Adminstration Delivers Systemic Risk Legislation to Capital Hill

By W. Bernard Mason

On July 22, 2009 the Administration issued its proposed legislation regarding the establishment of a systemic risk oversight regime. The legislation fleshes out the points on systemic risk contained in the Administration’s original regulatory reform announcement on June 17th.

The legislation proposes creation of a Financial Services Oversight Council to facilitate coordination of financial regulatory policy and resolution of disputes, and to identify emerging risks in financial markets. The Council would be chaired by the Treasury Secretary and its members would include each of the principal federal prudential regulators and operate with a permanent, full-time staff within the Treasury Department.

The legislation further proposes that all financial firms found to pose a threat to economic financial stability (based upon size, leverage, and interconnectedness) will be subjected to strong, consolidated supervision and regulation by the Federal Reserve, whether or not they own insured depository institutions. The firms so identified will be subjected to higher standards on capital, liquidity and risk management and also be subjected to a prompt corrective action regime that mirrors the current provisions contained in the Federal Deposit Insurance Corporation Improvement Act (FDICIA). The proposed legislation would also require these firms to maintain a credible plan for rapid resolution of the firm in the case of severe financial distress.

The proposed legislation would also raise capital and management requirements for all financial holding companies, and would close loopholes and gaps such that all companies controlling an insured financial institution would receive consolidated supervision by the Federal Reserve. It would also tighten restrictions on bank transactions with affiliates. The legislation additionally would require federal banking regulators to coordinate assessment of fees for examinations of institutions above $10 billion in assets.

The legislation would also require securitizers to retain a 5 percent interest in the credit risk of underlying assets and would require loan-level disclosure, in a standard format, for asset-backed securities. This legislation would also provide the Federal Reserve authority to oversee systemically important payment, clearing, and settlement activities and systems.

The proposed legislation would establish the Office of National Insurance to monitor all aspects of the insurance industry, including identifying gaps in the regulation of insurers that could contribute to a systemic crisis. Finally, the proposed legislation would require prior written approval of the Treasury Secretary for lending by the Federal Reserve under its emergency lending authority (Section 13 of the Federal Reserve Act).