Tags: Fed | Danger | Nonbank | Financial

Brookings' Elliott: Fed May Miss Dangers of Nonbank Financial Institutions

Sunday, 12 May 2013 06:00 PM

By Michael Kling

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The Federal Reserve may screw up oversight of nonbank financial institutions capable of threatening the financial system, warns a Brookings Institution fellow and former investment banker.

Although they've garnered the most attention, big banks are not the only threats to the financial system, writes Douglas J. Elliott, a former investment banker at JPMorgan. Insurance companies, hedge funds, securities firms, and others are "systemically important financial institutions" (SIFIs).

The Fed may not pay enough attention to them or ignore other regulators as it names SIFIs and writes new regulations, Elliott warns in his report, "Regulating Systemically Important Financial Institutions that are not Banks."

Editor’s Note: Put the World’s Top Financial Minds to Work for You

The Dodd-Frank Act instructs the Financial Stability Oversight Council, with input from the Fed, to name financial institutions that could cause trauma to the financial system and give them closer supervision and tougher requirements such as larger capital cushions. The Fed is charged with regulating SIFIs, along with the institutions' current regulators.

"However, the Fed has little previous experience of overseeing some of these types of institutions, particularly insurers," Elliott notes. The Fed, he advises, must strike a balance between blindly deferring to existing regulators and ignoring their specialized knowledge.

"There are multiple dangers in taking an idiosyncratic Fed perspective that pays too little attention to existing regulatory approaches."

For one thing, rules ill-designed for their industry may put companies at a considerable disadvantage, which could hurt their customers and the overall economy, he says.

"Life insurers in particular are quite different animals from banks, and so it is crucial that the Fed not instinctively treat them simply as funny-looking banks and try to force them to be more like traditional banks."

Capital requirements are the most likely area for a Fed mistake. "Applying bank capital standards inflexibly to life insurers would run the real risk of forcing them to act more like banks, even when this would actually increase their risk," he warns, saying life companies need to hold assets longer than banks in order to match their longer-term liabilities.

If federal regulators apply bank-style rules to nonbanks like life insurers, their effort will backfire, agrees Dirk Kempthorne, president and CEO of the American Council of Life Insurers.

"Not only will banking rules make it harder for life insurers to provide financial protection to customers, but they will fail to make our financial system safer and more stable," he warns in an article for Politico.

Editor’s Note: Put the World’s Top Financial Minds to Work for You

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