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1 1 (March 11, 2019)

handle is hein.crs/govygk0001 and id is 1 raw text is: ACongressional SResearch Service Activities-Based Regulation and Systemic Risk Updated March 11, 2019 Past financial crises have shown that systemic risk can emanate from financial firms or activities. It can be caused by the failure of a large firm (hence, the moniker too big to fail) or it can be caused by correlated losses among many small market participants. Although historical financial crises have centered on banks, nonbank financial firms were also a source of instability in the 2007-2009 crisis. The 2010 Dodd-Frank Act (P.L. 111-203) was enacted in response to the crisis. It enhanced the regulation of certain financial firms and activities to reduce systemic risk, particularly prudential regulation administered by the Federal Reserve (Fed) of banks and nonbanks. All large banks would automatically be subject to more stringent standards, as would nonbanks designated by the Financial Stability Oversight Council (FSOC), popularly known as systemically important financial institutions (SIFIs). This approach can be classified as an institution-based approach because it addresses risks to financial stability at the firm level. As discussed in this Insight, all four of the nonbanks that were designated by FSOC have since been de- designated, and the size threshold for enhanced regulation of banks was recently increased. In March 2019, FSOC issued proposed guidance stating it would give precedence to an activities-based systemic risk regulation-regulating particular financial activities or practices to prevent them from causing financial instability-over an institution-based regulation for nonbanks. The two approaches, however, need not be mutually exclusive. International insurance regulation has also moved away from a focus on institution-based regulation and toward activities-based regulation recently. Regulating Firms Versus Activities for Systemic Risk An institution-based approach addresses financial instability that stems primarily from the failure of large, interconnected firms. It particularly could address the experience during the 2007-2009 crisis, when large, complex firms, such as AIG, failed due to unanticipated correlated losses in different activities within a firm (credit default swaps and securities lending, in the case of AIG). An institution-based approach could also address the possibility of a firm failing due to more company-specific issues, such as inadequate internal controls, for example. Congressional Research Service https://crsreports.congress.gov IN10997 CRS INSIGHT Prepared for Members and Committees of Congress