Activities Are Not Enough!: Why Nonbank SIFI Designations Are Essential to Prevent Systemic Risk

Abstract

Since the financial crisis, policymakers have developed two different approaches to systemic risk arising from nonbank financial firms such as insurance companies and investment banks. The first, dubbed an entity-based approach, empowers a public entity like the Financial Stability Oversight Council or Financial Stability Board to designate individual nonbank systemically important financial institutions for enhanced regulation and supervision. The second, known as an activities-based approach, seeks to regulate financial activities that can produce systemic risk.

During the first several years after the crisis, governments and multi-national standard setters embraced both entity- and activities-based approaches to the problem of nonbank systemic risk. More recently, however, an emerging view has begun to dominate financial regulatory circles: that regulators should focus principally on an activities-based, rather than an entity-based, approach.

This book chapter challenges this emerging consensus. It argues that, in the absence of entity-based designations, a purely activities-based approach will expose the financial system to the same risks that the world experienced in 2008. This chapter, which is substantially based on a more detailed law review article by the authors, focuses on the international dimensions of nonbank systemic risk regulation and the shift by multi-national standard-setters to an activities-based approach.

Keywords: Systemic Risk, Financial Stability, Financial Stability Oversight Council, Financial Stability Board, Nonbank Financial Companies, Entity-Based Regulation, Activities-Based Regulation