What it means
Before the crisis, each regulator watched its own part of the system, such as banks, securities markets or insurance, and no one was responsible for the system as a whole. The Dodd-Frank Act of 2010 created the FSOC to close that gap.
It brings the regulators to one table so that risks that cross boundaries can be seen and discussed. The Council is chaired by the Secretary of the Treasury and has ten voting members, including the heads of the Federal Reserve, the Securities and Exchange Commission, the Federal Deposit Insurance Corporation and the Consumer Financial Protection Bureau, along with an independent member with insurance expertise.
Several other officials sit as non-voting members, including representatives of state regulators and the Office of Financial Research. The mix is designed to give a broad view of financial markets.
Its main duties are to identify threats to financial stability, to promote market discipline by making clear that no firm is guaranteed a rescue, and to respond to emerging risks. It publishes an annual report for Congress that reviews market developments and makes recommendations.
The report is a useful summary for anyone who wants an official view of current risks. A distinctive power is the ability to designate a nonbank financial company, such as a large insurer or asset manager, as systemically important.
A designated firm is then supervised by the Federal Reserve and subject to higher capital and risk management standards. The Council can also designate financial market utilities, which are the systems that clear and settle payments and securities, because their failure would affect many institutions.
Because the Council has no staff of examiners, it depends on its members and on the Office of Financial Research, which collects and analyses data. The Council's role is therefore to convene, to analyse and to recommend, and it relies on the individual regulators to act on most findings.
This is why its annual report often reads as a list of risks together with suggested actions for each regulator. The nuance is that how the Council uses its powers has changed over time, depending on the guidance it adopts and the priorities of those in office.
Designations have been made and later removed, and the approach continues to attract debate. Anyone relying on the detail should check the current position.
In practice
Real-world examples.
Example
The Council notices that several regulators are separately seeing growth in a certain type of lending. It brings them together, shares data and publishes a warning in its annual report. Banks and investors use the report when reviewing their own exposures, and risk committees often compare its warnings with their internal stress scenarios.
Example
A large insurer is considered for designation as systemically important. Its finance team prepares detailed information on its size, interconnections and funding to show how its failure would affect the system. The firm's capital planning is affected by the possibility of stricter rules.
Example
A clearing house that settles trades worth billions each day is designated as a financial market utility. It must meet higher risk management and reporting standards. Its member banks monitor the changes because they affect margin requirements.
Case study
Seen in the real world.
Bridgeway Mutual is an illustrative, fictional insurer with $600,000,000,000 in assets. Its chief financial officer was told that the oversight council was reviewing whether the company's failure could threaten the wider financial system.
The finance team spent three months preparing data on its investments, its borrowing and its links to banks. It also modelled the cost of tougher capital requirements, estimating that holding an extra 2% of assets in capital would mean setting aside 600,000,000,000 x 0.02 = $12,000,000,000.
The review concluded that the company was not systemically important, but the work revealed some concentrations of risk, and the firm adjusted its funding. The company's risk committee also used the exercise to improve its reporting of counterparty exposures. The illustrative lesson is that the process can lead to better risk management whatever the outcome.
Watch out
Common mistakes.
- Confusing the Council with a single regulator, when it is a committee that coordinates several regulators.
- Assuming that a firm designated as systemically important is guaranteed a rescue, when the aim is to reduce the need for rescues.
- Treating designations as permanent, when they can be reviewed and rescinded.
Questions
People also ask.
Who chairs the Council?
The Secretary of the Treasury chairs it, and the members include the heads of the main financial regulators.
What is a financial market utility?
It is a system that clears or settles payments, securities or derivatives, and its failure could disrupt many institutions.
Why was it created?
It was created by the Dodd-Frank Act after the 2008 crisis to monitor risk to the financial system as a whole.
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