IMF published its staff report under the 2018 Article IV consultation with the United States. Directors noted medium-term risks to financial stability, including those related to high equity market valuations, rising leverage, weakened underwriting standards, and cyber risks. Managing these risks would require high-quality and independent supervision. Directors stressed the need to preserve the current risk-based approach to regulation, supervision, and resolution; strengthen the oversight of nonbank financial institutions; and remain committed to agreed international standards.
Directors also looked forward to further progress in implementing the remaining recommendations of the 2015 FSAP. Annex IV of the staff report details various FSAP recommendations and their status. Out of the 29 recommendations, 5 have not been implemented and the remianing have been either fully or partially implemented. The report emphasizes that important gains have been made in strengthening the financial oversight structure since the global financial crisis and proposals to simplify regulations for smaller financial institutions represent further improvements. Some useful steps toward bettering the financial regulations are underway:
- Legislation has been signed into law to raise the total asset threshold to USD 250 billion for bank holding companies (BHC) to be classified as systemic. This change will help lessen compliance costs for medium-size BHCs but will increase the burden on high-quality and independent supervision to manage financial stability risks. Consideration should be given to continuing to apply stress tests at a regular frequency for banks that have assets between USD 100 and USD 250 billion. Implementation of these changes should be done in a way that does not weaken the ability of supervisors to take early remediation and risk mitigation actions for BHCs with assets below USD 250 billion.
- Modest changes have been made to exclude custodial assets from the calculation of the Supplementary Leverage Ratio, include highly liquid municipal bonds n the definition of High Quality Liquid Assets (subject to limits and haircuts), and exempt BHCs with total assets under USD 10 billion from the Volcker rule. However, care should be taken to ensure that the regulatory framework does not deviate materially from international standards.
- FED and OCC proposed to modify the enhanced supplementary leverage ratio (eSLR) for globally systemic important banking organizations (G-SIBs) to set the ratio at 3% plus a buffer of 50% of the entity’s risk-based capital surcharge. This would make the risk-based capital requirement binding for most G-SIBs. The proposal is more stringent than international minimum standards but would, however, diminish the buffers that have helped increase the resilience of the U.S. banking system.
- The Treasury has argued for changes to the resolution framework to strengthen the courts’ ability to deal with complex financial failures under a new special, streamlined bankruptcy procedure. This new process would complement—but not replace—the existing Orderly Liquidation Authority and more tightly circumscribe the authority granted to the FDIC— including in the use of public money—when it resolves a financial institution. It will be important that this change is implemented in a way that does not limit the flexibility of the resolution regime, hinder rapid action, or complicate cross-border resolution.
- The Treasury has proposed steps to increase the transparency and analytical rigor of the FSOC’s designation process. These include comprehensive cost-benefit analysis and the provision of clear guidance for financial institutions that are designated as systemic. In assessing systemic risks, evaluations would be based on an activity-based framework and designation would be used only as a last resort. These changes have the potential to strengthen the designation process but much will depend on how they are executed. Clarifying the changes to the process and the implementation of those changes should be done at an early stage.
- FED has advanced for comment, a proposal to lessen the compliance requirements for the Volcker Rule. The proposed measures are largely aimed at simplifying the regime, making it easier to enforce, and moving toward a more risk-based standard. Such changes are justified based on the experience to date with the rule but it will be important to carefully monitor the effects of its implementation and to clarify how the revised rule will be enforced and how much latitude banks will have for self-policing.
When each step is taken in isolation, the steps proposed to better tailor financial regulations are likely to have only a modest impact on financial stability risks. Future changes to financial oversight should ensure that the current risk-based approach to regulation, supervision, and resolution is preserved. Risk-based capital and liquidity standards, combined with strong supervision, should remain a central tool in motivating financial institutions to manage well the risks they undertake. In support of these capital and liquidity requirements, the Comprehensive Capital Analysis and Review exercise should be maintained and strengthened, including in its assessment of liquidity and contagion risks. While tailoring is fully justified, a greater burden of managing financial stability risks will be placed on high-quality and independent supervision. FSOC should continue its efforts to respond to emerging threats to financial stability and, in this work, there is scope to strengthen, and more fully resource, the Office of Financial Research. Finally, the U.S. should remain engaged in developing the international financial regulatory architecture and should be fully committed to the agreed international standards.
There remains a need to strengthen the oversight of nonbanks. There are potential weaknesses in oversight arising from the absence of harmonized national standards or consolidated supervision for insurance companies. Also, recent proposals to limit the engagement of federal authorities in international supervisory fora could prove cumbersome for the insurance standard-setting process and the development of the global capital standard. Progress has been made in money market reform but residual vulnerabilities, in repo markets and for money market funds, remain. There is also a need to introduce a comprehensive liquidity risk management framework for asset managers (that includes liquidity risk stress tests). Little progress has been made in reforming the housing finance system or the government sponsored enterprises. Finally, impediments to data sharing among regulatory agencies remain and there are data blind spots, particularly related to the activities of nonbanks, that preclude a full understanding of the nature of financial system risks, interlinkages, and interconnections. Overall, the authorities do not see the banking system as an imminent source of financial stability risk and risks from institutions outside the regulated perimeter are assessed to be moderate (insurance industry, asset management, crypto currencies, and cyber risk).
Related Link: Staff Report
Keywords: Americas, US, Banking, Article IV, Volcker Rule, Proportionality, FSAP, Financial Stability, IMF
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