formal action on its responsibility to monitor the financial system for potential threats to financial stability. Furthermore, the OFR lags in creating sophisticated analyses for the FSOC. Richard Berner, President Obama's nominee to head the OFR, has yet to be confirmed by the Senate.

"The time for action by the FSOC has long passed," the SRC states. "Further delay in addressing these risks prolongs the recovery and uncertainty for US financial markets while leaving them vulnerable to new and potentially more disastrous systemic disruptions."

At this week's press conference, Bair said, "When nearly everyone in the financial industry makes similar bets, the general public faces a real danger of financial instability. In the run-up to the 2008 financial crisis, significant warning signs went unheeded in the mortgage market, which had become a house of cards. There was little if any regulatory coordination before the crisis on systemic risk issues."

Bair provided six recommendations to help ensure that a repeat of the financial crisis does not occur. The largest financial institutions must hold sufficient capital to offset risk. The major nonbank financial institutions must be identified, and rules must be written to ensure effective oversight of them. The OFR must integrate data from all FSOC agencies.

Also, the challenges to Volcker Rule, which would prevent banking entities from engaging in proprietary trading, must be resolved. There must be greater oversight and transparency in the Over the Counter (OTC) derivatives market, and greater sharing of information internationally.

"The FSOC has the tools to address systemic risk, and we will proactively encourage that body and its members to take effective action consistent with their statutory duties," Bair said.

"In many ways, the financial system faces larger potential challenges today than it did in the run-up to the 2008 crisis, given the troubled state of the European Union and uncertainties at home related to fiscal and monetary policy," she continued. "We simply cannot afford to let it happen again."


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