Systemic Risk Council to US Treasury: Proposed Reforms Merit Fresh Look

On 19 September, the Systemic Risk Council (SRC), a private sector, non-partisan body of former government officials and financial and legal experts committed to addressing regulatory and structural issues relating to global systemic risk, sent Treasury Secretary Steven Mnuchen comments on the United States Treasury (UST) department’s June 2017 report titled A Financial System That Creates Economic Opportunities: Banks and Credit Unions. The report offered, among other items, recommendations for regulatory reform.

In the letter, the SRC said, “…we believe the UST report includes a number of worthwhile technical reforms and addresses important issues that are largely incidental to stability, but [we are] concerned that some of the report’s main recommendations would jeopardize the resilience of the financial system, the public finances, and the welfare of citizens.”

Although the SRC supports regulatory reform, they urge that such reform should take place within the five core pillars of system resilience. The following are the five core pillars:

• Mandating much higher common tangible equity in banking groups to reduce the probability of failure, with individual firms required to carry more equity capital, the greater the social and economic consequences of their failure;
• Requiring banking-type intermediaries to reduce materially their exposure to liquidity risk;
• Empowering regulators to adopt a system-wide view through which they can ensure the resilience of all intermediaries and market activities, whatever their formal type, that are materially relevant to the resilience of the system as a whole;
• Simplifying the network of exposures among intermediaries by mandating that, wherever possible, derivatives transactions be centrally cleared by central counterparties that are required to be extraordinarily resilient; and
• Establishing enhanced regimes for resolving financial intermediaries of any kind, size, or nationality so that, even in the midst of a crisis, essential services can be maintained to households and businesses without taxpayer solvency support—a system of bailing-in bondholders rather than of fiscal bailouts.

Judged against these pillars, the UST report contains welcomed proposals for improving the functioning of the Financial Stability Oversight Council (FSOC), but is worrying when it proposes the following reforms:

An “off-ramp” from regulation for large firms that have low measured leverage

• Diluting the “supplementary leverage ratio”
• Diluting stress testing of core intermediaries
• Subjecting independent financial regulators to the standard regime for regulatory cost-benefit analysis
• Excluding the FDIC from the supervision of firms’ resolvability.

If there is another major financial crisis over the next 10–25 years, let alone sooner, the likely political backlash would be so great that the basic fabric of our market economy and the system of republican democracy could be in jeopardy. The UST report promotes or gives an airing to proposals that would seriously reduce the resilience of the financial system and expose the public to unnecessary risk and hardship. Implementing them would amount to gambling on the questionable assumptions that loosening the constraints on banking would boost short-term credit growth, and that any such boom would bring benefits to parts of the community that would outweigh the longer-term and economy-wide risks for the nation as a whole.

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