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October 26, 2017

OFR published a Viewpoint paper examining the use of a multifactor approach to identify the systemically important banks. The paper argues that a multifactor approach is superior to considering size alone in determining systemic importance.

U.S. bank regulators often use asset-size thresholds, assuming that larger banks pose more risks than smaller banks. An alternative approach, used to identify global systemically important banks (G-SIBs), relies on multiple measures, not just size. Analysis suggests that using such a multifactor approach to identify non-G-SIB U.S. banks for enhanced regulation—one focused on systemic importance—would be an improvement on the asset-size thresholds now used. For large banks that are not G-SIBs, asset-size thresholds are too simplistic to assess systemic importance. For this second tier of banks, a modified version of the G-SIB multifactor approach could help determine the appropriate level of enhanced regulation. European regulators are taking such an approach, a more nuanced way to identify how to subject the banking operations of non-G-SIBs to enhanced standards.

The paper emphasizes that modifications would be needed to overcome two shortcomings of the multifactor approach. The first shortcoming involves substitutability. The current G-SIB approach may understate the systemic importance of some banks that provide critical services. The regulation establishing extra capital surcharges for U.S. G-SIBs either caps or eliminates substitutability measurements. Although the Basel Committee has proposed some modifications, these changes still do not address the concentration of critical services in a bank that substitutability indicators need to capture. More work on substitutability indicators is needed. The second shortcoming is that the existing multifactor approach may understate the risks posed by the U.S. operations of some foreign G-SIBs. The operations of foreign banks’ U.S. branches and agencies are not required to disclose systemic importance indicators annually on the FED Form Y-15, even though some of these firms’ footprints and operations are significant. Some foreign G-SIBs have U.S. intermediate holding companies and branches, but the combined risks of these operations are considered in only one regulation implementing enhanced prudential standards.

 

Related Link: Viewpoint Paper (PDF)

Keywords: Americas, US, Banking, G-SIB, Systemic Risk, Multi-Factor Approach, Viewpoint Paper, OFR

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