SIFIs - under control yet?

SIFIs – under control yet?

It’s more than two years since the collapse of Lehman Brothers and the financial crisis that ensued. Richard Willsher asks whether the regulators are any further ahead with reining in the ‘systemically important financial institutions (SIFIs)’ that could threaten the world’s financial system?

What are SIFIs?
This is a simple enough question on the face of it. The Financial Stability Board (FSB), the super regulator coordinating the work of national and international financial regulators and standard setting bodies, defines SIFIs as financial institutions whose ‘…disorderly failure, because of their size, complexity and systemic inter-connectedness, would cause significant disruption to the wider financial system and economic activity’. In other words organisations that are too big to be allowed to fail. But who the SIFIs actually are is a matter of great conjecture and the FSB is keeping its cards close to its chest.

When the Financial Times on 29 November last year reported a list of 30 SIFIs – see list at the end – that included the big banks in the major economies plus six European insurance industry giants, the FSB was not best pleased. A year later the UK Financial Services Authority (FSA) chairman and FSB member Adair Turner said in a speech to insurance regulators in Dubai that the FSB did not believe insurance firms should be on the list because they didn’t pose systemic risks like the big banks. The FSB says it will issue its list of SIFIs next year.

So where are we now?
The Seoul summit, according to a letter to G20 leaders from FSB chairman Mario Draghi, marked ‘...the delivery of two central elements of the reform programme… to create a sounder financial system and reduce systemic risk globally’. These were ‘a materially strengthened global framework for bank capital and liquidity, and a comprehensive policy framework to address the moral hazard risks associated with institutions that are too big (or complex) to fail.’

The first of these was the Basel III framework produced by the Basle Committee on Banking Supervision of the Bank for International Settlements (BIS). It sets out recommendations for increased capital and liquidity buffers for central banks to implement with the banks under their supervision.

These are due to start to be implemented on 1 January 2013 and the process completed by 1 January 2019. In the meantime there is almost daily a report from a bank or banking representative organisation or pressure group or commentator arguing that Basel III will have damaging effects on one bank or another or on the business that banks will able, or inclined, to undertake. In terms of ‘delivery’ at Seoul the acid test will be what happens if there is a threat to a SIFI between now and 2019? Moreover, what if the threat did not arise from the same banking problems that caused the 2008 crisis?

The idea of addressing the moral hazard element of the reform programme is that ‘too-big-to-fail’ institutions should not in future be bailed out by the taxpayer. The FSB has come up with a five-point action plan:

  * ‘improvement in resolution regimes’ which means having a bailout contingency plan to sort out the mess without damaging the financial system and without turning to the taxpayer
  * an even more stringent set of rules than Basel III for SIFIs, so that they can absorb losses and which reflect the risks that they pose to the global financial system
  * tighter national supervision of SIFIs
  * stronger standards for core national financial infrastructures that can prevent knock-on effects of the failure of individual institutions
  * a ‘peer review’ to be carried out by the FSB to ensure ‘effectiveness and consistency’ of national regulatory measures to start by the beginning of 2012.

National and international regulation and supervision
One of the key problems facing the FSB and the other supra-national bodies such as the BIS and the International Monetary Fund is ‘the weakest link’. Unless all governments and their regulators use the same standards and degree of stringency in their supervision there will be a risk that a particular institution in a particular jurisdiction may trigger a domino effect should it be stressed or fail. Moreover, a weak supervisory or regulatory environment may result is so-called ‘regulatory arbitrage’ where financial institutions may spot loopholes they can exploit for their greater profit. For this reason internationally coordinated super-regulation is the goal.

But it is not an easy one to achieve. There are some, for example in the USA, who criticise the FSB for being unelected and dominated by European banking representatives. They argue for greater autonomy for US financial institutions, which ought to set alarm bells ringing in light of the manner in which the sub-prime crisis came about and was led by US investment banks creating risk capacity by selling toxic debt packages to the world’s banks and other investors.

For this reason perhaps, another key plank in the FSB’s action plan is to reduce the dependency on credit rating agencies. According to the Draghi letter, ratings are ‘hard wired’ into the debt markets such that when a rating agency changes a rating it produces ‘mechanistic market responses’. This is regulator speak for herd behaviour, which may lead to over reactions and panics in the markets.

In the elliptical way that the dialogue between regulators and politicians about regulating the financial system seems to work, the FSB has made its set of recommendations to the G20 leaders and they have accepted them. The process of regulating the financial system in order to avoid a future Armageddon is grinding on but it is long way from being concluded.

Indeed it may never be; new risks and perils are certain to arise, which will need to be addressed as they occur. The SIFIs are core to the entire financial system and how to tackle and control them is still the subject of debate and, in large measure, experimentation. It has taken two years so far and the chances that the world financial system can ever be made shatterproof, let alone by 2019, still hangs in the balance.

Richard Willsher is a freelance journalist

30 possible SIFIs

Banks
US
Bank of America Merrill Lynch
Citigroup
Goldman Sachs
JPMorgan Chase
Morgan Stanley

Canada
Royal Bank of Canada

UK groups
Barclays
HSBC
Royal Bank of Scotland
Standard Chartered

Switzerland
Credit Suisse
UBS

France
BNP Paribas
Société Générale

Spain
BBVA
Santander

Japan
Mitsubishi UFJ
Mizuho
Nomura
Sumitomo Mitsui

Italy
Banca Intesa
UniCredit

Germany
Deutsche Bank

Netherlands
ING

Insurance groups
Aegon
Allianz
Aviva
Axa
Swiss Re
Zurich

This list appeared in the Financial Times on 29 November 2009