PRIMER: G-sibs and Sifis

Author: John Crabb | Published: 2 Feb 2018
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What are G-sibs?

Global systemically important banks (G-sibs) were initially identified by the Financial Stability Board (FSB) in 2011 following the financial crisis three years previously. The 29 institutions initially designated as G-Sibs were subject to additional capital requirements because they were deemed too big to fail (TBTF), as set out in the Basel III regulatory framework.

The FSB’s identifier defines G-sibs as:

a financial institution whose distress or disorderly failure, because of its size, complexity and systemic interconnectedness, would cause significant disruption to the wider financial system and economic activity’.

There are four categories of requirements imposed on G-sibs by the FSB. They must have a higher capital buffer, meet total loss-absorbing capacity (TLAC) standards, higher supervisory expectations and carry out regular resolvability assessments. The most recent list, published in November 2017, now includes 30 banks.

What are SIFIs, and how are they different?

G-sibs are subject to heightened capital and regulatory requirements
In the US there are also systemically important financial institution (Sifis) which are a similar, but a separate category of both banking and non-banking organisations designated as TBTF under section 113 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Dodd-Frank created the Financial Stability Oversight Council (FSOC), giving it the authority to designate Sifis and impose additional regulatory oversight.

Sifis are a post-financial crisis concept to identify the financial institutions with the biggest systemic footprint, and then impose on that group of institutions a heightened set of regulatory requirements. These requirements are meant to mitigate the risk in the event that the bank or firm experiences material financial distress and then goes on to collapse. 

These heightened requirements include increased capital and liquidity requirements, a set of resolutions explaining related stipulations, and risk management requirements. The institutions are also subject to supervision by the board of governors of the Federal Reserve System and as such they must meet certain prudential standards.

Put simply, a Sifi identifies a firm that the regulators think would have a ripple effect on the financial system and economy if it were to fail or experience material financial distress. But the designation also means a Sifi isn’t subject to a set of heightened requirements.

The current threshold for a Sifi is any bank with assets of $50 billion or more, excluding savings and loans.

What is the issue?

The fact that these categories exist is not necessarily broadly up for debate. The question is rather what requirements should they should be subjected to, how to strike the balance between the stability that was intended when the framework was developed and the ability to allow financial institutions to be intermediaries in the economy and to support economic growth.

According to David Portilla, partner at Debevoise & Plimpton, much of the debate is around G-sibs, and the question whether authorities got the requirements right or do these need adjusting.

“Eight years after the Dodd-Frank Act was passed, which was a complicated endeavour in itself, it’s fair to look back at where there are now areas for improvement and refinement,” he said. “Maybe the dial was turned a little too much to the right in some cases, and we can dial it back a little bit.”

FSOC was initially introduced to give a clear mandate that would provide collective responsibility for overseeing risks and threats to the US financial system. It is made up of 10 voting members including the chairman of the Securities and Exchange Commission and the comptroller of the currency, and is chaired by the secretary of the Treasury.

Since its origins, FSOC has been criticised for its lack of transparency.

“There is no consideration of cost-benefit analysis when they are doing Sifi designations, companies do not receive real due process when they are being considered as Sifis,” said David Tittsworth, counsel at Ropes & Gray. “And once they have been designated as Sifis there is little guidance in terms of rules and regulations of how you can get out of it.”

What about non-banking financial institutions?

Non-bank financial institutions that do not take deposits can also be classified as Sifis. Initially four firms were designated as such in 2013 and 2014: AIG, the financial arm of General Electric, Prudential Financial and MetLife. Since then, AIG, GE and MetLife have since been removed from this list leaving just Prudential.

The asset management industry has its own compelling case that they operate very differently from banks, because they take an agency position on behalf of their clients, not on behalf of themselves.

“The assets that they manage are their client’s assets, which are of course at risk, but if an asset manager suddenly fails and goes out of business it does not create a systemic risk to the U.S. financial system," said Tittsworth.

"There is no compelling evidence that asset managers' failures contributed to the 2008 financial crisis, yet they are held under the same Sifi stipulations"

Asset managers don’t diversify in general, they have portfolios that they manage on behalf of their third parties. They have a fiduciary duty under US law, and there is no compelling evidence that asset managers failures contributed to the 2008 financial crisis or other financial crisis, yet they are held under the same Sifi stipulations.

What does the Trump administration think?

On April 21 2017 President Donald Trump issued a memorandum directing the Secretary of the Treasury, Steven Mnuchin, to take the following actions:

  • conduct a thorough review of the FSOC determination and designation processes, including transparency, due process and non-banks;
  • evaluate and report on whether the activities of the FSOC related to the determination and designation processes; and
  • issue a temporary pause of determinations and designations.

In response to this, the Treasury issued a report with its recommendations for FSOC. Suggestions within the 68-page report include endorsing involvement by a firm’s primary regulator in the non-bank Sifi process, the need to assess costs and benefits of any non-bank designation, amending the current $50 billion of consolidated assets threshold, and providing a clear off-ramp for designated non-bank firms.

One aspect of the report states that the non-bank Sifi designation process is a ‘blunt instrument’ and that FSOC must ‘make every effort for its analyses to be rigorous, clear, and comprehensible to firms and to the public, and to be undertaken only when the expected benefits to financial stability exceed the costs imposed on the designated firm’.

This is a significant step, according to Portilla. “Improving the analytical framework, and the analysis itself is further indicative of a positive maturation of the agency,” he said.

Where are we now?

Fundamentally what the FSOC does is bring together a group of federal financial regulators and others, and at the principal level of those agencies revisits the balance between stability and economic growth.

“The view on where that balance lies and where it should be struck is obviously a very important policy issue,” said Portilla. “Where that collective body lands on that question has implications for the agenda it pursues, which has implications for the financial system and the economy at large.”

Federal banking regulators are evaluating how the G-sib regulatory framework should be adjusted, an ongoing process which could take several years. Last November, the Senate Banking Committee put forward a bill that seeks to address some of the more pressing issues of US banking regulation, including raising the threshold of Sifis from $50 billion to $250 billion, which would offer significant relief to a number of sizeable banking institutions including American Express, State Street and the US branch of Deutsche Bank.

William Galvin, chief securities regulator for the Commonwealth of Massachusetts, told IFLR that the last financial crisis should have taught everyone about the risks that Sifis can present to the financial system. Both Galvin and the North American Securities Administrators Association have publicly expressed their concerns regarding the Senate bill.

“We do not want to repeat the scenario of taxpayers being on the hook for the obligations and speculative investments of financial institutions,” he said.

“This is an unnecessary risk,” he said. “If changes are appropriate, financial regulators should be given the discretion and flexibility to adjust regulatory standards, but any changes must be must be subject to an overriding mandate to protect investors, consumers, and the overall economy.” By recalibrating the threshold and removing numerous large institutions from its range, the changes could arguably allow the Federal Reserve to focus on the risk attributes of individual institutions rather than focusing solely on an asset-based approach – as has been the case for the past decade.

"I think the regulators should be able to score the risk of each of the institutions and mould the regulation accordingly, but that is just not the Dodd-Frank approach"

Keith Noreika, partner at Simpson Thacher and Bartlett and former acting head of the Office of the Comptroller of the Currency, is concerned that critics will focus too heavily on the numbers, which don’t really have anything to do with the riskiness of the underlying conduct of the institution.

“In an ideal world, I think the regulators should be able to score the risk of each of the institutions and mould the regulation accordingly, but that is just not the approach that congress took in Dodd-Frank,” he said. “The amended Crapo bill seems to be the way we are headed: we will see as the bill works its way through Congress whether there are any further gradations put on it that would move us a little more away from an asset based fixation of a certain number.”

With bipartisan support the bill may well pass the Senate, and as many as 60 banks would no longer be classified as Sifis. “It is a healthy exercise to look back and reconsider the last eight years since Dodd-Frank was passed,” said Portilla, “and to think about where there are areas for improvement refinement or adjustment.”

See also

US Sifis: asset-based approach under fire

FSOC and Sifi designation reform welcomed

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