The Feds Look Hard at Non-Bank Financial Institutions

The Federal Reserve looking determined to continue raising interest rates, at least for the near future. There have been recent tremors in the banking industry when Silicon Valley Bank and Signature Bank were suddenly caught in liquidity-fueled runs. No wonder why federal banking regulators have started to look at how not just banks are working, but non-banks as well.

The Treasury Department’s Financial Stability Oversight Council—the top financial regulators in government—has now turned its eye to non-bank financial institutions and making it easier to determine when they should be considered systemically important. That would bring them under greater levels of regulation. It could also have an impact on sources of CRE financing via private funds and shadow lending.

“Under the Trump administration, financial regulators made it more difficult for the federal government to apply that designation to nonbanks, requiring the panel to first conduct a lengthy review of activities in a potentially risky sector before targeting specific firms,” reported the Wall Street Journal. “Treasury Secretary Janet Yellen has criticized those Trump-era rules as too onerous and potentially allowing risk to fester in the financial system.”

“The designation would hinge on FSOC’s determining that ‘material financial distress at the company, or the nature, scope, size, scale, concentration, interconnectedness, or mix of the activities of the company’ posed a threat to US financial stability,” said the Financial Times.

Moody’s Analytics has estimated that banks only provide 38.6% of CRE lending. Life insurance companies, which are one form of non-bank, are responsible for 14.7% of CRE loans. Another 12.4% are whatever is left after banks, life insurance, asset-backed securities (CMBS and CDO) are considered. That remaining portion would include hedge funds, money market funds, and the overall category of shadow lending.

A new rule proposal revises and updates of some interpretative guidance from 2019 with three major changes. The first is to eliminate a provision that “the Council would first rely on federal and state regulators to address risks to financial stability before the Council would begin to consider a nonbank financial company for potential designation.”

A second change would provide “new public transparency into how the Council expects to consider any type of risk to financial stability, regardless of which of the Council’s authorities may be used to address those risks.”

Third, the elimination of language that required “a cost-benefit analysis and an assessment of the likelihood of a firm’s material financial distress prior to making a determination under section 113.”

According to a Reuters report, Federal Reserve Chairman Jerome Powell told a meeting of the committee: “Overall, I believe that the changes proposed by the Council will create a balanced approach to addressing potential risks to U.S. financial stability and ensure that all the tools available to the FSOC will remain on equal footing.”